Multi-Office Bank Lending to Small Businesses: Some New Evidence

Abstract

In a long-awaited move, Congress enacted legislation last fall authorizing full interstate banking. While most states had already acted to allow some form of entry by outside holding companies, the new law was expected to hasten the spread of large multi-office banking organizations. Most analysts believe the change will benefit the public by increasing competition, improving services to depositors, and reducing banks' vulnerability to local downturns. Concern has been voiced, however, that the benefits of multi-office banking may be achieved at the expense of small businesses. Specifically, some analysts worry that large multi-office banks will be less able or less willing to lend to small businesses than the smaller banks they replace. Such a decline in small business lending could have serious consequences, these analysts argue, because small businesses account for a major share of job creation and lack alternative sources of financing. This article investigates the relationship between multi-office banking and small business lending using new information on small business loans in Tenth District states. Data for mid-1994 show that branch banks, smaller banks in multibank holding companies, and banks owned by out-of-state companies all tend to lend a smaller proportion of their funds to small businesses than other banks. These results support the view that further growth in multi-office banking may impose short-run costs on some small businesses. The article cautions, though, against concluding that multi-office banking should be curtailed. Instead, regulators should continue to ensure that local banking markets remain competitive, so other banks can step in and fill any gaps in the legitimate credit needs of small businesses. The first section of the article reviews the controversy over the effects of multi-office banking on small business lending. The second section describes the different forms of multi-office banking in Tenth District states. The third section presents the evidence on small business lending by multi-office banks in the district. The article concludes with a discussion of the policy implications. THE CONTROVERSY OVER MULTI-OFFICE BANKING AND SMALL BUSINESS LENDING While the advent of interstate banking has heightened interest in the issue, the debate over the effects of multi-office banking on small business lending goes back many years. In the first half of the century, the debate centered on differences in the lending behavior of branch banks and unit banks--banks with only one office. Later, as the holding company form of organization spread in the 1960s and 1970s, analysts debated whether banks affiliated with multibank holding companies (MBHCs) were less disposed to lend to small businesses than independent banks. More recently, as states moved to allow some form of interstate banking in the 1980s, attention turned to differences in lending behavior between in-state banks and banks owned by out-of-state MBHCs. This section reviews the effects these various forms of multi-office banking might have on small business lending and summarizes previous research. Why multi-office banks might make fewer small business loans Banking analysts have suggested several reasons why large, multi-office banks might lend less to small businesses than other banks.(1) One reason is that large banks do not have to rely as heavily on small borrowers to achieve a desired level and composition of commercial lending. Because loans to a single borrower cannot exceed a certain percentage of a bank's capital, small banks are legally prohibited from making loans above a certain size.(2) Also, given the limited funds at their disposal, the only way small banks can spread their risks sufficiently is by making a large number of small loans. If small banks instead made a small number of large loans, they would be more vulnerable to bad luck on the part of a few customers. Large banks do not have such concerns, both because the single-borrower loan limit is not binding for them and because they have enough finds to make mostly large loans and still spread their risks. …