Community Banks Succeed by Knowing Their Customers

Often lost in the enthusiasm for economies of scale that drive many mergers is the economic foundation of community banking: Community bankers know their customers and therefore make fewer bad loans.

Community banks, with their decentralized decision-making, can be flexible in meeting customers' credit needs.

Also, the community banker usually understands the customer's business better and so can better assess the chances of collecting on a loan.

Further, a community bank can use its local directors to check on prospective customers.

The Affiliate Model

A large banking company can do the same, but only if structured as a system of affiliates, each with its own board.

Banc One Corp., based in Columbus, Ohio, is the prototypical example of a multistate franchise that retains the knowledge that community bankers and their boards can create.

First of America Bank Corp., Kalamazoo, Mich., also operates as a system of community banks. "The economics of community banking are different... and better," says vice president Sam Stone.

The Branch Model

San Francisco-based Bank-America Corp. has the opposite structure: pure branch banking. It counts on is cost-effective distribution system and name acceptance.

The real economies of scale in retail banking are not so much operating systems and technology, as is commonly thought.

A big banking company offers retail customers the convenience of standardized financial services throughout a large area.

And it offers the business customer the ability to finance operations, including independent business units, in different areas.

Niche Banking

A recent survey by Bank Mergers and Acquisitions found that small community bankers are in general surprisingly unconcerned by competition from the megabanks.

Instead they plan to maximize their economic advantage over the big branch bank systems by "niche" banking.

A good example of this strategy is Oregon's Commercial Bankcorp, a $201 million-asset holding company formed in 1982.

The Salem-based institution began in 1955 as Commercial Bank and since then has seen many of its community bank competitors sold to larger banks.

With that in mind, Commercial has committed itself to being, in its words, "Oregon's premier independent community bank holding company."

A Focus on Small Businesses

In 1990, Commercial's strategy focused on two niches. Ed Martin, president of Commercial Bank, said it would concentrate on "small businesses and customers, 50 years or older."

Commercial's idiosyncratic definition of a small business goes hand in hand with its community banking emphasis. A small business by Commercial standards is any business that is family owned and run, whether it has two employees or 2,000.

Lower turnover among loan officers lets community banks like Commercial develop strong relationships with the businesses they serve, Mr. Martin said.

He noted that Oregon has seen three community bank start-ups in the past few years. "People want an independent bank where they can walk in and talk to the president."

A package of services developed for the "mature" market, dubbed the Value Builder Gold Account, brought in 3,105 new accounts in its first year.

Many community bankers find that the lower cost and increased power of computer technology nullify many of the supposed economies of scale.

Through an Independent Bankers Association of America program, even Michigan's tiny Newberry Bancorp, which has $43 million in assets, is able to enjoy the benefits of economies of scale without the headaches.

A microcomputer package in Newberry's main office calls up a mainframe computer at night to update records.

Through such collaborative efforts, "you can set up structures that give better economies of scale than a midsize bank," said Stephen Ranzini, the chief executive officer of Newberry.

Regarding Consolidation

The distinction between community-based and branch banking systems is vital to understanding the consolidation of the industry - for two reasons.

First, size alone does not necessarily equal strength.

Second, community-based and branch banking systems behave differently in consolidations.

Healthy branch systems usually acquire weaklings. Healthy community-based banks often acquire other healthy community-based banks.

Ron McRae,Ed Dillon, and Dan Piro are respectively senior, associate, and executive editors of Bank Mergers and Acquisitions, a newsletter published by SNL Securities. The data base and publishing firm, based in Charlottesville, Va., specializes in the banking and thrift industries.

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