Over the last quarter of a century, the structure of the U.S. banking industry has undergone an almost unprecedented transformation—one marked by a substantial decline in the number of commercial banks and savings institutions and a growing concentration of industry assets among a much smaller number of extremely large financial institutions.

After remaining fairly stable since the 1930s, the number of federally-insured banks and savings institutions began to decline rapidly in the mid-1980s. At the beginning of 1984, there were 15,101 banking and thrift organizations (defined as commercial banks, thrifts, and bank and thrift holding companies). By year-end 2003, that number had fallen to 7,842—a decline of almost 50 percent (Chart 1). Distributed by size, nearly all the decline occurred in the community-bank sector (organizations with less than $1 billion in assets), and especially among the smallest size group (less than $100 million in assets).

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The bulk of the decline in the number of organizations from 1984 through 2003 was due to unassisted mergers and acquisitions. During that period, 8,122 individual bank and thrift organizations disappeared through unassisted mergers and acquisitions and 2,262 were eliminated through failure. About 75 percent of the failures occurred in the five year period between 1987 and 1991, when failures averaged 388 per year. In contrast, from 1994 to 2003 only 66 institutions failed (fewer than 7 per year), which reflected the greatly improved condition of the banking industry in a generally favorable economic climate.

Amid the two-decade wave of consolidation, significant entry into banking was also taking place. Some 3,097 new banking organizations entered the industry from 1984 to 2003—an average of 163 per year. The presence of significant entry into banking during an era of large-scale consolidation suggests a somewhat more complex picture of structural change than the overall figures would suggest.

Moreover, the evolution of industry structure has not been uniform over time. The rate of decline in the number of banking institutions reveals a very strong cyclical pattern, occurring at an increasing rate in the 1980s only to slow in the 1990s (Chart 2). Since 1992, the rate of decline in the number of banking organizations has trended consistently lower than the rate during the previous eight-year period. The slowing rate of decline in the number of banking organizations since the early 1990s suggests the influence of economic, regulatory, and technological changes that have taken place since then. In particular, the turning point roughly coincides with both the end of the 1990-1991 recession and a sharp decline in the number of bank and thrift failures.

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This report constructs scenarios for the future population of U.S. banking organizations based on analysis of the historical data. As a starting point, a simple linear method is used to project the number of banking organizations in each of five size classes through the year 2013. These projections, which are based on the average quarterly net change over the five-year period 1999-2003, suggest a continuing decline of 136 organizations per year. This pattern would reduce the total number of bank and thrift organizations from 7,842 at year-end 2003 to 7,161 at year-end 2008 and 6,480 at the end of 2013—declines of 8.7 percent and 17.4 percent, respectively, over those intervals.

However, due to the presence of a nonlinear trend in the data pointing to a slowing of the rate of decline, it would appear that the linear projections represent a lower-bound estimate of the future population of banking organizations. Projections based on the rate of change indicate that the number of organizations comprising the banking industry is likely to decline more slowly over the next five to ten years. Under this nonlinear projection (shown as the upper bound in Chart 3), the number of banking organizations will decline from 7,842 at the end of 2003 to 7,435 by 2008. From there, the pace slows further, resulting in 7,167 organizations by 2013. However, because this result is somewhat sensitive to the selection of the base period used to form the projection, it should be viewed as an upper-bound estimate of the future population of the banking industry.

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Regardless of the exact numbers of institutions going forward, these projections indicate that in the absence of a new shock to the industry, the U.S. is likely to retain a structure characterized by several thousand very small- to medium-sized community bank organizations, a less-numerous group of midsized regional organizations, and a handful of extremely large multinational banking organizations. It does not appear that the future U.S. banking industry structure will resemble the banking structures seen in some countries (Germany, for example), where only a handful of universal banks are present. Instead, this report envisions an eventual balance developing between the number of new bank start-ups and charter losses due to mergers and acquisitions—with little net change in the number of banking organizations nationwide.

Community Banks: Their Recent Past, Current Performance, and Future Prospects
Although the number of community banks (community banks are defined as independent banks and savings institutions and bank and savings institution holding companies with aggregate assets less than $1 billion) has declined significantly, they still comprise 94 percent of the banking industry, a figure essentially unchanged from 1985. ²

Moreover, detailed analysis of the changes in the number of community banks revealed that community banks in 2003 had maintained a proportionally similar presence in all types of markets—urban, suburban and rural—and this remained true for markets that experienced both population growth and decline; in addition, there was only a slightly greater decline in community banks in formerly unit-bank states in comparison to non-unit-bank states.³

Community banks' deposit share declined significantly since 1985, during a time when large banks greatly extended their reach throughout the country (See Table 1). Community banks' ability to provide personal service to depositors continues to be one of their strengths, allowing them to continue to play an important role in local deposit markets, albeit a smaller one than before.

Although the asset share of community banks also dropped, an examination of community bank lending demonstrates that they continue to have a stable share of real estate lending to businesses, and continue to provide a disproportionate amount of credit to the small business and agricultural sectors. Success in these sectors is due to the ability and willingness of community banks to assess the creditworthiness of borrowers who may have been traditionally ignored by larger banks or who have been dissatisfied with the services provided by larger banks. Typically, these borrowers do not have the types of credit histories or financial reporting mechanisms that fit the model-based lending approaches used by many larger banks. As such, they react positively to the relationship-based lending practiced by community banks.

The earnings performance of community banks since 1985 has until very recently been comparable to that of the very largest banks. Over the past decade, it has been stable, with a return on assets of at least one percent, a level that many industry observers would term "satisfactory" (See Chart 4). Moreover, this is true even in areas that have experienced population declines. Additionally, the market has provided an impressive case for the continued presence of the community bank in today's banking landscape: more than 1,200 new community banks have been established since 1992. New bank owners have therefore been willing to risk their capital in these ventures, and often have done this in areas where existing community banks have been acquired by large and distant banks to take advantage of customers who may find the business practices of large, non-local banks to be unsatisfactory.

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Community banks do face challenges. Many community bankers state that it is difficult to both find and retain qualified employees. Competition with large banks and nonbank competitors, including credit unions, will continue. The fixed costs of regulatory requirements fall more heavily on community banks than on larger ones. Regulatory burdens could, therefore, have a significant negative effect on community banks' future prospects. Nevertheless, the evidence from the recent past about community banks' market presence, industry share, and earnings performance, coupled with the continued creation of new community banks, points strongly to community banks being a viable business model in the future.

Rural Depopulation: What Does it Mean for the Future Economic Health of Rural Areas and the Community Banks that Support Them?
The United States is currently in the midst of a major demographic event: the depopulation of a significant portion of its rural counties. While the U.S. population continues to increase overall, many rural areas are experiencing population outflows. In fact, 662 of the nation's 2,052 rural counties lost population between 1970 and 2000. This issue has significant ramifications for the banking industry and its regulators, as 1,451 banks and thrifts with total assets of $132 billion were headquartered in rural counties with declining populations at year-end 2003.

Rural depopulation is occurring in several areas of the country, as seen in Map 1, which illustrates population trends by county. Blue counties gained populations between 1970 and 2000; yellow counties lost population but at a relatively stable rate; and red counties not only lost population over the three decades, but saw population outflows increase in the 1990s.

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