Small Community Banks Research Articles

Market share, larger competition and the profitability of rural, small community banks

PurposeCommunity banks continue to offer important financial services including agricultural and small-business lending as well as residential mortgage origination. Because community banks’ share of available source funds may be threatened in rural markets due to competing larger banks seeking less expensive core deposits, this study examines whether large-bank competition, market share of deposits and changing market share impact the profitability of rural, small community banks.Design/methodology/approachUsing a Heckman-type selection model to control for sample selection bias, ordinary least squares (OLS) regression analysis with time and bank fixed effects is conducted to study the drivers of profitability in small, community banks that operate exclusively in rural markets. Profit drivers for rural, small community banks of particular interest in the study are larger-bank competition, market share of deposits and year-to-year change in market share of deposits.FindingsThe research indicates that rural, small community bank profitability decreases in concurrent market share of deposits and may increase in changing market share but that the presence of a larger competitor decreases the profitability of small community banks in rural markets as larger banks compete for deposits in these markets. The paper also finds that increased Internet access in rural markets accompanies lower performance for small community banks, indicating that online banking services may threaten rural, small community banks.Originality/valueThis paper offers new findings to the literature on the performance effects of large competitors in rural banking markets. The results suggest implications for managers of rural, small community banks and offer additional knowledge about profit drivers of rural, small community banks of which regulators should be cognizant.

Elimination of the reserve requirement: impact on liquidity at community banks versus non-community banks

PurposeThe purpose of this paper is to better understand the differences between community and non-community banks (CBs and Non-CBs) in the US. As the former have been declining in numbers, previous literature shows inherent differences between the business models of CBs and Non-CBs. This study attempts to gauge whether the impact of the reserve elimination during the Covid pandemic affected all banks similarly or whether community banks showed a differentiated response.Design/methodology/approachOn March 26, 2020, the Federal Reserve, at the onset of the Covid pandemic, altered the depository institution reserve requirement for the first time since 1992. This significant change in policy led to the reserve requirement reduction from 10% to 0%. This study examines the impact of the 2020 reserve elimination on all community banks and non-community banks in the US and finds that although the level of cash to assets increased at both types of depository institutions post reserve elimination, the impact on liquidity-focused ratios was more pervasive at community banks in the first quarter post the regulatory shift. Among community banks, the largest depository institutions experienced the biggest balance sheet adjustments in the June 2020 quarter that followed the change in Federal Reserve’s policy. Further, the study finds that over two-quarters post reserve elimination, the non-community banks demonstrate a greater increase in balance sheet liquidity. Past literature shows that community banks tend to carry more liquidity than non-community banks and small community banks tend to carry more liquidity than their larger counterparts. These previous findings may provide some explanation for the different speed documented in this study at which various banks have reacted to the reserve elimination in 2020.FindingsThis research finds that community banks had a quicker response to the change in the reserve elimination, showing quick increases across liquidity ratios. The larger non-community banks tended to play catch up, increasing their liquidity in the subsequent quarter. The study also shows that the changes in liquidity were initially driven by the segment of large community banks.Originality/valueThis study looks at how the reserve elimination enacted by the Federal Reserve in March 2020 in response to the Covid pandemic affected community versus non-community banks. Currently, as far as the authors know, there are no other published papers that look at this issue.

How bad is a bad loan? Distinguishing inherent credit risk from inefficient lending (Does the capital market price this difference?)

Small community banks and the largest banks experience higher ratios of nonperforming loans than other sizes of banks. To what extent does their nonperformance result from lending to riskier borrowers, and to what extent does it result from a lack of proficiency at loan making? Does market discipline punish or reward credit risk and lending proficiency? Using stochastic frontier estimation, we develop a technique to decompose banks’ ratio of nonperforming loans to total loans into three components: the best-practice ratio representing the inherent credit risk of the loan portfolio, the excess ratio representing lending inefficiency, and statistical noise. We apply the decomposition technique to data from 2010, 2013, and 2016 on top-tier U.S. bank holding companies. The largest banks with consolidated assets exceeding $250 billion experience the highest ratio of nonperformance among the five size groups. Our decomposition shows that the high ratio of nonperformance of the largest banks appears to result from lending to riskier borrowers, not inefficiency at lending. Restricting the sample to publicly traded bank holding companies, we find that the nonperformance ratio is negatively related to market value except at the largest banks. When the two components of the nonperformance ratio are used instead, we uncover a more informative underlying story: taking more inherent credit risk enhances market value at many more large banks and the value-enhancing effect increases sharply from 2010 to 2016, whereas lending inefficiency is negatively related to market value at all banks and more so from 2010 to 2016. Market discipline appears to reward riskier lending at large banks and discourage lending inefficiency at all banks − incentives that are both increasing over time.

Impact of Bank Closings on Credit Extension to Businesses in Low-Income and Minority Neighborhoods

New research is surfacing since the last financial crisis, not only to help predict risks associated with bank failures but also to assess the impact of bank failures on the economy and local geographies. However, although bank failures occurred mostly among small (community) banks, much less is understood regarding how the closing of mission-oriented community banks, or minority-owned banks, affect traditionally underserved markets, areas such failed banks were designed to serve. We conduct an empirical investigation testing the effects of bank closings on local areas. We find that, as a result of bank closings, there are significant frictions with small businesses obtaining credit, which appear to be potent enough to cause cumulative declines in aggregate small business lending in neighborhoods, lasting up to 3 years. We also find evidence that such lending shocks have repercussions on small business growth. We find that the closing of large banks also has an impact on small business lending, consistent with previous research, which has shown that as small businesses lose credit from large banks, they are not able to switch easily to other banks, leading to a decline in aggregate lending in local areas. We find this to be true for low- or moderate-income (LMI) and minority businesses/neighborhoods. We also find that the failure of community development financial institutions (CDFIs) and minority depository institutions (MDIs) leaves a credit void that may not automatically be filled in LMI and minority neighborhoods.

CEO Succession Planning in Small Community Banks: A Qualitative Case Study of “PNW” Bank

The case study explores an effective, successful chief executive officer (CEO) succession at a small community bank. The outcome of CEO successor choice can have a substantial impact on the organization’s strategy and success. Lack of an effective succession planning process presents a challenge for these banks that are thinly staffed and have aging CEOs and executives. The emergent themes and major findings were initial vision of candidate, intentional communication during transition, successor cultural fit, and trusting relationships. Other small community banks can use the major findings for succession planning to reduce the risk of negative or unintended consequences.

Does scale matter in community bank performance? Evidence obtained by applying several new measures of performance

We consider how size matters for banks in three size groups: small community banks with assets less than $1 billion, large community banks with assets between $1 billion and $10 billion, and midsize banks with assets between $10 billion and $50 billion. To illustrate the differences between these banks and larger banks whose business models are distinctly different, we examine large banks with assets between $50 billion and $250 billion and the largest banks with assets exceeding $250 billion. Community banks have potential advantages in relationship lending compared with large banks. However, increases in regulatory compliance and technological burdens may have disproportionately increased community banks’ costs, raising concerns about small businesses’ access to credit. Our evidence suggests several patterns: (1) while small community banks exhibit relatively more valuable investment opportunities, larger community banks, midsize banks, and larger banks exploit theirs more efficiently and achieve better financial performance; (2) average operating costs that include costs related to regulatory compliance and technology decrease with size; (3) unlike small community banks, large community banks have financial incentives to increase lending to small businesses; and (4) for business lending and commercial real estate lending, compared with small community banks, large community banks, midsize banks, and larger banks assume higher inherent credit risk and exhibit more efficient lending. Thus, concern that small business lending would be adversely affected if small community banks find it beneficial to increase their scale is not supported by our results.

Technology and Small Business Lending: A Case Study

Community banks are more able than their larger, more bureaucratic competitors to meet clients’ unique demands. This adaptability is evident in their growing market share in small business and agricultural lending, which often require distinctly structured loans. Community banks are active in the communities they serve and, therefore, have a deeper understanding of client needs. Smaller community banks do not have the vast resources to market and develop financial technologies often offered by their larger, bigbank competitors. The purpose of this paper is to determine how technology usage impacts small business lending and profitability at community banks.

Earnings, risk-taking, and capital accumulation in small and large community banks

Abstract We examine the relationships between ownership structure and both earnings and risk-taking among community banks before, during, and after the US financial crisis. We find that publicly-held small community banks had lower earnings than privately-held ones before the recession, but had higher earnings during and after the recession. Publicly-held small community banks exhibited similar risk-taking to privately-held ones before and during the recession, but greater risk-taking after. We also find that publicly-held small community banks de-risked more slowly than privately-held ones following the recession. Large community banks, on the other hand, show no consistent relationship between ownership structure and earnings, and a strong cyclical relationship between ownership structure and risk-taking. These findings expand our understanding of how community bank performance and capital accumulation behaves through different cyclical periods, and how ownership structure affects that behavior.

Treating Apples Like Oranges

In response to the Financial Crisis of 2008 and the Great Recession that followed, Congress passed the Dodd–Frank Wall Street Reform and Con- sumer Protection Act in 2010. The Volcker Rule is a controversial section of the Dodd–Frank Act that prohibits all banks, no matter their size, from pro- prietary trading and entering into certain relationships with private equity funds. But the Volcker Rule forces banks to incur significant costs to ensure compliance. While Big Banks have the capital and infrastructure to comply with the Volcker Rule, small Community Banks often do not. This gives Big Banks an unfair competitive advantage over Community Banks. However, re- cently there has been renewed interest in the Volcker Rule, particularly regard- ing its effects on Community Banks. Both the legislative and executive branches are calling for changes to the Volcker Rule. But there is no consen- sus on how the Volcker Rule should be changed and what types of financial institutions those changes should affect. This Article will explore this issue. First, this Article will discuss the background of the Financial Crisis, Great Recession of 2008, Dodd–Frank, and the Volcker Rule. Second, this Article differentiates between the business models of Big Banks and Community Banks. Third, this Article examines the Volcker Rule’s effect on Community Banks. Fourth, this Article will consider recent proposals for changes to the Volcker Rule by the House of Representatives, Senate, and the Department of Justice. Finally, this Article will argue that Community Banks should be ex- empted from the Volcker Rule, preferably by a bill recently proposed by the Senate Banking Committee.

The Economic Impact of Hurricanes in the US: Does Local Finance Matter?

This paper examines the role of local lenders during recoveries from 33 hurricanes between 1999 and 2019, using a novel dataset of residential and commercial losses. I estimate the average effect of local finance and identify necessary conditions allowing lenders to mitigate employment shocks. The evidence consistently shows that higher access to local finance dampens the county employment contractions at the average industry, at individual sectors (except manufacturing), at smaller businesses, and dur- ing block-buster/less-costly disasters. Community banks aid the recovery by both identifying firms with potential to survive and avoiding direct loan losses. To support the former, I show that local finance has a stronger effect in more productive counties. In support of the latter, I show that local finance has a stronger effect in more spatially/geographically dispersed counties, and that smaller community banks outperform/lend more than bigger ones within affected counties.

Bank Competition and Firm Credit Availability: Firm-Bank Evidence From Europe

We examine the impact of bank competition on firms' access to credit using a large panel of 900 banks matched to almost 60.000 firms across the euro area over the period 2010-2016. Results provide empirical support for the market power hypothesis whereby low inter-bank competition worsens firms' credit conditions. Specifically, we find that higher bank market power is associated with lower short and long-term bank credit, higher reliance on trade credit and higher funding costs for corporate borrowers. Furthermore, the effect of bank competition is heterogeneous across firms and banks. On the one hand, high bank market power is especially detrimental for small and opaque firms, suggesting that low competition exacerbates the financial constraint of borrowers most exposed to information problems. On the other hand, the reduction in credit availability associated with high market power is attenuated for firms that borrow from small and local community banks, a finding consistent with the information hypothesis, whereby low competition increases banks’ incentive to supply relationship loans. On balance, however, the predominance of medium-large commercial banks in our sample determines that the overall effect of low inter-bank competition on credit conditions is unequivocally adverse for most firms, i.e. the market power effect outweighs the information effect. This evidence contributes to previous research on bank competition, firms’ credit constraint and relationship lending, and has implications for competition policy. Indeed, with respect to the prospect of greater banking consolidation in the European Union, our results suggest that considerations of efficiency and financial stability should be weighed against the potential negative consequences in terms of firms’ access to credit.

Winners and losers from financial derivatives use: evidence from community banks

ABSTRACTThis article provides empirical evidence on how profitability of small community banks was affected by derivatives use before and after the 2008 crisis. We use an endogenous switching regressions model to estimate the sensitivity of bank profitability to risks and control for the endogenous choice to use or not to use derivatives. We then compute counterfactual effects and show how profitability would have looked without derivatives use for banks that used derivatives and how it would have looked with derivatives for banks that did not use derivatives. The results show that derivatives helped reduce the sensitivity of profitability to credit risks and improved profitability for most specialists. However, for the largest number of banks which are non-user non-specialists, devivates use would have resulted in lower return on assets had they used derivatives post 2008. Therefore, our evidence suggests that implementation of the Volcker Rule, imposing high compliance costs on community banks and, thus, discouraging hedging, may have a negative impact on profits of specialists banks but, overall, a neutral effect on profits in the community banks industry as a whole.

How Bad is a Bad Loan? Distinguishing Inherent Credit Risk from Inefficient Lending (Does the Capital Market Price this Difference?)

We develop a novel technique to decompose banks’ ratio of nonperforming loans to total loans into three components: first, a minimum ratio that represents best-practice lending given the volume and composition of a bank’s loans, the average contractual interest rate charged on these loans, and market conditions such as the average GDP growth rate and market concentration; second, a ratio, the difference between the bank’s observed ratio of nonperforming loans, adjusted for statistical noise, and the best-practice minimum ratio, that represents the bank’s proficiency at loan making; third, a statistical noise. The best-practice ratio of nonperforming loans, the ratio a bank would experience if it were fully efficient at credit-risk evaluation and loan monitoring, represents the inherent credit risk of the loan portfolio and is estimated by a stochastic frontier technique. We apply the technique to 2013 data on top-tier U.S. bank holding companies which we divide into five size groups. The largest banks with consolidated assets exceeding $250 billion experience the highest ratio of nonperformance among the five groups. Moreover, the inherent credit risk of their lending is the highest among the five groups. On the other hand, their inefficiency at lending is one of the lowest among the five. Thus, the high ratio of nonperformance of the largest financial institutions appears to result from lending to riskier borrowers, not inefficiency at lending. Small community banks under $1 billion also exhibit higher inherent credit risk than all other size groups except the largest banks. In contrast, their loan-making inefficiency is highest among the five size groups. Restricting the sample to publicly traded bank holding companies and gauging financial performance by market value, we find the ratio of nonperforming loans to total loans is on average negatively related to financial performance except at the largest banks. When nonperformance, adjusted for statistical noise, is decomposed into inherent credit risk and lending inefficiency, taking more inherent credit risk enhances market value at many more large banks while lending inefficiency is negatively related to market value at all banks. Market discipline appears to reward riskier lending at large banks and discourage lending inefficiency at all banks.

Does Scale Matter in Community Bank Performance? Evidence Obtained by Applying Several New Measures of Performance

We consider how size matters for banks in three size groups: banks with assets of less than $1 billion (small community banks), banks with assets between $1 billion and $10 billion (large community banks), and banks with assets between $10 billion and $50 billion (midsize banks). Community banks have potential advantages in relationship lending compared with large banks. However, increases in regulatory compliance and technological burdens may have disproportionately increased community banks’ costs, raising concerns about small businesses’ access to credit. Our evidence suggests that: (1) the average costs related to regulatory compliance and technology decrease with size; (2) while small community banks exhibit relatively more valuable investment opportunities, larger community banks and midsize banks exploit theirs more efficiently and achieve better financial performance; (3) unlike small community banks, large community banks have financial incentives to increase lending to small businesses; and (4) for business lending and commercial real estate lending, large community banks and midsize banks assume higher inherent credit risk and exhibit more efficient lending. Thus, concern that small business lending would be adversely affected if small community banks find it beneficial to increase their scale is not supported by our results.

Community bank structure an x-efficiency approach

Community banks have historically been important sources of intermediary services. Changes in regulation and intermediation technologies have affected the efficiency with which these firms can perform these services. Relatively small community banks, those with assets of $1 billion or less, have experienced particular changes in their ability to generate loan products as efficiently as their larger counterparts. Using FFIEC data for all banks of $10 billion or less, we measure the x-efficiency of all community banks and compare the results of small and all other community banks since 2010. We test for the importance of internal and external determinants of efficiency. We observe that declines in product provision are related to specific determinants of declining x-efficiency in small community banks. The results indicate limited assets or customer growth rates experienced by small community banks, coupled with a declining population in community bank trade areas, do not support improvements in x-efficiency through expanded intermediation activity. Small asset community bank managers will need to strategically deploy products that allow the customer relationship to be enhanced and sustained, using customer affiliations that cannot be easily adopted by larger competitors.

How Small Banks Deal with Large Shocks

After a natural disaster such as a hurricane, tornado, or flood, banks in the affected area experience a sharp rise in the demand for loans as property owners look to repair the damage. Recent research has focused on such events to study how small community banks adjust their typical way of doing business to respond to large shocks. The research finds that banks strategically adjust their business in three ways to meet the increased demand. Two adjustments increase the funds available for lending, while one shifts lending from areas unaffected by the disaster to the affected area, a strategy that extends the negative impact of large shocks to distant areas otherwise untouched by the disaster.

The State and Fate of Community Banking

This working paper focuses on the plight of community banks in the United States. It begins by examining different definitions of what constitutes a community bank, and goes on to review what makes these institutions unique and distinguishes them from larger regional or national peers. Our assessment of Federal Deposit Insurance Corporation data finds that community banks service a disproportionately large amount of key segments of the U.S. commercial bank lending market – specifically, agricultural, residential mortgage, and small business loans. However, community banks’ share of U.S. banking assets and lending markets has fallen from over 40 percent in 1994 to around 20 percent today. Interestingly, we find that community banks emerged from the financial crisis with a market share 6 percent lower, but since the second quarter of 2010 – around the time of the passage of the Dodd-Frank Act – their share of U.S. commercial banking assets has declined at a rate almost double that between the second quarters of 2006 and 2010. Particularly troubling is community banks’ declining market share in several key lending markets, their decline in small business lending volume, and the disproportionate losses being realized by particularly small community banks. We review studies on the impact of regulation, consumer trends and other factors on community banks, and examine the consequences of consolidation on U.S. lending markets. We conclude with a discussion of policies that could promote a more competitive and robust banking sector.

Competitive Operations Priorities and Firm Performance in Small Community Banks: A Test of Trade-offs

IntroductionThe concept of competitive priorities has been widely adopted by operations strategy researchers (Ward, McCreery, Ritzman, & Sharma, 1998; Avella, Vazquez-Bustelo, & Fernandez, 2011), and these researchers continue to produce a growing body of literature on manufacturing operations strategy, including the identification of competitive strategies, the process for developing and implementing strategies, and the relationship between strategy and performance (Kroes & Ghosh, 2010; Ferdows & De Meyer, 1990; Noble, 1995; Skinner, 1969; Ward, Leong, & Boyer, 1994). However, despite growing interest in the topic, the concept has been rarely applied to firms outside of a manufacturing context. Moreover, there have been few attempts to assess the value of these priorities in smaller firms. This work submits that it is imperative that this work be extended to these contexts if this worthwhile sub-field is to add value outside of operations management.One such context, community based banking, is undergoing a revolutionary transformation as these institutions attempt to recover and reorganize after a deep recession (Prasad, Tata, and Guo, 2012). This study contends that a study targeted at these firms and their use of competitive operations priorities is timely, and may provide valuable insights for firms existing in this turbulent sector. To assist these firms in overcoming the effects of this downturn, and prepare for the next, researchers, policy-makers and managers need to have an understanding of the competitive operations priorities that are most important to them. More importantly, managers need to understand how selected priorities relate to firm performance.It is the goal of this research to empirically explore this relationship. The extant literature regarding competitive priorities is first reviewed. This literature is then wedded with established strategic management theory. In this literature review, the focus is on the few studies that have been published utilizing samples of smaller firms and banking firms. After stating theoretically derived hypotheses, the study utilizes a valid and reliable scale to examine the competitive priorities in a sample of small, community based banks. Finally, the relation between these priorities and firm performance is empirically explored. Results and implications are then discussed.Competitive Operations Priorities and Strategic ManagementThe process of formulating strategy requires decisions about how resources should be managed in order to achieve goals and build capabilities. Much of the theory about strategies at the operational level of organizations developed from ideas proposed by Skinner (1969). He suggested that manufacturing strategy should support the corporate strategy of the company. To accomplish this, manufacturing choices are made among alternatives such as lower costs, better quality, and dependable delivery. Four widely recognized manufacturing strategies consisting of cost, quality, flexibility, and dependability evolved from the work of Skinner (1969, 1978) and others, including Ferdows and De Meyer (1990), Noble (1991), Hayes and Wheelwright (1984), and Hill (1989). Notably, as the field of manufacturing strategy developed, researchers used various terms to describe strategic attributes. In this study, the term competitive operations priorities (e.g. Diaz, Machuca, & Alvarez-Gil, 2003) is used to identify operational-level strategic alternatives that firms may emphasize in the pursuit of competitive advantage. It might also be noted that, after some initial vacillation, the extant literature coalesced around these four priorities some 20 years ago and did not evolve extensively. As a result the base of literature on the construct of competitive operations priorities is somewhat dated. Below this literature is developed and definitional choices are elucidated.The extant literature with regard to competitive priorities in service firms is far less developed, but not insignificant (e. …

Bank size, lending paradigms, and usage of Farm Service Agency's guaranteed loan programs

Purpose – An established paradigm in small business lending is segmented by bank size with large banks more likely to lend to large informationally transparent firms while small banks are more likely to lend to small informationally opaque firms. In light of banking consolidation, this market segmentation can have implications for credit availability. Federal loan guarantees, such as those provided by USDA's Farm Service Agency (FSA) may reduce the risks of lending to informationally opaque firms thereby mitigating the impacts of the bank size lending paradigm. This paper aims to discuss these issues. Design/methodology/approach – This analysis utilized a binomial logit procedure to determine if there was any empirical evidence that smaller community banks served a unique clientele of farmers when making FSA-guaranteed loans. The analysis relied on a unique data set which incorporated detailed data on farm businesses receiving FSA-guaranteed loans, loan characteristics, as well as information about the originating bank and characteristics of the local credit markets. Findings – Results were consistent with the bank size lending paradigm with smaller banks being less likely to engage in fixed-asset lending, and more likely to serve a riskier and less established clientele when making guaranteed loans. Research limitations/implications – Data limitations did not permit detailed analysis of banks larger than $250 million in total assets nor for consideration of non-bank lenders. An expansion by these lender groups into serving more informationally opaque borrowers could mitigate any adverse impacts arising from fewer small community banks. Practical implications – The results suggested that Federal guarantees do not completely eliminate the relative informational advantages of large and small size banks. And, continued bank consolidation, such that there are fewer small community banks, could result in less credit availability among smaller, less creditworthy farm businesses. Social implications – While FSA guarantees may not enhance a large banks propensity to serve informationally opaque farm borrowers, they may enhance the ability of smaller community banks to serve groups specifically targeted through FSA lending programs; the provision of credit to family farmers who, despite being creditworthy, are unable to obtain credit at reasonable rates and terms. Originality/value – The analysis examines relationship between bank size and the use of FSA guarantees using a unique data set which incorporated information on FSA-guaranteed loans, farm financial characteristics, along with characteristics of commercial banks which participated in the FSA-guarantee program.

Do Small Businesses Still Prefer Community Banks?

We formulate and test hypotheses about the role of bank type – small versus large, single-market versus multimarket, and local versus nonlocal banks – in banking relationships. The conventional paradigm suggests that "community banks" – small, single market, local institutions – are better able to form strong relationships with informationally opaque small businesses, while "megabanks" – large, multimarket, nonlocal institutions – tend to serve more transparent firms. Using the 2003 Survey of Small Business Finance (SSBF), we conduct two sets of tests. First, we test for the type of bank serving as the "main" relationship bank for small businesses with different firm and owner characteristics. Second, we test for the strength of these main relationships by examining the probability of multiple relationships and relationship length as functions of main bank type and financial fragility, as well as firm and owner characteristics. The results are often not consistent with the conventional paradigm, perhaps because of changes in lending technologies and deregulation of the banking industry.