# Presentation: 685009

## Small Banks and Deposit Insurance: The U.S. Experience

**Rural Finance Seminar**
**Challenges and Opportunities **
**in the U.S. and China**
- Presentation by
- Christine Blair, Sr. Financial Economist
- Alan Bush, Regional ManagerFederal Deposit Insurance Corporation
- May 22, 2008

## Small Banks and Deposit Insurance: The U.S. Experience

- Outline of presentation
- Small banks and the U.S. banking industry:  structure and characteristics
- Small-bank business model
- Role of deposit insurance
- Challenges and prospects

## Small Banks and Deposit Insurance: The U.S. Experience

- The FDIC plays several roles:
- Deposit insurer
- Insure deposits at member institutions
- Approve applications for deposit insurance concurrently with the chartering decision made by the states, OCC and OTS
- Regulator and supervisor of state-chartered (non-member) banks and state-chartered savings banks
- Receiver for failed banks
- Maximize return on failed-bank assets and minimize cost to the deposit insurance fund

## U.S. Banking Industry:Structure and Characteristics

- U.S. banking system has some of the world’s largest banking organizations and thousands of relatively small banks
- Large, complex banking organizations
- the top 25 organizations in terms of assets
- Regional and other mid-sized banks
- assets greater than $1 billion but less than the assets of the smallest of the top 25 banks
- $77 billion as of year-end 2007
- Small or community banks
- less than $1 billion in assets

## Slide 5

| Table 1
FDIC-insured Institutions by Number and Asset Size 
December 31, 2007 |  |  |  |  |  |
| --- | --- | --- | --- | --- | --- |
| All FDIC-insured institutions |  | Asset Size Distribution |  |  |  |
|  |  | Less than $100 million | $100 million to $1 billion | $1 billion to $10 billion | Greater than $10 billion |
| Number of institutions | 8,533 | 3,440 | 4,425 | 549 | 119 |
| Commercial banks | 7,282 | 3,065 | 3,706 | 425 | 86 |
| Savings institutions | 1,251 | 375 | 719 | 124 | 33 |
| Total Assets (in billions) | $13,038.8 | $181.9 | $1,310.1 | $1,420.3 | $10,126.5 |
| Commercial banks | $11,176.1 | $162.9 | $1,062.1 | $1,112.7 | $8,838.4 |
| Savings institutions | $1,862.7 | $19.0 | $247.9 | $307.5 | $1,288.2 |
| Source:  FDIC Quarterly Banking Profile Fourth Quarter 2007   |  |  |  |  |  |

## Slide 6

| Table 2
FDIC-insured Institutions 
by Type of Institution and Primary Federal Regulator 
December 31, 2007  
($ in millions) |  |  |  |  |
| --- | --- | --- | --- | --- |
| Commercial Banks and
 Savings Institutions  | Number of
 Institutions | Total Assets | Domestic
 Deposits | Estimated
Insured
Deposits  |
| FDIC-Insured Commercial Banks  | 7,282 | 11,176,096 | 5,806,795 | 3,426,148 |
|    FDIC-Supervised | 4,772 | 1,874,698 | 1,370,557 | 927,470 |
|    OCC-Supervised | 1,632 | 7,782,387 | 3,590,744 | 1,995,866 |
|    Fed-Supervised  | 878 | 1,519,012 | 845,494 | 502,812 |
| FDIC-Insured 
Savings Institutions  | 1,251 | 1,862,669 | 1,104,986 | 860,936 |
|    FDIC-Supervised | 425 | 305,999 | 212,394 | 164,101 |
|    OTS-Supervised   | 826 | 1,556,670 | 1,104,986 | 696,835 |
| Total  | 8,533 | 13,038,765 | 6,920,667 | 4,293,201 |
| Source:  FDIC Quarterly Banking Profile Fourth Quarter 2007   |  |  |  |  |

## Slide 7

| Table 3
FDIC-insured Institutions, December 31, 2007 
by Agricultural Lending Specialization and Rural Location 
($ in millions) |  |  |  |  |
| --- | --- | --- | --- | --- |
|  | Number of
 Institutions | Total Assets | Domestic
 Deposits | Estimated
Insured
Deposits  |
| FDIC Insured Institutions | 8,533 | 13,038,765 | 6,920,667 | 4,293,201 |
|     Agricultural Banks | 1,591 | 157,474 | 128,160 | 99,416 |
|     All Other Institutions | 6,942 | 12,881,291 | 6,792,507 | 4,193,785 |
|     Agricultural Banks (share,%) | 18.6% | 1.2% | 1.9% | 2.3% |
| FDIC Insured, Located in Rural Areas | 2,129 | 287,107 | 233,651 | 177,560 |
|     Agricultural Banks | 975 | 82,526 | 68,413 | 53,350 |
|     All Other Institutions | 1,154 | 204,581 | 165,238 | 124,510 |
|     Agricultural Banks 
         (Share, %) | 45.8% | 28.7% | 29.3% | 30.0% |
| Source:  FDIC 
Note:  Agricultural Banks have 25 percent of total loans and leases invested in agricultural production or farmland loans.  Rural areas are more sparsely populated areas and are outside micropolitan or metropolitan areas. |  |  |  |  |

## Rural America

**Rural America**

**Banks in Rural America (as of year-end 2007)**

**Rural Bank Failures Have not been Geographically Clustered**

**Sources: FDIC, Census Bureau**

## U.S. Banking Industry:Structure and Characteristics 

- Exit of banks through mergers and failures
- Extensive consolidation over past two decades (after product and geographic restrictions on branching were lifted) affected banks of all sizes
- Although the number of banks fell by 49 percent since 1985, the small-bank share of all U.S. banks has remained stable—about 94 percent
- Entry of new banks
- Chartering of new banks—called de novo banks—dampened the effect of mergers and failures
- About 1,250 new community banks were established between 1992 and 2003

## Slide 10

| Table 4
FDIC-insured Institutions
Structural Changes in 2007 |  |  |  |  |  |
| --- | --- | --- | --- | --- | --- |
| Structural 
Changes  | All FDIC-insured institutions | FDIC-insured Institutions by Asset Size  |  |  |  |
|  |  | Less than $100 million | $100 million to $1 billion | $1 billion to $10 billion | Greater than $10 billion |
| New Charters 
(de novo institutions) | 181 | 174 | 5  | 2 | 0 |
| Institutions absorbed by mergers  | 321 | 114 | 167 | 31 | 9 |
| Failed Institutions  | 3 | 2 | 0 | 1 | 0 |
| Source:  FDIC Quarterly Banking Profile Fourth Quarter 2007   |  |  |  |  |  |

## Small-Bank Business Model

- Loan-to-one-borrower limits affect small business lending
- By law, the amount any bank may lend to a single borrower is limited to a percentage of its unimpaired capital and surplus
- 15 percent if loan is not fully secured
- Implication:  small banks specialize in small loans

## Small-Bank Business Model 

- Niche banking and innovation
- Provide credit to important segments of the business-loan and farm-loan markets
- Small commercial and farm real estate
- Small business C&I, small farm operating loans

## Small-Bank Business Model 

- Able to successfully lend to “informationally opaque” borrowers
- Know their customer base
- Excel at underwriting small heterogeneous business loans
- Where larger banks rely on credit scores, small banks actively review each loan
- Automated securitization is not their business model

## Small-Bank Business Model 

- Rely on core deposits—domestic deposits less time deposits over $100,000—for their funding, unlike large banks
- Charge lower fees for deposit services
- Pay higher rates on retail deposits
- Supplement core deposits with Federal Home Loan Bank borrowings

## Banks in Rural Areas Are More Dependent on Core Deposits

## Small-Bank Business Model

- Competitive advantage in personal service
- Market personal service, local connections
- Active in communities
- Serve small relationship-based customers
- Why de novo institutions thrive in areas where mergers and consolidation have affected the community

## Small-Bank Business Model

- Although profitable, small banks’ average ROA is lower than that of large banks
- Large percentage of assets in non-taxable lower-yielding municipal bonds
- Commercial real estate development lending
- Weak point for small banks during the U.S. banking crisis of the 1980s and early 1990s
- 2008?

## Confidence Provided by Deposit Insurance Halted Panics and Allows for a More Orderly Resolution

- American Union Bank, New York – Closed June 30, 1931

## The Role of Deposit Insurance

- Deposit insurance is important to small banks
- Protects insured depositors against the consequences of a bank failure and instills public confidence
- Insured deposits: a safe haven in turbulent times
- Consumer: greater confidence about saving
- Lenders: funding stability promotes lending in the community

## The Role of Deposit Insurance

- Coverage limits matter
- Core deposits are an important funding source
- Community banks and their trade associations actively lobby for expanded coverage
- Federal Deposit Insurance Reform Act of 2005
- Coverage up to $250,000 extended to retirement accounts
- Indexation for inflation begins in 2011

## The Role of Deposit Insurance

- Small banks’ prospects are important to the FDIC
- Small-bank failures have represented a disproportionate share of FDIC losses in recent years
- Rapid growth, high-risk policies can lead to high resolution costs
- Less likely with larger banks

## Challenges and Prospects

- Rapid growth of the largest banking organizations presents challenges to the FDIC and small banks
- Size relative to the deposit insurance fund
- Basel II
- Should small banks be isolated from the effects of large-bank failures?
- Capital adequacy standards and supervision
- Optimally pricing deposit insurance
- Separate safety net for small banks

## Challenges and Prospects

- The small or community bank is a viable business model
- Informational advantages as lenders to “informationally opaque” borrowers
- Small business, small farmers, borrowers who lack long credit histories
- Higher risk-adjusted returns on business loans than large banks
- Private investment in de novo banks

## Small Banks and Deposit Insurance: The U.S. Experience

- Sources:
*FDIC Quarterly Banking Profile*
- _[http://www2.fdic.gov/qbp/index.asp](http://www2.fdic.gov/qbp/index.asp)__ _
- Community Banks:  Their Recent Past, Current Performance, and Future Prospects *FDIC Banking Review*  2004, volume 16, no. 2:1-56.
- Rural Depopulation:  What Does It Mean for the Future Economic Health of Rural Areas and the Community Banks that Support Them? *FDIC Banking Review*  2004, volume 16, no. 2:57-96.