For banking to function properly, it needs to come in many forms to serve different markets. It makes no sense, for example, for a tiny bank to finance massive projects and vice versa. Each bank size must have the flexibility needed to serve its clientele.
Banking must also have a constant influx of new banks entering the system to continually revitalize itself.
Modern banking tends toward gigantism. This trend consists of giant banks gobbling up smaller ones, with the idea that large-scale operations are always more economical and profitable. This practice also discourages new banks from entering the system, since the big banks monopolize all markets, leaving little room for newcomers.
Like all business fields, banking needs small, medium, and large-sized enterprises that cater to different needs. It needs new banks as part of the dynamics of a healthy economic model.
The Attack on Small and New Banks
The tendency is to see small and new banks as outdated in today’s global economy. They do not have the power to maneuver in markets and, therefore, are to be discouraged.
However, this narrative is wrong. Indeed, it was the big banks that got into trouble during the 2008 subprime mortgage crisis. They overextended themselves by buying high-risk, subprime mortgages, bundling and repackaging them as mortgage-backed securities and selling them to broad markets. They lost the personal, small-bank touch with borrowers that helps prevent bad home loans.
Big banks caused the global crisis, and the government bailed them out. Small and new banks are now paying the consequences.
New Regulations That Strangle
After the crisis, the government entered the scene by introducing massive regulations that kill new banks and strangle small ones. Both are the lifeblood of the banking sector.
In 2010, Congress passed the Dodd-Frank Act, its answer to the subprime mortgage crisis. The law mandated larger capital requirements, new accounting procedures and other cumbersome measures to ensure that banks deemed “too big to fail” would never fail.
Many of these new regulations do not apply to smaller and new banks, but because of those that do apply they are forced to shoulder massive, prohibitive costs of compliance, an expense that larger firms can more easily absorb.
Fewer New and Small Banks
As Jeb Hensarling and Michael Solon write in The Washington Post, the predictable result of Dodd-Frank was fewer small banks and a consolidation of midsize banks into a few megabanks, which offered fewer local services.
As a consequence, small bank account holders plummeted. Before Dodd, these banks served some 4.9 million account holders. Now the number is around 500,000.
Another byproduct of this over-regulation is a drastic decline in the number of new banks. From 1990 to 2008, for example, an average of 149 new banks were granted charters every year. After Dodd-Frank, that number has declined to a mere five new banks a year.
Thus, banks are far from replacing themselves. Even before Dodd, only 32 new banks emerged for every one hundred that failed, liquidated or merged. After Dodd, that number crashed to 3.4 new banks.
The Need for Small Community Banks
Despite the decline of small and new banks, these institutions occupy a disproportionately large and important place in today’s economy.
Small community banks engage in what is known as relationship banking, in which they maintain familiarity with borrowers and provide more personal support. Thus, these banks still provide nearly 40 percent of small-business loans, even though their share of banking assets is about 13 percent.
Small businesses also need these banks because they provide capital that larger, more established banks might not consider it worth their while to extend. Business leaders feel more comfortable borrowing from local banks where they know everyone. Small banks tend to be much more nimble than megabanks. They have often discovered valuable banking innovations while catering to their niche markets.
Indeed, many Fortune 500 companies, including Walmart, began their growth by borrowing extensively from local community banks willing to extend credit for local expansion projects.
There Is Hope
Thus, small and new banks need help. The burden of compliance is overwhelming. Small banks can pay as much as three times as much on non-interest expenses as megabanks do. These banks need relief.
This year, the House of Representatives has passed the bipartisan Main Street Capital Access Act, which, while it does not eliminate regulations, at least tailors them to bank size. It also eases capital requirements and provides a three-year regulatory phase-in period for new banks.
The bill must still pass in the Senate. If it passes, it will be a major step toward helping this important segment of our banking system. An economy cannot prosper when strangled by regulations. Government’s preferential option for mega-banks to the ruin of new and small ones needs to stop.
Photo Credit: © Antonio – stock.adobe.com
