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Slate Writer Is Dead Wrong to Root Against Community Banks

WASHINGTON – Slate's economic and business blogger, Matthew Yglesias, published a provocative blog post on Tuesday, essentially arguing that community banks need to be euthanized.

No fan of the biggest banks either, he called for a system that limits the megabanks while encouraging the regional players, like U.S. Bancorp (USB), PNC Financial Services Group (PNC) and Fifth Third Bancorp (FITB), to "swallow up local franchises and expand their geographical footprints." Instead of the 6,891 banks that existed at the end of the third quarter, Yglesias envisions a world in which "dozens rather than thousands of banks exist."

To support his vision, Yglesias posits three arguments: Small banks "are poorly managed"; they "can't be regulated"; and they "can't compete."

Yet he provides scant evidence to back those claims and an examination of the current environment facing small banks suggests that in all three cases he is dead wrong.

Here's why:

1. Most Small Banks Are Well Managed (And Aren't Dumb)

Among the more inflammatory remarks in Yglesias' blog post is the suggestion that community bankers are simply stupid. In his words: "You know how the best and brightest of Wall Street royally screw up sometimes? This doesn't get better when you drill down to the less-bright and not-as-good guys. It gets worse."

I'm not sure why Yglesias assumes small banks are populated by Wall Street-rejects who couldn't hack it in the big city, but that simply isn't the case. Most small banks are run by individuals who have risen locally through the ranks or were poached from nearby institutions.

Unfortunately, there are no good statistics to refute his sweeping claim. Generally speaking, however, it's fair to use the Camels rating system, which includes "management" as part of its criteria. (For non-bankers: Camels is a confidential grading system for banks, with the best score being 1 and the worst being 5.)

As of Sept. 30, there were 515 institutions on the Federal Deposit Insurance Corp.'s "problem bank" list, the vast majority of which are Camels 4- and 5-rated banks. While all of those are almost certainly community banks, they make up just a sliver (7.4%) of the overall number of institutions.

Those looking for more proof should consider this: The vast majority of community banks survived the financial crisis, an unprecedented period of turmoil that challenged and nearly defeated many of the so-called "best and brightest." That is a pretty big indication community banks have talented people at their helm.

2. Small Banks Are Way Easier to Regulate

The most perplexing argument that Yglesias makes is that small banks "can't be regulated." He goes on to say that "small banks regularly get various kind of carve-outs from regulation" because policymakers want to ensure their survival.

It is true that small banks receive periodic exemptions from some regulations. For example, institutions with less than $10 billion of assets are not examined by the Consumer Financial Protection Bureau. The Federal Reserve Board's cap on interchange fees for debit cards also does not apply to small banks.

Yet the vast majority of rules and regulations do, in fact, apply to small banks. While the CFPB carve-out exempts small banks from oversight by that agency, they still have to follow the rules it writes. The Fed interchange cap, too, could end up affecting small banks after all, if retailers pressure them to match the lower rates bigger institutions charge.

Moreover, some of the biggest new rules required by Dodd-Frank also apply to small banks. Take Basel III, a collection of new capital and liquidity rules that most everyone thought should apply only to the largest banks. Instead, regulators have applied it to all institutions with limited exemptions. The other big rules of Dodd-Frank, including sweeping new mortgage and underwriting regulations, mostly apply equally to all banks, regardless of size.

Leaving aside which rules apply to whom, the bottom line is that the small banks are regulated by a horde of examiners from state and federal agencies. The vast majority of institutions are examined each and every year. The FDIC, which oversees most small banks, has roughly 3,000 people dedicated to bank supervision, according to its latest budget. That figure does not include the thousands of state examiners, with whom the FDIC shares oversight of nonmember state-chartered banks. It's hard to think of an industry that is more regulated than banking.

Moreover, let's not forget that it's far easier for regulators to oversee small banks, which by and large engage in the traditional business of banking: Taking deposits and making loans in their communities. Compared to a megabank (whose far-flung operations may include, ahem, derivatives traders in London) or even a regional institution, it is much simpler for regulators, not to mention the general public, to look at a small bank's business and assess its health.

3. Small Banks Are Profitable and Competitive

Yglesias concludes that if "you want the JPMorgan Chases and Bank of Americas of the world to be held to account, you need both regulation and competition. But a bank serving a handful of rural counties or a single midsized city doesn't offer any real competition."

Whether or not small banks are competitive depends a great deal on how you define "small." It is true that America's smallest institutions, those with less than $100 million of assets, are struggling. Those institutions – there are 2,117 of them at last count – generate a return on equity of 6.16%. That's significantly below the industry average of 8.92%, as well as institutions above $10 billion of assets (8.87%), according to the latest FDIC data.

Banks with $100 million to $1 billion of assets – the bulk of the industry's numbers, at 4,106 institutions – are more competitive. Their return on equity is 8.51%, close to the industry average and not far behind their biggest brethren.

For institutions with $1 billion to $10 billion of assets, a universe of 561 banks that are still considered community institutions under every known definition, the future is even brighter. Their ROE is 9.9%, well above the other peer groups – proof, if needed, just how competitive small banks can be.

Moreover, there are legions of stories about small banks that continue to thrive even in the current environment, including Monarch Bank and Cardinal Bank in Virginia, German American Bancorp. in Indiana and Eagle Bank in Maryland. American Banker Magazine recently compiled a list of the best-performing small banks with less than $2 billion of assets, ranked by average return on equity over the past three years. Of the top 20 banks listed, 15 had less than $1 billion of assets.

But Yglesias didn't discriminate by asset size, appearing to lump in all banks below regional status as "microbanks." Had he limited his remarks on competitiveness to the smallest institutions, he might have had a point in saying that policymakers need to take a hard look at their viability.

Yet even if policymakers decided to kill off the smallest, weakest-performing institutions, that would leave nearly 4,700 banks – an order-of-magnitude larger population of banks than the "dozens" envisioned by the Slate blogger.

4. Small Banks Are Vital to Credit Availability

Accepting Yglesias' premise could prove disastrous. Forming an oligopoly of regional banks is bound to leave fairly big coverage gaps. Scores of markets, especially across rural America, would be underserved at the onset of such a shift. Bank of America (BAC), for instance, has one of the nation's largest branch networks, but management blatantly skipped Mississippi while they expanded. There are plenty of people in Mississippi – not to mention large swaths of Kansas, Nebraska and Wyoming – who need loans and other bank services.

It's also not clear who would lend to the nation's smallest businesses, many of which lack the proper documentation or size to catch the eye of larger lenders. Data provided at the Federal Reserve's inaugural conference on community banking, held in October in St. Louis, found that community banks are best equipped to handle so-called "opaque information" when looking at a loan application. In many instances, the loan is based more on the bankers' understanding of the market, the borrower and the situation -- and smaller banks tend to do an exceptional job in this arena.

Looking ahead, it appears certain that there will be fewer banks in this country. Given the regulatory and economic headwinds small institutions face, it is not surprising that many are selling to credit unions, other community institutions or regional and large banks. Some experts have predicted that the downsizing will leave the country with around 5,000 banks.

Yet it seems bizarre to actively root for such an outcome. There's a reason most Americans like their local banks, even if they detest the megabanks after the financial crisis. Small banks are better positioned to understand their customers' needs and as a result, usually provide better service. Their existence is uniquely American, and while they have made plenty of mistakes, they pale in comparison to those made by their larger brethren. If you are worried about the safety of the economy, you want more small banks, not fewer. They pose less systemic risk and their failures are uneventful.

Small banks' alleged demise is something to resist, not cheer on.

Rob Blackwell is the Washington bureau chief of American Banker. The views expressed are his own. Paul Davis and Alan Kline contributed to this post.


(11) Comments



Comments (11)
From the perspective of a small business owner, I have noticed NO significant difference in the efficiency, customer service, or willingness to lend money to businesses in their community. Therefore, I see no reason to switch to a small bank. My small community probably has more banks per capita than any city I have ever lived in. The bankers are constantly peddling their "small businses friendliness" which is a bunch of crap. The only thing they are after is your money, and everyone knows it. While Bank of America is a monster in mho I dont have the energy to switch to another bank yet and then which monster do I choose? I will be leaving Bank of America, however, as I think they are garbage and not only will I be taking my business accounts but my personal as well. Ive given them 11 years of my money. Enough is enough.
Posted by ToomanybanksinPleasanton | Wednesday, February 19 2014 at 10:27PM ET
Survival theory suggests that small banks will continue to die out until only the strongest will remain. Many of the current small banks simply lack a needed attribute, whether management, demography, creativity, or something else. How many truly creative, very well managed community banks do we need to have a competitive market? By looking at Canada, not very many.
Posted by | Saturday, December 07 2013 at 6:16PM ET
This is a big topic and one that deserves more than a verbal "sound bite" or two. We are an industry of scale and that has important implications for our how we organize and how we attract capital. What most everyone seems to be missing though is how the big banks are consistently validating the business models of community banks and what an enormous opportunity community banks and bankers have in the years ahead if we figure out how to get this right.
Posted by ETO | Thursday, December 05 2013 at 1:11PM ET
Let's not forget the support that community banks provide to the non-profits in their community. These agencies can't navigate the big bank's labyrinth (usually located out-of-market) to secure grants, and usually don't meet their narrow grant making guidelines.
Posted by bmchan | Thursday, December 05 2013 at 10:23AM ET
By Matthew Yglesias's definition of me, I would assume that he couldn't hack it at the WSJ, Financial Times or other credible financial reporting service. He is thus relegated to posting stuff on the internet in the hope that other bloggers read it and comment. He doesn't care about what I do and I don't really care about what he does either.

Roy Harmon, CEO
Bank of Tennessee (an employee owned community bank)
Posted by rharmon | Thursday, December 05 2013 at 7:11AM ET
And perhaps and hopefully we are seeing, with the new Bank of Bird-in-Hand, that once again new banks can form. A healthy industry needs to have a healthy stream of new entrants.
Posted by WayneAbernathy | Wednesday, December 04 2013 at 5:17PM ET
And the best with these banks is that they can fail!
Posted by Per Kurowski | Wednesday, December 04 2013 at 4:29PM ET
I do not know who Matthew Yglesias is or what he does besides blog, but I envision a person who has never been outside of a large city and , therefore has no knowledge of what community banks do or what services rural America require. He probably does no understand relationships. In his world everything is black and white.

Mr Yglesias, you hopefully know that the United States is the most successful economic power ever on earth. Not coincidentally, in my opinion, the United States is also the only nation on earth to ever have such a diversified and localized financial services sector. We have a variety of charter choices available to best serve a community or segment to accomplish the business plan of the organizers. We have small community banks, regional banks, nation wide banks, and international banks. No other country has this vast variety of banking choices and not other country has the successful economic wealth. Why would anyone want to destroy that?

Efficiency is not always the best solution. Our system is not particularly efficient. It is clumsy and sometimes invites redundancy. However, it must work pretty darn well considering all of its success.

What is the correct number of banks in the U. S.? I don't know and neither does anyone else. The investors who want to create a bank should have that option and how many others there are across the country should have no bearing on whether there is a need for the one being created.

S. Joe DeHaven
Posted by jdehaven | Wednesday, December 04 2013 at 3:17PM ET
It seems to me that we are generally trending toward celebrating diversity in this wonderful (work-in-progress) we call the United States of America. We just finished celebrating Small Business Saturday during the peak retail weekend of the year. This is a long deserved celebration of the diversity of business models and shopping preferences of consumers in America. I fail to see how the curiously devoid of facts or data blog posting of Mr. Yglesias should somehow trump the clear trend among consumers to a have a preference for choices in when, where and how they purchase goods and services, including financial services. I am a community bank CEO and my customers have made a clear choice to do business with our bank. The communities that we serve value our contributions to the quality of life in our communities. Our employees, many from much larger banks earlier in their professional careers, value their work and the ability to rewarding contribute to the communities where they live. And finally, our shareholders are very, very pleased with the long term performance of their investment in our company. As to the question of how many community banks are enough, I must first ask: How many communities don't deserve a community bank ... or two ... or more?
Posted by artwork | Wednesday, December 04 2013 at 2:48PM ET
The market every day (albeit with some significant regulatory distortions) is deciding how many banks, and of what types, there should be in America. The answer is "many" and of a variety of types, sizes, charters, and business models. Remember that behind every successful bank there stands a lot of customers who think that this particular bank is right for their financial services needs. Let's let the people who use banks decide by their own financial decisions how many banks there should be and of what size and shape.
Posted by WayneAbernathy | Wednesday, December 04 2013 at 12:19PM ET
I think that most news outlets are poorly managed and tend to write articles that have more opinion than facts. Most writers tend to be biased toward large government and liberal politics. Based on my assumptions, I belive we should only have one newspaper in this country, the Wall Steet Journal and Fox news the only news outlet. How does that feel news guy. Sarcasm noted.
Posted by dahlers | Wednesday, December 04 2013 at 11:57AM ET
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