The business community's reaction to the declining role of core deposits in financing banks' loans reminds me of the man smiling on the deck of a sinking ship while everyone else is in a panic.

When queried on his optimistic attitude, he replies: "Why should I care? It's not my boat."

When most businesspeople are informed that core deposits equaled 62% of banks' assets in 1962 but only 46% at the end of last June, they have a similar response:

"Who cares? That's their problem."

But, as the Federal Reserve Bank of Chicago points out in its December letter, this decline has serious implications for business borrowers.

As the core deposit percentage falls, banks must rely more on interest-sensitive funds, Federal Home Loan Bank advances, and deposit brokers. And since the maturities of bank assets are lengthening at the same time, bank exposure to interest rate risk is also increasing.

When declining asset quality is thrown into the picture, the result is a fear for the safety and soundness of the banking industry. Many banks are less willing to provide funds, and in most cases they are increasing the cost of funding.

"Since some borrowers have few alternatives to bank loans, constraint on banks' ability to fund profitable investments can adversely affect economic activity," the Chicago Fed concludes.

For community banks, the impact of this core deposit trend on lending is even more striking. Since the smaller bank is less able to obtain funds elsewhere, the core deposit ratio drop produces a much steeper decline in loan expansion than it does at larger banks.

As deposits leave community banks for Internet banks, equity investments, and time deposit balances at brokerage firms, the real losers are not just the banks but also the businesses that depend on them almost exclusively for credit.

"Our bank is growing by leveraging," heralds a radio ad for a major foreign bank trying to make inroads in the New York market. "So the next time you need as little as $500,000, give us a call." Clearly, that bank is not targeting small-business customers.

There is another seldom-mentioned point raised in the Chicago Fed letter. Not only do regional banks with solid core deposit bases lend more to their customers, but these banks also are willing to share the lower cost of funding with these customers. As the letter states, these banks "tend to insulate their borrowers against aggregate changes in credit risk and market rates by smoothing interest rates charged on loans."

As banks fund a smaller percentage of their assets with core deposits, interest rate increases are more likely to be passed on to borrowers. Such smoothing by community banks deserves more publicity.

It is well known that as part of their local service, community banks try to keep charges for their depositors low. And we know that these banks are usually the leaders in aiding the community's nonprofit enterprises, both with funds and loaned talent.

But it is less well known that when people pull their deposits out of the local bank to gain a slightly higher interest rate at an Internet bank or a brokerage firm, the real losers are the local borrowers, who provide jobs and spend money in their communities.

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