The potential for large out-of-state banks to operate branches in New Jersey - a prospect that would be facilitated by a bill currently before the state Senate - is an impending threat to community banking as we know it, and to small businesses and their communities by extension.

The Interstate Banking/Branching Bill, which passed the state Assembly last spring and is due for a second reading before the Senate this term, would allow increased branching into the New Jersey banking community by domestic and foreign financial institutions.

Proponents of interstate banking argue that bigger banks, with geographically and economically diversified loan portfolios, are "safer" banks. Economists at the Federal Reserve Bank of Minneapolis disagree. They say larger banks get into trouble more often than smaller banks.

Another argument proffered by interstate banking advocates is that consolidated operations lead to increased services at lower fees.

But we are in the realm of myth here.

A study by Arthur E. Wilmarth Jr., associate professor of law at George Washington University, showed that in the highly concentrated California banking market, banks charged higher rates for loans and paid lower rates on deposits than banks in comparable states.

A study released in September by the Federal Reserve clearly demonstrates that bank fees rise as banks grow and branch across state lines.

The Fed's annual survey, Retail Fees and Services of Depository Institutions, found that during 1994 customers at out-of-state banks paid about $2 more in fees for stop-check orders, bounced checks, and overdrafts than did customers of in-state banks. Interstate bank customers also were required to keep up to $170 more in their accounts to avoid additional fees.

Professor Nicholas M. Didow summarized it well years ago during testimony before Congress: "The larger the bank, the higher the level of fees. The smaller the bank, the lower the level of fees."

It's a simple equation: bigger banking equals higher fees.

Businesses should worry about the alarming phenomenon known as "flight of capital," a scenario in which deposits collected by branches in one state are disbursed as loans in another. As an insidious effect of mergers, geographic diversification, and flight of capital, a handful of powerful, centralized banks will eventually divide our nation into "colony" and colonizer" states, whereby the bank's home state economies will thrive at the expense of the colonized states.

This point was recently brought to the fore by Kenneth H. Thomas, a professor at the Wharton School of Business, a banking consultant, and author from Miami who has seen colonization at work in his home state. A major out-of-state bank in Florida now operates with a 30%-to-5% imbalance of deposits to loans, and the colonizing bank directs fully 80% of its loans to its home state.

Who wants to see this type of economic subjugation? My home state of New Jersey seems particularly vulnerable in this regard flanked as it is by New York, the world's financial center, and Philadelphia.

Another red flag for small business is that the largest banks control half the state's deposits, but offer less than a third of all small- business loans. The chairman of one new banking conglomerate stated openly that the bank does not even consider granting small-business loans less than $200,000.

That's perfectly understandable for one of the titans of banking, but it also makes a powerful case for the importance of community banks. After all, the nation is full of small businesses looking for moderate-size loans to expand or upgrade their enterprises. If continued interstate mergers and acquisitions drive out your community bankers, who will be left to provide these crucial moderate loans for businesses? Community banks by nature recycle deposits locally in the form of commercial and consumer loans to help foster community growth.

Banks looking to expand through interstate mergers or acquisitions would prefer not to discuss a number of inevitable consequences. The fact is, when operations are consolidated, offices are centralized, local boards of directors are eliminated, and staffs are trimmed.

Not too long ago, one West Coast institution cut 15,000 jobs; that's 15,000 paychecks removed from the local economy. Another recent merger is projected to cause 12,000 lost jobs, primarily in the New York Metropolitan area, while the anticipated acquisition of First Interstate by California- based Wells Fargo is expected to force 20,000 employees out the door.

It's a scary trend, and not one likely to abate anytime soon. In fact, a study reported Dec. 11 in the Sarasota, Fla., Herald-Tribune projects at least 300,000 jobs will be lost at U.S. financial institutions in the coming years. And more importantly, "colony states" bear the brunt of these cuts. In Florida, for example, employment at financial institutions fell 19% in five years, from 120,000 in 1989 to 98,000 in 1994.

Massive job losses certainly can't be good for the economy, our businesses, or the communities they serve. For those of us in community banking, jobs lost in the local economy means losing customers and hurting our own market. In this regard, our interest and the community interest are one and the same.

Out-of-state banks pay the bulk of their taxes in their home state, so unless tax laws are changed, out-of-state banks could evade paying state taxes where they branch. That would hit all of us right where it hurts - in our wallets.

Small businesses are well equipped to understand that bigger is not always better. Those that have resisted the temptation of growth for its own sake in order to remain faithful to a specific mission and service standard will understand the predicament facing moderate-size community banks.

Lest they fall prey to the public relations efforts supporting the voracious appetites of the megabanks, state legislatures should stop, look, and listen before leaping.

Mr. Abbate is president and chief executive of Interchange State Bank in Saddle Brook, N.J.

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