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FDIC Banking Review
The Future of Banking in America
Community Banks: Their Recent Past, Current Performance, and Future Prospects
Tim Critchfield, Tyler Davis, Lee Davison, Heather Gratton, George Hanc, and Katherine Samolyk*
The U.S. banking system has long had a multitude of small institutions. This characteristic of the industry has been shaped by a number of factors. The dual banking system—that is, the coexistence (since the end of the Civil War) of both federal and state chartering—has fostered the creation of small banks, and this effect was reinforced by chartering regulations at both the national and state levels that were frequently permissive. In addition, the fear of concentration, as well as efforts to keep local markets free of outside competition, led many states to impose longstanding limits on branching, and this legacy of unit banking helped swell the numbers of small banks, particularly in the Midwest. The lack, until fairly recently, of the technology necessary for creating very large banking organizations was another factor contributing to the multiplicity of small banks. Of course, during the last quarter of the twentieth century the requisite technological advances occurred at the same time that legal impediments to branching were being gradually removed. Thus, for the last decade of the century in particular, the industry saw a great deal of consolidation, much of it involving community banks, whose numbers fell significantly.1 (See table 1.) Moreover, community banks' shares of deposits, assets, and offices have fallen steadily and significantly since 1985. (See table 2.) Given these trends and the oft-cited notion that such small banks are destined to disappear, victims of their inability to compete with larger institutions, one might ask why the future of community banks is of interest.
Table 1 - Number of FDIC-Insured Community Banks, 1985-2003
Table 2 - Shares of Banking Industry Assets, Deposits, and Offices, 1985-2003
One reason is that although the number of community banks (those with less than $1 billion in assets, a definition explained on the next page) has decreased, thousands of such banks remain: at year-end 2003 community banks constituted 94 percent of all banks in the nation. Thus, by this criterion, what happens to these banks is not insignificant. Another reason is that from an economic viewpoint, these institutions remain very important in specific business and economic sectors, notably small-business and agricultural lending. Small businesses play a critical role in the U.S. economy as a whole and in economic growth in particular, so their ability to find credit—and where they find it—is of consequence. Some observers have expressed concern that a continued banking industry consolidation that significantly diminished the number of community banks serving small-business and agricultural lending could leave the credit needs of such businesses unmet (although evidence as to the validity of this concern is mixed).
The future of community banks is worth examining from a third viewpoint as well—that of deposit insurance. Community banks' prospects are of significant interest to the FDIC because small-bank failures have represented a disproportionate share of FDIC losses in recent years; between 1998 and 2002, for example, community banks with 63 percent of failed-bank deposits accounted for approximately 72 percent of the FDIC's failure costs.2 Many of these failed small banks experienced at least some period of very high growth within five years before failure, and some of the failed community banks, whether through new ownership or a change in business plan, had adopted rapid-growth, high-risk policies, which resulted in high resolution costs when the institutions failed. Such a rapid transformation of a bank's risk profile is rarer in the case of a large bank.
A community bank can be defined in different ways, but size is usually the determining factor. These banks are generally thought of as relatively small institutions that do most of their business within a fairly circumscribed geographic area. For the purposes of this article, community banks are defined as banking organizations (bank and thrift holding companies, independent banks, and independent thrifts) with aggregate bank or thrift assets of less than $1 billion; in addition, bank asset-sizes are calculated using assets measured in 2002 dollars.3 Some studies may not include thrifts, but if thrifts and banks can be viewed as competitors, it is logical to include both kinds of financial organizations. However, it must be noted that some analyses in this article, particularly those examining earnings and performance, require the exclusion of de novo banks (defined here as banks less than five years old) because during the early years of a bank's existence, earnings and growth are atypical. In addition, because of historical differences between banks and savings institutions, certain analyses of performance and balance sheets treat commercial banks separately from savings institutions.
This article first explores some of the more significant characteristics of community banking, examining the importance of community banks in small-business lending in terms of their ability to handle "soft" data, their tendency to rely on retail deposits for funding, and their emphasis on personal service. The tremendous consolidation that community banks have experienced has already been mentioned, and the second section of the paper investigates the decline in community bank numbers from 1985 to 2003, analyzing both the nature (failures, mergers, and new banks) and the geographic distribution of the decline. Was consolidation more pronounced in formerly unit-bank states than in other areas? How did consolidation differ between large metropolitan, small metropolitan, and rural areas and between growing and declining markets? This section also examines changes in the presence and the importance of community banking in different types of local deposit markets. Having examined changes in community bank presence, we turn our focus to these banks' balance sheets, business lines, and performance. Where has community banks' share as lenders suffered, and where have these banks held their own? Have the characteristics of community bank funding changed? How have community banks performed, both compared with larger banks and within their own ranks? How has community bank performance been affected by growth in the markets in which community banks are present? The article ends with some discussion of the prospects for community banks in light of their competitive strengths and the challenges facing them.
The Economic Role of Community Banks
Although the number of community banks has declined over the past 20 years, the performance of these banks and the fact that their numbers remain high confound predictions of their virtual demise—predictions made just a few years ago. For example, in 1997 one bank analyst predicted that the industry would consolidate at a rate of 300 banks per quarter, with a total of less than 1,000 banks remaining. A 1996 prediction held that consolidation would mean the United States would have "well under 5,000" banks just four years later; much of this decline would obviously have involved community banks.4 Such prognostications are, of course, often inaccurate. It should be noted that this view was not universally shared. As early as 1991 former FDIC Chairman William Isaac believed that consolidation did not pose a danger to well-run community banks; in 1996 Alan Greenspan was quoted as stating that those who were predicting the end of the community bank were "just plain wrong"; and by 1997, others were predicting (rightly) that the decline in small-bank numbers was slowing dramatically.5
Since community banks have not vanished, it appears that many of them must be doing something right; moreover, the formation of significant numbers of new community banks since 1992 (to be discussed in greater detail below) demonstrates that these banks are perceived to be viable. Researchers have therefore sought to determine just what the "something right" is and whether it will continue to be important. That "something" is strongly related to community banks' economic role, and three areas of that role will be discussed here: community banks' success in providing credit to certain business sectors, their ability to attract retail deposits, and their capacity to build on the provision of personal services to their customers.
One of the more significant elements of community banks' economic role is their function as providers of credit: they serve important segments of the business-loan and farm-loan markets. Although overall their share of small-business loans (loans of less than $1 million at origination) has declined during the past decade, they still provide almost a third of all small commercial and industrial loans and more than 40 percent of small commercial real estate loans. They are even more important as farm lenders, providing 65 percent of all farm real estate loans, 61 percent of all farm operating loans, and roughly 75 percent of small farm loans (loans of less than $500,000 at origination) reported on bank balance sheets. A detailed examination of community bank lending is presented below in the section "Community Bank Industry Shares, Portfolios, and Performance."
Much recent literature has identified the strength of community banks in these areas as stemming from their ability either to successfully lend to what have been variously described as "informationally opaque" borrowers—borrowers without long credit histories suitable for credit-scoring or other model-based lending practiced by large banks—or to engage in relation- or reputation-based lending or lending in low-volume markets. As a recent article notes, "large hierarchical firms are at a comparative disadvantage when information about individual investment projects is innately soft."6 Soft data include a borrower's character or ability to manage, and this information is generally gleaned through a local presence and personal interactions with borrowers; also thought to be helpful is a favorable organizational structure (close proximity of lending officers to management).7 In contrast, large banks prefer hard data (e.g., credit history, income, debts, and other data available from financial statements and credit reports) and are less willing to lend to "informationally difficult credits."8 With the ability to process the soft data, community banks are thought to have certain comparative advantages in lending to informationally opaque borrowers, and these advantages are helpful in underwriting and monitoring loans to small businesses and farmers. Empirical support for this view is provided by a recent study that found that small banks earn higher risk-adjusted returns on business loans than large banks; the study concluded that small banks make "better choices" in lending to businesses.9
Community banks have also been defined by their tendency to rely more on retail and insured deposits for their funding than large banks have done. A recent study notes that at year-end 2002, community banks "held 24 percent of deposits [as a percentage of deposits at all banks] in accounts of $100,000 or less, but only 15 percent of deposits in accounts over that amount."10 Given this emphasis, it is not surprising that community banks usually charge lower fees for deposit services.11 In 2002, the Federal Reserve Board found that, on average, small institutions charged lower fees than large banks. For example, the average annual fees charged by large banks for simple passbook accounts were 72 percent higher than those charged by the smallest banks, and the average stop-payment fee was 38 percent higher at large banks than at the smallest banks.12 It should be noted, however, that the fee advantage held by smaller institutions, though still present, has been declining; the decline may indicate that small banks are seeking to exploit fee income somewhat more than they have in the past.13 Community banks, because they rely on retail deposits and need to attract them, also appear to pay higher rates on retail deposits than large banks competing in multiple markets.14 Paying the higher rates has been feasible because surviving small banks have been able (until very recently) to earn a higher rate of return on their assets, maintaining profitability even while growing more rapidly than large banks during nearly the past two decades.15
A third significant element in community banks' economic role is the manner in which they interact with customers. Although advances in information technology, such as the Internet, have enabled many customers to transact banking business without having recourse to a bank's premises, there apparently remain customers who prefer face-to-face contact. Community banks have typically seen personal service as their most important competitive advantage, and they market personal service and local connections to prospective customers. Many community banks seek to demonstrate this service by being active in their communities. For example, a significant percentage of community bankers responding to a recent survey noted that they participated in civic groups, worked with local chambers of commerce, supported local schools, assisted local relief efforts, and offered special help to low-income segments of the community.16 Recent research has shown that the formation of new banks is strongly correlated with mergers that shift "ownership away from small organizations or toward distant organizations"; one explanation for this correlation is that large organizations tend not to adequately serve "small, relationship-based" customers. The new institutions may be finding a market in providing for the needs of customers to whom the business methods of larger banks are unsatisfactory.17
Anecdotal evidence supports the view that small banks can attract such customers. In a recent Federal Reserve System survey of community bankers, respondents commonly noted that because of their local knowledge and personal service, they were able to draw business away from larger institutions. They also reported that some community banks experienced significant asset growth in the wake of recent acquisitions of other community banks by large institutions.18 Another indication of the "personal-service" phenomenon is large banks' efforts to emphasize personal service even though their comparative advantage would seem to be in mass-market lending based on hard data (credit history and other objective indicators of risk).19 Whether face-to-face contact will continue to be as important is a subject dealt with below.
Consolidation and the Geography of Community Banking
There is some concern that the economic role played by community banks has diminished. Their presence has clearly declined as the banking industry has been transformed into one composed of fewer, larger institutions. Changes in community bank presence can be measured in a number of ways. Two approaches are used here. One is to examine the components of change (mergers, failures, and new banks) between 1985 and 2003 in different types of markets (rural, small metropolitan, and large metropolitan [and, within the last, urban and suburban] as well as in markets experiencing population growth and population decline) and under different past restrictions on branching. The other approach used here is to analyze changes in community banks' shares of deposits and deposit-taking offices across the same types of markets also between 1985 and 2003. Both approaches allow us to see if there were kinds of markets or states where, in the face of consolidation and competition, community banks fared better or worse than they did in other markets or states.
Changes in the Number of Community Banks
Before exploring the consolidation that led to the decrease in community bank numbers, we examine the positive side of the ledger—the formation of new banks—because trends in their establishment have implications for the future of community banks. New-bank formation fell into three periods: the first, from 1985 to 1990, corresponded with a relatively permissive chartering environment and saw considerable numbers of new banks formed (though formations dwindled as the period drew to an end);21 the second period, from 1991 to 1995—from the last part of banking crisis through the beginning of the industry's recovery—had few new banks; and the third period, from 1996 to 2003—as the industry thrived and consolidation created new opportunities-once again saw significant numbers of new banks. (See table 1.)
The substantial number of new banks confirms that many investors believe the community bank model remains viable, at least where local economies are growing. Since 1992 there have been approximately 1,250 new community banks, of which about 150 have been merged and about 1,100 still exist as independent organizations.22 This market test is impressive testimony on behalf of viability, even though some of these de novos developed substantial risk factors as they matured. Young banks, because they have tended to locate in rapidly growing markets and because they have concentrated more heavily on real estate lending, are substantially more vulnerable to serious real estate problems than their established counterparts.23
In the 1980s new institutions did not fare well, but institutions formed in the 1990s can be expected to do better. First, newly chartered banks now face more stringent supervision.24 Second, in 1991 the FDIC obtained separate statutory authority to approve deposit insurance for national banks;25 previously approval had been automatic. Third, new banks in the 1990s might have been able to tap more experienced management than new banks in the 1980s because in the 1990s many de novo banks were formed in the same geographic areas where there had been merger activity. Thus, the supply of locally available bank management personnel would have increased.26 Fourth and most important, serious regional recessions comparable to those of the 1980s have been absent.27 Only 4 of the approximately 1,250 new community banks established between 1992 and 2003 have failed.
Although new-bank formation has been significant, the effect of consolidation on the community bank population far outweighs it. There were essentially two components to the decline: mergers and failures. Throughout the entire period 1985–2003, mergers accounted for most of the decrease in the number of community banks; failures were significant as well, but (not surprisingly) were almost completely confined to the years of industry problems—the years before 1993.28 This consolidation, coupled with the lifting of structural restrictions and the frequent expression of belief that community banks were doomed to vanish, might have seemed to augur great geographical disparities in the landscape of community banking (even aside from the sheer decrease in numbers).
As we began our investigation, it seemed likely that further examination of the decrease in community bank numbers might help explain why the number of community banks had been halved. We explored two logical explanations for the decline: (1) that the removal of interstate branching restrictions likely played a significant role, and (2) that community banks located in markets having differing economic prospects would have experienced differential declines in numbers. (We analyzed four market segments: rural markets, small metropolitan markets, and suburban and urban parts of large metropolitan markets.) Both analyses, however, yielded surprising results and demonstrated that neither of these explanations was persuasive; the declines were, in fact, proportionally similar no matter how the pie was sliced. (See figure 1.)
To examine the hypothesis that, with the removal of branching restrictions, formerly unit-bank states would have witnessed a disproportionate decline in community bank numbers, we compared 12 such states with the rest of the country.29 We found that community bank numbers declined by 53 percent in the unit-bank states and by 46 percent in the non-unit bank states. The unit-bank states contained 42 percent of community banks in 1985 but still had 39 percent of them in 2003. This decline in share stemmed largely from less new-bank activity and proportionally more failures in the unit-bank states.30 These relatively small differences fail to suggest that unit-banking laws had artificially maintained high numbers of community banks, and it is hard to argue, at least from experience, that by virtue of their previous banking statutes these states will see greater consolidation in the future. However, since many of the unit-bank states are predominantly rural and since banks in rural areas have been comparatively less attractive as merger targets, it may be that not enough time has passed for consolidation to occur.
An examination of community bank presence in different types of markets yielded a similar picture-one of proportional stability in the community bank population.31 There were significant declines of 46 to 52 percent in all types of markets (figure 1), but the differences in the percentage changes of community banks in each type of market between 1985 and 2003 were small. However, there have been significant differences in the dynamics underlying the declines in the number of community banks. Rural areas saw proportionally fewer mergers and very little de novo entry in comparison with both small metro and large metro areas, and the largest amount of merger and de novo activity took place within large metro areas.32 When we extended our analysis to community banks in both growing and declining markets, we saw similar patterns. Predictably, the overall drop in the number of community banks was less in growing markets than in declining markets. Also predictably, particularly in all three types of metropolitan markets, mergers and new banks were far more numerous in areas of growing population than in areas of declining population.33
The other article in this issue of the Banking Review notes that many banks are located in rural areas with declining populations, and that long-standing trends in farm depopulation and consolidation have led to economic decline in many of these areas-most notably in the Great Plains states. Despite depopulation and its attendant economic effects, however, reductions in the number of banks even in areas experiencing the most profound depopulation mirrored the reductions in rural areas across the country. The long-term effects of depopulation, coupled with a lack of succession plans at closely held community banks, may eventually lead to problems with the survival of community banks in those states.34 Thus far, however, these banks have not performed badly, and predicting with confidence how quickly consolidation will occur in these areas as a result of such long-term processes—and how much of it there will be—is difficult.
It is, however, worth noting that community banks in the Great Plains represent only about 13 percent of all U.S. community banks. And not all rural areas are declining; some are growing because of high birth rates and high immigration. During the 1990s, the rural West grew by 20 percent—twice the national average. The overall population in the 343 rural counties in the Western Census Region increased by about 27 percent from 1985 to 2001; only just over a quarter of those counties experienced population decline, whereas the remainder saw their populations expand.35 Furthermore, many rural areas are no longer dominated by agriculture. Indeed, the U.S. Department of Agriculture finds that in seven out of eight rural counties the economy is now dominated by manufacturing, services, and other employment not related to farming. Even within agricultural areas, future job growth is more likely to come from industries related to farming than from farming itself.36 The performance of, and prospects for, banks located in rural areas that are not experiencing depopulation are likely to mirror those of similar-size banks in urban areas.
Community Bank Presence in Local Deposit Markets
Community banks' share of the deposits held in all types of local markets certainly declined between 1985 and 2003. The largest decline was in the urban parts of large metro markets, where the community bank share was halved; in other types of markets, decreases in community bank market shares were proportionally smaller (see table 3). Moreover, these changes in community bank market shares understate the extent to which surviving community banks have actually maintained their competitive position in the face of local consolidation activity. In other words, given the shift that has taken place toward fewer, larger banks, one would have expected to see even greater declines in community bank market shares than have actually occurred. Indeed, when we net out changes in deposit share that are due to the reclassification of banks into larger-size categories (because of subsequent mergers, acquisitions, or asset growth), we find that the remaining community banks have been increasing their deposit shares; this is particularly true in small MSAs and suburban areas of large MSAs.
Table 3 - Changes in the Distribution of Domestic Deposits by Type of Geographic Area, 1985-2003
It is also instructive to look at changes in the extent to which the different size categories of banks have any deposit-taking presence (i.e., the extent to which they report any deposit-taking offices) in local banking markets. The 25 largest banking organizations were those best positioned to expand their geographic reach. In 1985 they reported having offices in roughly half of large urban areas, in 40 percent of small MSAs, but in only 11 percent of rural counties. Midsize banks had deposit-taking offices in practically all metropolitan markets but in fewer than half of all rural counties. Hence, as recently as the mid-1980s, a significant number of rural banking markets were served entirely by community banks. By mid-2003, the 25 largest banks had increased their deposit-taking reach to more than 45 percent of rural markets and almost all urban markets. Of course, the widening reach of the very largest banks is not surprising, for they tended to be the banks most constrained by the branching restrictions that were lifted during the period.
Like measures of deposit market share, the relationship between bank consolidation and the geographic scope of banking offices yields information about the nature of consolidation activity at the local-market level. Between 1985 and 2003, the number of rural markets where community banks reported having any deposit-taking offices declined; but given the consolidation that has taken place, one would have expected this decrease to have been much more pronounced. Conversely, the very largest banks have increased the number of rural markets where they have deposit-taking branches; but in many of the rural markets where they acquired a branching presence they have not maintained it. Rather, the data suggest that other community banks entered markets where a community bank presence had been lost because of merger activity.
These patterns in local deposit markets indicate that changes observed in community bank presence understate the extent to which surviving community banks are actually prospering. Adjusting for reclassifications in size category due to acquisition activity or asset growth, we find that despite experiencing market share declines, community banks—here measured in terms of their local deposit taking—were actually growing. In other words, activity by existing (and new) community banks has offset what would have been larger declines in market share due to bank consolidation.
Other studies have found similar patterns for community bank assets, deposits, and small-business lending. A study of the performance of smaller community banks shows that, after adjustments for mergers, the growth of assets has been "significantly faster" at small banks than at large banks in every year from 1985 to 2000.37 Deposit growth—both total deposits and uninsured deposits—followed the same pattern. Along the same lines, a study of small-business lending by community banks found that, adjusting "for size category reclassifications due to consolidation or asset growth and for local market conditions," community bank small-business-loan market shares increased from 1994 to 2000.38 Together these findings indicate that the relative growth of surviving (and new) community banks (measured in terms of assets, deposits, and small-business lending) has been such that one would have underestimated community banking's continuing presence by looking only at the pace of merger activity.
Changes in the presence of larger (noncommunity) banks in local deposit markets have affected where community banks tend to operate. Not surprisingly given the spreading reach of the top 25 banks, the concentration of the largest banks' deposits in large urban centers has declined as they have diversified into smaller markets. Perhaps also not surprisingly, the concentration of community banks' deposits in rural markets has risen, a trend suggesting that community banks' comparative advantage has shifted even more toward serving small, less densely populated markets. However, the declines in deposits held in metro areas are smaller than the declines implied by reclassifications due to acquisition activity or community bank growth during the period; indeed, the share of community banks' deposits located in suburban markets actually increased between 1985 and 2003. This increase is consistent with the notion that there is a niche for service-oriented community banks in suburban markets.
To understand the geographic deposit patterns in relation to longer-term economic prospects in local markets, we conducted a parallel analysis of deposit trends for growing versus declining markets, defined in terms of positive and negative population growth.39 Community banks do not appear to have been relegated to providing services in markets where the economic base is dwindling. Community banks have seen their deposit market shares decline in all types of markets, but those declines are no more pronounced in growing markets than in declining ones.40
Community Bank Industry Shares, Portfolios, and Performance
As noted above, the many observers who argue that the community banking segment of the industry remains viable often base their claims on the importance of community banks in certain types of loan markets—specifically, in lending to small businesses and farms. A significant amount of research holds that community banks' strength as lenders stems from their ability to form the relationships necessary to lend to informationally opaque borrowers (an advantage widely viewed as important in small-business and small-farm lending), and studies have documented the importance of smaller banks in such lending.
This section describes the evolving role of community banks in the banking industry. It examines the ways in which community banks as intermediaries are different from larger banks in terms of their industry shares, portfolio composition, and performance. The analysis of community banks' performance includes a comparison between community banks that remained community banks and surviving community banks that outgrew the community bank size classification or were acquired out of it. We also relate the performance of community banks to the longer-term growth of the local markets where they were located.
Unless otherwise indicated, all analyses of "banks" and "banking" include both commercial banks and savings institutions. Here we do, however, also pre-sent some trends for commercial banks and savings institutions separately to highlight relevant differences between these two types of institution. Despite their increasing similarity, these segments of the industry have evolved from very different places and continue to exhibit differences (particularly on the asset side of their balance sheets) that are important to consider when one is assessing community banking's prospects.
Industry Shares of Assets and Liabilities
Table 4 - Share of Banking-Sector Assets and Funding, 1985, 1994, and 2003
Trends in the shares of industry assets held by community banks are consistent with the view that larger banks have a growing advantage in the increasingly standardized consumer credit and home mortgage markets. Meanwhile, community banks remain important for less-standardized types of lending, such as small-business loans and loans collateralized by business real estate. Moreover, as discussed above, community banks that survived the consolidation trend have actually increased their market share, offsetting some of the effect of community bank mergers.
Looking only at industry shares of assets held by all community banks, however, does obscure some important differences between commercial banks and saving institutions as separate segments of the industry.41 In 1994, the largest organizations controlled only 8 percent of savings institution assets but had already come to dominate the commercial banking sector. Although some large organizations (such as Citigroup) have increased their presence, midsize organizations continue to dominate the savings institution industry. Meanwhile, the shares of consumer credit and home mortgages held by community savings institutions have declined less (in relative terms) than the shares held by community commercial banks. However, in both segments of the industry, community banks appear to be holding their own as business lenders, particularly in funding small loans to businesses and farms.
Turning to the liability side of the banking industry's balance sheet, we see in the bottom panel of table 5 the changes in the distribution of bank liabilities and equity across bank size groups between 1985 and 2003. Community banks continue to hold higher shares of deposits (compared with their share of banking sector assets) and rely less on other types of borrowing than larger organizations. However, community banks' shares of the industry's deposits have generally moved lower with their overall share of industry assets. Recently concerns have been expressed about whether Federal Home Loan Bank (FHLB) advances are propping up small institutions, and we note that the share of total FHLB advances owed by community banks appears also to have tracked their declining share of the industry.
Table 5 - Banking-Sector Balance-Sheet Ratios: 1985, 1994, and 2003
There are, however, some differences between commercial banks and savings institutions in how liabilities are distributed across the bank size classes.42 First, the share of commercial bank equity held by community commercial banks has declined more than these banks' share of commercial banking assets; the opposite has been true for community savings institutions. These contrasting patterns reflect differences in the types of institutions that needed to be recapitalized after the banking sector problems of the 1980s and early 1990s. In the commercial banking industry, it was the larger institutions that needed greater recapitalization, whereas in the savings institution industry, recapitalization was more pronounced among smaller institutions. Second, in the commercial banking sector, community banks account for a disproportionate share of total FHLB advances, but among savings institutions, the opposite is true: community banking's share of total FHLB advances to saving institutions has been declining as borrowing among institutions controlled by the very largest organizations has expanded dramatically.
Given trends in industry shares on the asset side of the balance sheet, it is not surprising that community banks have increased their business real estate lending—including commercial real estate loans, farm real estate loans, and construction & land development loans—as a share of their assets. In contrast, the largest banking organizations have not exhibited comparable shifts. Instead, consumer credit and home mortgage lending now account for greater shares of the total assets controlled by the 25 largest banking organizations.
It is important that increases in business real estate lending by community banks are not merely substituting for other types of lending (such as C&I loans or consumer credit). After moving lower during the late 1980s and early 1990s, the loan-to-asset ratio for all community banks rose from 57 percent in 1994 to more than 63 percent in 2003. To some extent this increase undoubtedly reflects lending opportunities associated with the economic expansion of the 1990s. These portfolio trends, however, also reflect community banks' need to generate sufficient earnings to maintain profitability.
Turning to the composition of community bank liabilities, one finds (as mentioned above) that anecdotes about the reliance of community banks on retail deposit funding are borne out by the data. Although deposits as a share of total liabilities for community banks are lower than a decade ago, this share still exceeds 90 percent, and these deposits are almost all domestic deposits. Portfolio ratios also indicate that FHLB advances have become a more important funding source for community banks; but this is also true for larger banking organizations (table 5, lower panel).
There are significant differences in portfolio composition between community commercial banks and community savings institutions, particularly on the asset side of the balance sheet.44 As discussed below, these differences have important implications for the relative performance of, and prospects for, these two types of community banks. The increase in community banks' loan-to-asset ratio reflects greater lending (as a share of assets) by commercial community banks, and specifically more real estate lending of all types. In contrast, community savings institutions (which historically have had higher loan-to-asset ratios than community commercial banks) remain primarily home mortgage lenders.45 In mid-2003, 38 percent of community savings institution assets were home mortgage loans, and another 13 percent were mortgage-backed securities; the next-largest loan component was commercial real estate lending, which accounted for 9 percent of savings institution assets.
Community commercial banks and community savings institutions differ as well in the composition of their liabilities.46 The former rely more on deposits and less on other borrowing—mainly FHLB advances—than do the latter. And although both community commercial banks and community savings institutions have increased their reliance on FHLB borrowing as a source of funds, large savings institutions rely more on FHLB advances as a source of funding. On the other hand, the recapitalization of savings institutions has reduced this sector's overall riskiness in terms of their leverage measured relative to their buffer stock of capital.
Table 6 reports aggregate performance ratios for all banking organizations (by size category) from 1985 through 2003. Since 1993, community banks have tended to earn a healthy return on assets (ROA), exceeding 1 percent. And until very recently, the ROA for the community banking sector was very comparable to that earned by the 25 largest banking organizations (although the ROAs measured for midsize banks exceeded those mea-sured for both of these groups). However, because smaller institutions have tended to have higher capital ratios than larger institutions, a given level of earnings has translated into a lower return on equity (ROE) for the smaller institutions.47 Thus ROE measured for community banks is below that for larger banks, and the ROEs earned by small community banks have tended to be lower than those for larger community banks.
Table 6 - Banking-Sector Performance Ratios, 1985-2003
Among commercial banks, earning differentials across the three size groups do not reflect poorer interest margins for community banks.48 To the contrary: their profitability reflects higher net interest margins earned by these smaller banks. Even among community banks in the commercial banking sector, the smaller ones have tended to have higher net interest margins than the larger ones. However, the size-related differentials in net interest margins among all but the very largest banks have narrowed in recent years. At the same time, smaller banks have increasingly faced higher relative costs, here measured by the ratio of noninterest expenses to the sum of net interest and noninterest income. In terms of this "cost ratio," the gap has been growing between community banks and their larger commercial bank counterparts; the gap has also been growing among community banks in the different size categories. These patterns suggest an "economies-of-scale" interpretation of performance differentials across the bank size groups during the past decade. Although smaller institutions earned more on their assets, these earnings did not translate into higher ROAs because smaller institutions also had higher costs. Moreover (as noted), the need to hold more capital translated into lower equity returns among community banks.
Performance differentials evident among saving institutions in the different size classes appear to reflect the continuing role of these institutions as mortgage lenders.49 ROA measured for large savings institutions have been rising relative to the ROA measured for community savings institutions. And net interest margins for community savings institutions have moved closer to those earned by their large counterparts, while cost ratios for community saving institutions have been rising. Therefore, the lower profitability evident for community savings institutions appears to reflect the higher costs facing these banks, without the higher net interest margins to cover them. Overall, these patterns suggest that community savings institutions face greater competitive disadvantages than their commercial banking counterparts, which are more focused on business lending. In addition, these patterns are consistent with the evolution in mortgage lending toward standardized transactions in a national market.
Performance and Community Bank Migration
To better understand the declining population of community banks, it is useful to compare the relative performance of institutions that remained community banks with the relative performance of institutions that outgrew the size classification or were acquired by larger banks. In particular, was it the better performers that became part of the population of larger banks? To examine this question, we tracked the performance of all institutions (other than de novos) that had originally been classified as community banks to see if there were differences in performance between those that were still classified as community banks in subsequent years and those that had either grown out of the community bank classification or been acquired out of it. Because industry conditions in the 1980s and early 1990s were starkly different from conditions in the later 1990s, we conducted separate analyses of the two nine-year subsets of the 1985–2003 period. We also analyzed commercial banks and savings institutions separately. For each year (and both segments of the banking industry) we first measured the performance of institutions that had been classified as community banks at the beginning of the eight-year period and were still community banks as of the year in question; we also measured the performance of institutions that had been community banks at the beginning of the period but had outgrown the classification or been acquired by larger banks in a given year.50
Certain general patterns emerged from this analysis. Not surprisingly, patterns evident for the banks that outgrew the community bank size classification are consistent with some of the size-related performance differentials discussed above. However, a comparison of community banks that were acquired with those that remained community banks fails to suggest that those continuing as community banks were generally poorer performers.51 Moreover, differences in performance between banks that remain community banks and those that outgrow the classification are likely to reflect differences in the economic conditions in the markets where they are located.
Performance and Local Market Conditions
Because of community banks' small size, their portfolios and performance have an inherently local dimension. In analyzing their performance, therefore, we examined the extent to which community bank performance has been related to longer-term local-market demographic and economic prospects in the markets where these institutions are located. Some recent studies have looked at the prospects for community banks in rural markets where population has been declining.52 But it is also useful to look at the prospects in high-growth areas, where community banks may play an important role in meeting the strong small-business loan demand attendant on local growth.
In this analysis of the relationship between community bank performance and longer-term conditions in local banking markets, we classified longer-term local market conditions in terms of population growth between 1985 and 2003.53 Each market (defined in terms of metropolitan statistical areas [MSAs] and non-MSA counties) was placed in one of three population-growth classes: (1) low growth if population growth was negative, (2) moderate growth if average annual population growth was between zero and 2 percent, and (3) high growth if population growth averaged more than 2 percent per year during the 1985-2003 period.
During this period, urban markets had higher growth on average than rural markets, although 12 percent of MSAs had negative population growth.54 These negative-growth metro markets tended to be in the northeastern United States, whereas high-growth metropolitan areas tended to be in the South and West. Not surprisingly, rural markets tended to have lower population growth (and lower real personal income growth) than urban markets: 40 percent of rural counties experienced negative population growth between 1985 and 2003, 49 percent had moderate population growth, and only 10 percent had high population growth.55 As in the analysis above of changes in the number of community banks, we examined the link between local population growth and community bank performance in particular market segments: rural markets, small metro markets, and suburban and urban parts of large MSAs.56
We calculated five performance measures for community banks headquartered in markets that experienced negative, moderate, or high population growth.57 The results indicate that community banks located in markets exhibiting higher growth during our study period tended to have greater earnings growth and, for the past decade, somewhat higher ROAs and larger net interest margins. At the same time, cost ratios also exhibited some relation to local market conditions, with community banks in higher-growth markets also tending to have higher expenses relative to their income.58 In recent years, however, cost ratios have tended to converge across markets. Higher net interest margins suggest that community banks in robust regions have benefited from local lending opportunities to a greater extent than community banks in lower-growth markets.
On the other hand, even community banks in low-growth (by our definition, negative-growth) markets seem to have been buoyed up by the economic expansion of the 1990s. Although community banks in higher-growth markets have higher loan-to-asset ratios, community bank lending (relative to assets) has increased most in low-growth markets. And it is noteworthy that even in regions with low growth, community bank performance has been solid during the past decade, as has the performance of the banking industry generally.
It should also be noted that there are some qualitative differences in the relationship between local growth and bank performance ratios in different types of markets.59 For example, we find the greatest variation in cost ratios for community banks in urban parts of large metro markets, where local rents and other costs are likely to be more sensitive to local conditions. But the general patterns, particularly for profitability and net interest margins, are evident in the different segments of local markets studied here.
To further test the robustness of the relationship between local growth and community bank performance, we constructed comparable sets of performance measures that tracked the performance of institutions that had been community banks in 1985.60 Specifically, we constructed measures to reflect the performance of all community banks in 1985 that had neither failed nor been merged into a bank not classified as a community bank.61 These measures were intended to explore the notion that observed community bank performance could understate true community bank performance because top performers outgrow the classification.62 Somewhat surprisingly, there was very little difference in the cohort-level performance mea-sures for this broader group when compared with the cohort-level performance measures for community banking organizations classified in terms of their current asset size. Hence, at least for this period, banks exiting the community banking population (through internal growth or acquisition activity) do not appear to be markedly better performers than community banks that remained community banks.63 In sum, although there is a clear link between the local environment and the performance of community banks, community banks seem quite able to survive in a variety of environments.
Competition Faced by Community Banks
Community banks face many competitors. A useful way to assess these is with an examination of just what kinds of financial institutions community bankers themselves have identified in surveys as their most significant competitors. (See tables 7 and 8.) Community bankers view other community banks as their prime competitors, and also see credit unions as significant competitors. When community banks are broken down by asset size, the same pattern emerges, but community bankers running the largest community banks view regional or megabanks as competitors much more than do those running the smallest community banks. The idea that other community banks are prime competitors is borne out when one looks at core business lines: other community banks are regarded as the main competitors in short- and medium-term loans to businesses and farmers, unsecured loans to consumers, and consumer and business deposits. Other types of firms are prime competitors in markets that have a nationwide reach—for example, finance companies for auto loans, and mortgage companies for first mortgages. (See table 9.) Perhaps surprisingly, regional banks and megabanks are not identified as the most important competitors except in a few business lines, such as business and personal trust operations and home equity loans.
Table 7 - Perceived Competitors of Community Banks, Survey Results, 1994-2003 (Percentage of Respondents)
Table 8 - Perceived Competitors of Community Banks, by Community Bank Size, 2004 (Percentage of Respondents)
Table 9 - Top Two Competitors of Community Banks by Business Lines, 2003
The attitude of community bankers (particularly those associated with smaller institutions) to their large-bank competitors may reflect their belief that their business model is effective in its emphasis on reputational lending and personal service and that they have an advantage in their presumed ability to attract customers dissatisfied by the more impersonal approach of large banks. Credit unions would seem to be a natural competitor to community banks and might well have been viewed as even more significant competition in the surveys, were it not for the effects of both their size and their location. Among credit unions, as of year-end 2003, 88 percent held under $100 million in assets, whereas only 50 percent of community banks were in that size category. And credit unions are located mainly in urban areas in the central and eastern states. Eighty percent of credit unions are located within MSAs, whereas only 53 percent of community bank offices are (as of midyear 2003). These differences in size and geography suggest that some community banks face formidable credit union competition, while others do not.
For several reasons (credit unions' perceived importance as competition, their tax-exempt status, and their exemption from provisions of the Community Reinvestment Act, as well as legislation that has allowed credit union membership to expand significantly), it is useful to look briefly at the trends in deposit share of credit unions and community banks. Community banks' share of deposits, as noted above, has decreased steadily, from 25.5 percent in 1994 to 17.7 percent in 2003; during the same period, credit unions with over $100 million in assets have seen their deposit share increase, while smaller credit unions have lost deposit share. Deposit share growth was greatest for the largest credit unions (those with more than $1 billion in assets—by our definition larger than a community bank). Overall, credit union deposit share has increased, but not dramatically (from 7.7 percent to about 9.5 percent).64 By far the largest gains in deposit share have been made by the 25 largest banks, with their share rising from 28.4 percent in 1994 to 44.2 percent in 2003.65 (See table 10.) An examination of deposit share in rural areas and in large and small metropolitan areas finds similar general patterns: to varying degrees, in each of these areas community banks have lost deposit share, credit unions with more than $100 million in assets have had gains in deposit share (and again, credit unions with more than $1 billion in assets saw the greatest percentage growth in deposit share—particularly in all types of metropolitan areas), and the largest banks have experienced gains (for the largest banks, the gains were especially strong in urban and suburban areas within large MSAs).66 In terms of credit union deposit share, overall it has been the large credit unions that have experienced the fastest growth; most credit unions, however, remain small in comparison even with small community banks. Whether credit unions will capture a significantly greater share of the market in the future remains an open question.
Table 10 - Share of Deposits and Offices
The extent to which these trends in deposit share are causally related is hard to determine. Because the geographic overlap between community banks and credit unions is limited, changes in the aggregate deposit shares of these groups may not reflect increased competition between them. To address the question of competition, we performed a separate analysis using markets with both a community bank presence and a relatively large and growing credit union presence. In these markets, community banks experienced a decline in deposit share that was not, on average, significantly greater than the decline they experienced in all areas. For example, in the 20 MSAs in which small credit unions both increased their deposit share from 1994 to 2003 and held 8 percent or more of the deposits at the end of this period, community banks experienced a mean loss in deposit share of about 7 percent. In comparison, the mean decline in deposit share of community banks in all MSAs during this period was approximately 6 percent, and the median declines were almost identical. An analysis of rural counties yielded similar results.
It is useful to examine the industry more closely by looking at credit unions according to their membership types.67 Perhaps most credit unions, especially the smaller ones that make up much of the industry, have a local component and so could be seen as competitors with community banks. Federally chartered community credit unions, which are defined as those whose members are within a well-defined local community, neighborhood, or rural district, might be perceived as particularly competitive with community banks, especially as recent NCUA rules have allowed for broad interpretations of "local."68 Our analysis will therefore emphasize trends observed in these institutions.
The credit union industry, like banks, has undergone significant consolidation in recent years. When we look at the number of institutions within this context, the only type of credit union that has seen significant growth since 1997 is the community credit union, though at about 1,000 institutions these still make up only about 11 percent of the industry. Since 1997, community credit unions' industry asset share has also increased, from just over 3 percent to more than 12 percent (state-chartered credit unions' asset share has also increased, while both single- and multiple-common-bond credit unions' shares have decreased). Community credit unions' average asset size has also seen the fastest growth, more than doubling to over $76 million dollars in 2003, although this size means that they remain small in comparison with all but the smallest community banks.69
Some industry observers have asserted that credit unions are acting more like commercial banks, and point to their increasing entry into business loans as evidence for this trend. Although some individual credit unions are engaging more heavily in this activity and the industry ratio of member business loans to assets has nearly doubled since 1997, this measure, until now, has grown only to just under 1.5 percent. Community credit unions' ratio of business loans to assets dropped between 1997 and 2000 but has risen since then, from just over 1 percent to about 1.8 percent. So although business loan activity has been increasing in recent years, on an industry-wide basis it remains a relatively small part of credit union lending. In terms of performance, credit unions overall have done reasonably well since 1997, though not as well as community banks. Community credit unions' ROAs have generally been the lowest of the four types since 1997, dipping as low as 80 basis points in 2001, though in the past two years they have performed more in line with state-chartered and multiple-common-bond institutions, with ROAs above 90 basis points (single-common-bond credit unions have performed best). Credit union ROEs have been lower than those of community banks, and since 1997, community credit unions' ROEs have been either in line with or somewhat lower than other types', starting the period at about 9 percent, dipping to about 7.5 percent in 2001, but recovering to about 8.7 percent in 2003.70
Prospects for Community Banks
Our examination of community banks' future must take into account what may happen to their numbers, as well as these banks' competitive strengths and challenges.
Decline in Community Bank Numbers
Competitive Strength and Challenges
Table 11 - Bank Offices by Size Category, 1985–2003
Community banks' competitive strengths, however, must be matched against the competitive challenges they face in a number of respects. The need to attract and hold qualified personnel will remain a significant issue. Community banks may face the need to find a more diverse set of both funding options and sources of income. Possibilities for moving beyond reliance on core deposits exist, as does the potential for generating more fee-based income, but difficulties may accompany such courses. Community banks, having at first lagged behind large banks in adopting and using technology, are now rapidly making up their deficit and must navigate the best path for its use. Finally, community banks face the problem of the fixed costs incurred in complying with banking regulations.
Surveys of community bank executives indicate that attracting and retaining qualified personnel is perhaps these executives' most important concern. Retaining key employees was identified as a factor critical to success by 93 percent of respondents in the Grant Thornton survey published in 2003, including those from both large and small community banks.73 Although only 13 percent of respondents in an American Bankers Association (ABA) survey published in 2003 found retention a significant problem (a situation probably reinforced by a soft economy), the survey nevertheless demonstrated that finding qualified candidates for important positions was often hard (and sometimes very hard). (See tables 12 and 13.) The difficulty filling a particular type of position sometimes depended on the community bank's size or location or both. There was, however, some general concern about the unavailability of qualified employees and a belief that potential employees were moving into nonbanking jobs, as well as concern that large banks were better able to attract personnel.74 (See table 14.) Overall, community banks located in declining or slow-growth economies are likely to experience the most difficulty with employment.
Table 12 - Problems Attracting and Retaining Employees, 2000-2003 (Percentage of Respondents Reporting Significant Problems)
Table 13 - Level of Difficulty in Finding Qualified Candidates, 2003 (Percentage of Respondents)
Table 14 - Reasons for Problems Attracting and Retaining Employees, 2002 (Percentage of Respondents)
Community banks largely depend on core deposits, and for many community banks, this may not pose any concern.75 In recent years, however, core deposits in many areas have lagged behind total deposits and behind loan demand. Responses to ABA surveys from 1997 to 2001 suggest that deposit growth lagged behind loan demand at a significant number of community banks. More recently, a return flow from the stock market has eased funding problems, but perhaps only temporarily.76 Raising rates to increase core deposits in the local community may be costly because of cost increases for existing accounts, or because of a limited supply of local funds in slow-growth areas. Funds attracted from the outside through brokers or the Internet may be volatile.
At this point, Federal Home Loan Bank (FHLB) advances are the main supplement to core deposits. There has been some use of other "nontraditional" sources, such as fed funds, sales of participations, and repurchase agreements.77 (See table 15.) Measured as a percentage of community bank liabilities, FHLB advances clearly have been used increasingly since 1993; these advances moved from just over 2 percent of liabilities in 1993 to almost 6.8 percent in 2003. Not surprisingly, larger community banks have made greater use of advances during the period, but even among the smallest community banks the use of advances has increased substantially. (See figure 2.) Although narrower funding options may be a handicap, community banks have been able to offset higher interest costs with higher loan rates charged to idiosyncratic borrowers who have limited access to large-bank funding.
Table 15 - Nontraditional Funding Methods of Community Banks
In principle, small banks have fewer prospects for diversifying their sources of income; mergers may allow them to expand their opportunities to do so. Diversification does not, however, lead only to benefits. A recent study notes that diversification can carry risks because community banks may "move beyond areas of comparative advantage and enter businesses where they lack the necessary expertise, technology, or scale to compete successfully," and concludes that community banks "do better when they stay focused on major activities but gain by diversifying within that area of expertise."78
Some observers have suggested that community banks should rely more on fee income. Fee income of small banks is largely from deposit services, and (as noted above) fees on deposit services tend to be lower at small banks than at large banks. Because small banks generally offer a narrower service base, their total fee income is proportionally lower than that of large banks. Broadening fee income would make community banks less dependent on core deposits and less vulnerable to reductions in interest margins in periods of rising interest rates. Raising fees associated with deposit services, however, might conflict with community banks' efforts to attract retail deposits and with their personal service image. As noted above, the gap between large- and small-bank fees appears to be closing, so some community banks may be making greater use of fees to generate income.79 In a survey recently conducted by the Federal Reserve System (admittedly with a very small sample—only ten bankers), half the participants noted that they intended to increase revenues through fee income, and those interviewed realized that "chronically delinquent or overdraft customers are profitable."80 Broadening fee income from other sources generally entails broadening the service base. However, some of the sources of fee income of large banks, such as investment banking, securitization, and back-up lines of credit, require a large base of transactions and therefore are not feasible for small banks.
Community banks will face a strategic choice between trying to perform relatively narrow functions more efficiently and trying to broaden into new activities that may involve greater risk and greater cost for small-scale operations.81 It is not clear which course will prevail or whether all banks will make the same choice. The important point seems to be that numerous community banks have found it possible to grow and prosper not by trying to emulate large banks with many business lines but by performing largely traditional functions more efficiently.82
Although automation of back-office operations is essentially universal, community banks have lagged behind large banks in adopting other technologyspecifically, Internet banking. However, delayed entry after some of the initial problems have been resolved has not necessarily been a major disadvantage.83 Moreover, community banks are adopting Internet services fairly rapidly. One measure of the Internet presence of community banks is found in their reporting a Web address on their Call Reports. As of September 30, 2003, there were 7,374 community organizations containing 5,663 institutions that reported Web addresses. A survey conducted by the Independent Community Bankers of America indicates that 77 percent of community banks have Internet sites and that 75 percent of these community banks have transactional Web sites;84 an earlier Grant Thornton survey suggests similar magnitudes.85 Small banks are less able to make large investments in technology individually but have generally been able to meet their needs by outsourcing or purchasing widely available systems for in-house use. However, when a community bank is just one client of a service provider, the bank may face varying levels of loss of flexibility.86 The great uncertainty, however, concerns future technological change. De Young and Hunter have laid out two possibilities: First, new technology may enable large banks to personalize their services while maintaining the advantages of large-scale operations. Second, small banks may be able to retain the advantages of their personalized approach while overcoming the disadvantages of small-scale operations.87 It is difficult to know which of the two is more probable.
It should also be noted that the provision of a bank safety net and the existence of regulatory agencies to enforce compliance have led to substantial reporting and other regulatory burdens. These requirements normally involve fixed costs that tend to be proportionally heavier for small banks; thus, regulatory burden is likely to have some effect on these banks' long-term prosperity.88 Conceivably such regulatory requirements will contribute to further consolidation.
Community bank numbers shrank by almost half between 1985 and 2001; during this period their market share dropped considerably, with small community banks affected most. Taken at face value, such observations might suggest that community banks face considerable difficulties. However, more detailed examination presents a rather different picture. Community banks made up 95 percent of the industry in 1985, yet despite the tremendous consolidation that has occurred, they still constituted 94 percent of U.S. banks in 2003. Moreover, closer inspection of the geography of consolidation reveals some surprising results: by many different measures, community bank declines were proportionally similar. The number of community banks decreased only slightly faster in formerly unit-bank states than in non-unit-bank states. Community banks did not disappear more rapidly in declining markets than in growing ones. Declines were similar across rural, small metropolitan, and large metropolitan areas, and within the last category, across both urban and suburban areas, although the factors that contributed to community bank numbers (failures, mergers, and new banks) differed subtly with the type of area. In particular, both mergers and de novos were concentrated in large metropolitan areas. Community banks have been able, however, to maintain their presence in all areas.
Community banks experienced a significant loss of deposit share between 1985 and 2003, a period during which large banks were by far the largest gainers in deposit share, and credit unions saw modest gains. Community banks also had significant losses in asset share; in lending this was most pronounced in sectors (such as consumer credit) that have been commoditized. They are, however, holding their own in real estate lending to businesses. It should be noted that community savings institutions remain primarily mortgage lenders. As regards earnings, community banks are at a minimum performing satisfactorily, and the performance of community commercial banks reflects higher net interest margins sufficient to offset higher costs. Community banks did perform better in high-growth than in low-growth markets, but even in the latter their performance may be regarded as acceptable, with returns on assets of 100 basis points or better for the last decade of the period studied.
Overall it is impressive that community banks, while facing intensified competition due not only to the removal of branch restrictions (which had protected many from competition) but also to the growth of nonbank competitors, have been able to achieve both respectable earnings and growth in recent years. Community banking, therefore, appears to be a viable business model. Research suggests that these banks possess certain advantages as lenders to small businesses, small farmers, and other informationally opaque borrowers through their ability to assess the risks of borrowers who lack long credit histories, to process soft data such as borrower reputations, or to operate effectively in situations where the proximity of decision making to customers is important. The proposition that community banks have informational advantages in lending to small business is supported by research suggesting that small banks have higher risk-adjusted returns on business loans than large banks. The willingness of private investors to risk their own money to create new banks is a powerful market test of the viability of small banks, at least in areas of high population density. Moreover, a concentration of new banks in areas where large and distant banks have taken over local institutions also suggests that many customers may prefer the more personal approach of community banks. Consumer attitudes may change and larger banks may seek to emulate the personal service approach of smaller institutions. However, community banks should continue to occupy an important position in the banking industry for the foreseeable future if policymakers can maintain economic stability and moderate the impact of regulatory burden.
*The authors are all with the Division of Insurance and Research of the Federal Deposit Insurance Corporation: Tim Critchfield is a senior financial analyst; Tyler Davis, a research assistant; Lee Davison, a historian; Heather Gratton, a senior financial analyst; George Hanc, a former associate director; and Katherine Samolyk, a senior financial economist. The authors thank Robert DeYoung for his helpful comments.
Avery, Robert B., and Katherine A. Samolyk. 2004. Bank Consolidation and Small Business Lending: The Role of Community Banks. Journal of Financial Services Research 25, nos. 2-3:291-325.
Figures A.1–A.5 present aggregate performance measures for community banks classified by the population growth of the MSA or non-MSA county where each bank was headquartered. High-population-growth markets include all MSAs and non-MSA counties that experienced an average annual growth rate of more than 2 percent during the 1985–2003 period. Medium-population-growth markets include all MSAs and non-MSA counties that experienced an average annual growth rate between zero and 2 percent during the 1985–2003 period. Low-population-growth markets include MSAs and non-MSA counties that experienced negative population growth over the 1985–2003 period. Community banks are defined as banking organizations (bank and thrift holding companies, independent banks, and independent thrifts) that controlled bank assets or thrift assets of less than $1 billion (in 2002 dollars).
Table A.1 - FDIC-Insured Community Banks Unit-Bank States vs. Non-Unit-Bank States, 1985 and 2003
Table A.2 - FDIC-Insured Small Community Banks Unit-Bank States vs. Non-Unit-Bank States, 1985 and 2003
Table A.3 - Number of FDIC-Insured Community Banks by Type of Geographic Area, 1985 and 2003
Table A.4 - Number of FDIC-Insured Small Community Banks by Type of Geographic Area, 1985 and 2003
Table A.5 - Number of FDIC-Insured Community Banks in Growing Markets, 1985 and 2003
Table A.6 - Number of FDIC-Insured Community Banks in Declining Markets, 1985 and 2003
Table A.7 - Changes in the Distribution of Domestic Deposits by Type of Geographic Area, Declining Markets, and Growing Markets, 1985-2003
Table A.8 - Share of Banking-Sector Assets and Funding, Commercial Banks vs. Savings Institutions 1985, 1994, and 2003
Table A.9 - Banking-Sector Balance-Sheet Ratios, Assets, and Liabilities, Commercial Banks vs. Savings Institutions
Table A.10 - Commercial Bank Performance Ratios, 1985-2003
Table A.11 - Savings Institution Performance Ratios, 1985-2003
Table A.12 - Performance Measures for Community Banks Based on Their Subsequent Size-Group Classification
Table A.13 - Community Bank Performance and Local Growth by Type of Geographic Area, 1985-2003
Table A.14 - Mean Share of Deposits and Offices by Type of Geographic Area, Banks vs. Credit Unions by Size Category, June 1994
Table A.15 - Mean Share of Deposits and Offices by Type of Geographic Area, Banks vs. Credit Unions by Size Category, June 2003
Table A.16 - Federally Insured Credit Union Summary Data by Type of Membership: Year-end 1997-2003 (Dollars in Thousands)
Table A.17 - Percentage of Community Banks Offering Various Internet Services in 2002 and Expectations for those Services Three Years Later
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