Would the financial system have gotten into the mess it did if all the banks in the U.S. were small fry? President Obama seems to think not. He even gave a shout-out to "responsible lenders, including community banks, doing the right thing" in his Lehman Brothers anniversary speech. Leaders of big banks don't agree of course. But the numbers, at least for the moment, bear out the president's thinking on the subject.

The economic crisis is still taking its toll on the banking industry. So it is too early to say for certain that small banks did a better job than big banks. Defaults on loans to small businesses and commercial real estate projects — which make up a relatively bigger chunk of smaller banks' books — tend to lag the corporate sector.

But a glance at some preliminary data for the first half of the year, culled for Breakingviews.com by SNL Financial, shows smaller banks besting their behemoth brethren on nearly every criterion important to shareholders — not to mention customers and public policy makers. As legislators consider ways to prevent another near-collapse of the global financial system, they could do worse than analyze the startling performance divide between America's big and small commercial banks.

Shareholder hot buttons include returns on assets and equity. In the second quarter, American banks with assets of more than $5 billion — of which there are about 150 ranging from GMAC's Ally Bank to Zions of Utah — reported a median return on average equity of 3.15%. The group's median return on average assets — a measure of the performance of their loans — stood at 0.31%.

Now consider the 7,300 banks followed by SNL that reported assets of less than $5 billion at the end of the first quarter. The median return on assets, at 0.56%, was nearly double that of the big banks. And the median return on equity of small banks — from Arizona's 1st Bank Yuma to Zavala County Bank in Crystal City, Texas — was also significantly higher at 5.31% in the second quarter.

This appears to show something simple: smaller banks make better loans. Net charge-offs as a percentage of all loans stood at 0.20% for small banks. Big banks wrote down eight times as much relative to their books. Any community banker can explain why: "We know our customers better."

But there is a wrinkle. Spending so much time with borrowers may hold back lending by small banks. They lend out a smaller percentage of their customers' deposits — 83.11% in the second quarter to be exact — than the big banks, which converted 94.24% of deposits into loans, according to SNL.

That's a meaningful difference. If all banks in the U.S. kept their loan-to-deposit ratios in line with smaller banks, some $830 billion less credit (on total deposits of $7.54 trillion) would reach American businesses and consumers than if they adopted the big banks' lending ratio. Credit is important to a smoothly functioning system - but of course, it might not be such a bad thing if only the dodgiest layer of today's borrowers couldn't get loans.

On balance, these data tend to support those who favour dismantling or shrinking massive institutions like Wells Fargo, JPMorgan and Bank of America, all of which actually increased their market shares during the financial panic by acquiring weakened and failed rivals.

And yet while small banks have indeed done better by many measures, the gap between them and the big players appears to be narrowing. For example, from the first quarter to the second, the spread between the return on assets at small and large banks shrank by nearly 20%. And net charge-offs, while still far lower at small banks, had doubled as a percentage of average loans. They rose by a comparatively low 50% among big banks.

That may be a sign that the loans small banks focus on, such as those made to small businesses and property developers, tend to underperform later in an economic downturn than big corporate and consumer loans. But it's still hard to see the gaps between big and small narrowing completely through the cycle.

And there's another benefit to fragmentation besides performance. While many of the largest lenders have, through the bailout policies of the past year, been officially designated too big to fail, no community bank represents a systemic risk. The president may be on to something in praising the merits of a financial system consisting of banks that are too small to bail.

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