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Community Banks: Strengthening the American Economy, One Community at a Time Executive Summary Community banks are essential to the American economy. These institutions, generally defined as having under $10 billion in assets, act as primary lenders to the small businesses, farms and real estate transactions that create jobs and fuel prosperity for millions of Americans. 1 These small institutions provide the low-cost banking, community support and financial education that larger institutions might not. Deeply embedded in the areas they serve, community banks serve as economic lifelines for their local economies during periods of financial stress, most recently during the Great Recession of 2008-2009. Vital contributors to the nation’s economic resilience, their strength and stability have an almost incalculable impact on the lives of millions of Americans. In this white paper, we examine the unique role of community banks in the U.S.; their critical importance to small businesses, especially during recessions; and the burdens that the Dodd-Frank Act and other regulations are placing on their institutional strength and survival. Finally, we consider how community banks will be able to continue driving growth in the American economy going forward. How Community Banks Support the U.S. Economy The U.S. banking system is comprised of several Community banks, on the other hand, have very large banks as well as many relatively small focused more on relationship banking, basing their community banks. This banking structure emerged decisions on personal knowledge of customers’ from a legal framework that, in the past, restricted creditworthiness and a keen understanding of banks’ abilities to diversify geographically. The business conditions in the communities they serve. institutional structure of our system, in turn, Indeed, most community banks are chartered to reflected a longstanding concern in the U.S. about serve their communities, providing services to local the risks of concentrating banking power in a few residents that range from financial education for very large institutions located far from the the unbanked to community redevelopment loans. 2 customers they serve. In this way, the bifurcated banking system has The bifurcated framework of the U.S. banking served the needs of a diverse U.S. economy system has encouraged large banks to become composed of businesses of all sizes and complex organizations engaged in a wide range of consumers with varied needs. Large and small activities. They provide a variety of services to their banks together create the backbone of our customers, generally relying on hard financial complex economy – they are both vital to our information, computer models and centralized ongoing strength and stability. decision-making as the basis for conducting business. 3 The Relationship Between Community Banks and Small Businesses The activities of community banks stand in sharp contrast to those of the very large banks. During the second quarter of 2014, the FDIC recognized 6,163 community banks, representing 93 percent of all FDIC-insured institutions, that were responsible for assets totaling $2.0 trillion, or just Known as “America’s favorite lenders,” community 13 percent of industry assets. However, these banks play a central role in financing and community banks accounted for 45 percent of strengthening local economies by making loans small business loans. 6 that support farms, residential and commercial real estate activities, and small businesses. These Examined another way, the big banks that control services are especially important in rural areas, 87 percent of all the money in the banking system where community banks account for 58 percent of only account for 55 percent of small business all banking offices and 49 percent of all deposits. loans. As suggested by these numbers, big banks 4 7 don’t carry their weight when it comes to small business lending. Their business models focus more on completing profitable transactions than Community banks account for on developing long-term relationships with small 58% of all banking offices 49% of all deposits business clients. Local enterprises know that the community bank will reliably provide access to the capital they need to grow their businesses and hire more workers. Big banks control 87% of all the money in the banking system While community banks account for a smaller portion of urban banking activity, they play an important role in smaller metro areas. In metro AND areas with less than one million people, for example, community banks operate 31 percent of all banking offices and control 23 percent of all deposits. 5 only account for 55% of small business loans Community banks were lifelines to small businesses during and after the crisis. What Role Did Community Banks Play in the 2008 Financial Crisis? Instead, community banks were lifelines to small businesses during and after the crisis, offering loans at the local level when lending restrictions were tightening. Between 2008 and 2010, community banks’ share of outstanding small business loan balances jumped nearly 2 percent, The financial crisis of 2007-2008, followed by the but megabanks’ (with more than $100B in assets) 10 Great Recession, was the worst economic disaster share decreased by nearly 2.5 percent. since the Great Depression of 1929. The crisis was down further, in 2010, the smallest community largely caused by the risky practices of mortgage banks—those with less than $1B in assets—held 38 lenders and the packaging of bad loans by Wall percent of small business loan balances, while Street firms. megabanks held just 27 percent of such loan 8 Drilling 11 balances. While the too-big-to-fail megabanks Community banks, however, were not implicated in pulled back on their lending in many parts of the and did not contribute to the causes of the country, community banks continued providing financial crisis. They were not involved in much-needed credit to keep their local economies widespread subprime lending. They did not take afloat. part in the securitization of subprime residential mortgages, nor did they use derivatives to engage As Governor Daniel Tarullo of the Federal Reserve in risky speculation to maximize return. Board noted in a 2009 speech, the importance of 9 traditional financial services – like those provided by community banks – “tends to increase” in times Share of Bank Small Business Loans Outstanding by Organization Asset Size 6/30/2008 40.0% 35.0% 34.7% 6/30/2009 12 of crisis. In fact, many community banks fared well, by comparison, during the crisis because of their personalized, relationship-based business 12/31/2010 13 model. 35.5% 36.2% 29.4% 30.0% 27.4% 27.0% 25.0% 19.6% 20.0% 20.2% 20.0% 16.3% 16.8% 16.8% 15.0% 10.0% 5.0% 0.0% Less than $1B $1B-$10B $10B-$100B More than $100B When inflexible regulatory pressures, rather than consumer preferences, lead to consolidation, risks to the banking system inevitably rise. Dodd-Frank and its Effects on Community Banks The laws and regulations taken to address the The effects of the new regulatory burdens on financial crisis and meant for large banks had community banks have been severe and include a unintended consequences for community banks. growing number of mergers, acquisitions and Most significantly, in January 2010, Congress closings. The number of community banks (those passed the Dodd-Frank Wall Street Reform and with less than $10 billion in assets) shrank 14 Consumer Protection Act. percent between Dodd-Frank’s passage in 2010 15 and late 2014. Compliance and staffing costs have The twin goals of Dodd-Frank were to ensure the exploded during that time, placing additional stability of the financial system and to protect stresses on small banks. The Banking Compliance consumers from reckless actions undertaken by Index showed that the average community bank in 14 too-big-to-fail banks. Yet community banks are, by the fourth quarter of 2016 required 2.16 additional definition, too small to destabilize the financial full-time employees just to manage the regulatory system. In addition, the business model employed changes and enforcements introduced in that by community banks has served to protect 16 quarter alone. consumers. For example, community banks have far different incentives in underwriting loans than Similarly, a 2013 survey revealed that more than a mortgage originators like Countrywide or huge quarter of small banks anticipated engaging in a institutions like Citibank. Their success – indeed, merger or acquisition in the near future, which their survival – depends on the repayment of the would further reduce the number of small banks. loans on their books and the continued goodwill When inflexible regulatory pressures, rather than and loyalty of their customers. consumer preferences, lead to consolidation, risks 17 to the banking system inevitably rise. Where Community Banks Stand Today The tide of consolidation among community banks continues unabated. In 2016 alone, there were 62 fewer community banks in the second quarter of the year than in first quarter, with two bank failures. Community banks also continue to incur 18 significant compliance costs that place them at a further competitive disadvantage to large banks. 19 The Stakes for Community Banks, and the Nation And small businesses and individuals that do not fit neatly into standardized financial modeling, or who live outside of the metropolitan areas served We must reexamine the assumption that bigger, by larger banks, are likely finding it more difficult to more standardized banks benefit consumers. Until obtain credit. we do so, we will continue to undermine the customization that is one of the signature 62 Q1 strengths of the community banking model. fewer community banks in the 2nd quarter of 2016, with 2 bank failures. Countless small business owners and employees thrive because their local financial institutions are as rooted in the community as they are. Q2 If the number of community banks continues to shrink, through failures and mergers, we will see an increased consolidation and continued growth These issues matter because the Americans who of too-big-to-fail banks. If that occurs, the risks are most count on the local presence of these clear: since recessions are cyclical, today’s strong institutions are the ones most likely to pay the economy will eventually slide into a downturn. It is price for their consolidation today, and in the next only a matter of time before some version of the recession. However, much of this consolidation has Great Recession repeats itself. When that occurs, been confined to banks with less than $100 million the engines of small business will need reliable in assets. Community banks with assets between financing to keep their regional economies running $100 million and $10 billion are actually outpacing until a national recovery can be engineered. 20 their giant competitors. But if the nation at that time has a limited number Just looking at the second quarter of 2016, local of local banks embedded in and responsive to their financial institutions made $300.7 billion in small communities, those businesses will have fewer loans to businesses, up $3.9 billion (1.3 percent) sources to turn to for financing and support. from the first quarter. Community banks continue Forcing large institutions to bear the costs of the to hold 45 percent of small loans to businesses: in risks that they create, while taking steps to reduce Q2 2016, for example, they increased their small the burden of regulation on community banks, are loans to businesses by $9.5 billion, or 3.2 percent, measures that would help ensure the continued a robust improvement over the 2.8 percent growth viability of the community banking model. And at non-community banks. they are steps that should be considered well in 21 22 advance of the next recession. Looking Forward We live in a world where institutions like Amazon.com and Citibank dominate the market by exploiting economies of scale that local businesses can never hope to approach. But that doesn’t mean our communities are better and stronger as a result. People live and work locally. They create families, buy homes and start businesses locally. For local communities to thrive, they need the support and resources that only local banks can provide. Small banks today face the threat of consolidation and failure just when Americans need them to be accessible, efficient and responsive. For these institutions to remain relevant, community bankers must double down on their commitment to supporting the communities they serve. And political leaders need to recognize that dismantling small banks places consumers, small businesses and the overall economy at significant risk. The health of our local economies is the health of the nation, and small banks are essential elements to any plan for a prosperous future. We need these vital institutions to be strong and we need them local. References 1 https://www.fdic.gov/bank/analytical/qbp/2016jun/qbp.pdf 2 https://www.kansascityfed.org/Publicat/econrev/Pdf/2q03keet.pdf 3 http://citeweb.info/20030393384 4 https://www.kansascityfed.org/publicat/econrev/Pdf/2q03hoen.pdf 5 Ibid 6 http://www.sbc.senate.gov/public/?a=Files.Serve&File_id=66534743-2c4d-4ee8-9af2-6aec737dc7d8 7 Ibid 8 http://www.heritage.org/research/reports/2008/04/the-subprime-mortgage-market-collapse-a-primer-onthe-causes-and-possible-solutions 9 http://www.oba.com/usr_uploads/doddfrankimpact.pdf 10 ICBA analysis of Call Report data obtained from the FFIEC and FDIC Statistics on Depository Institutions. 11 Ibid 12 https://www.federalreserve.gov/newsevents/speech/brainard20150930a.htm 13 https://www.americanbanker.com/opinion/fasb-chief-is-dead-wrong-on-small-banks-role-in-crisis 14 https://www.whitehouse.gov/economy/middle-class/dodd-frank-wall-street-reform 15 https://www.mercatus.org/publication/small-banks-numbers-2000-2014 16 http://info.continuity.net/bci 17 https://www.mercatus.org/publication/how-are-small-banks-faring-under-dodd-frank 18 https://www.fdic.gov/bank/analytical/qbp/2016jun/qbpcb.html 19 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2302392 20 https://www.whitehouse.gov/sites/default/files/page/files/20160810_cea_community_banks.pdf 21 https://www.fdic.gov/bank/analytical/qbp/2016jun/qbp.pdf 22 Ibid