For release on delivery
9:30 a.m. EDT (8:30 a.m. CDT)
October 1, 2019
Advancing Our Understanding of Community Banking
Remarks by
Michelle W. Bowman
Member
Board of Governors of the Federal Reserve System
at
"Community Banking in the 21st Century"
2019 Community Banking Research and Policy Conference sponsored by
the Federal Reserve System, the Conference of State Bank Supervisors, and
the Federal Deposit Insurance Corporation
St. Louis, Missouri
October 1, 2019
It is a special honor for me to be part of this conference and its tradition of
advancing our understanding of how banking shapes our economy and our communities.1
As a community banker, I sought out actionable research that I could leverage to better
serve my customers and my community. As a state bank regulator, I conducted my own
research to answer questions about issues affecting the banks my agency regulated. I also
appreciated learning what researchers thought would provide better insight into the
industry. Today I am honored to be here as the first person to serve on the Federal
Reserve Board in the role that the Congress designated for someone with community
banking or state supervisory experience. My work at the Board has given me an even
greater appreciation for how creative, insightful research informs and shapes policy
decisions that support our economy. But it also tells me there is still much to be learned
and many additional areas that deserve more exploration.
More than 10 years on, as the entire banking industry continues to evolve post-
crisis, I would like to share with you some of my thoughts and observations on the forces
influencing the future of banking, and community banking in particular. I will also
suggest some areas where policymakers could use the help of researchers, bankers, and
state supervisors to better understand how community banking is changing and how we
can better provide a path for the continued viability of this sector and its business model.
I hardly need to tell this audience that community banks play a vital role in the
financial services industry and in the economy. From my perspective, the Federal
Reserve supports community banks as a central component of a strong, resilient, and
stable financial system. Our system is made more resilient through a broad and varied
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range of institutions serving different types of customers, with community banks
providing access to credit and other financial services in towns and cities across America.
With the support of community bankers, these investments are the building blocks of a
strong community and help support a vibrant economy across the country-from here in
the Midwest to the coasts on either side.
Research on community banking and the accessibility of financial services is
incredibly important. Community bankers and policymakers want to better understand
how technology, competition, regulation, and other factors are driving decision making,
consolidation, and the other challenges and opportunities that are shaping community
banking. Existing research provides us with some answers to these questions, but there
are many gaps. The lack of a full understanding of these institutions, their functionality,
and their needs may limit our ability to identify important areas of focus for research.
This is where I would like to ask for your expertise and assistance. We need to
challenge ourselves to tackle some questions and issues that have not been fully explored
by researchers. If you are a community banker, are involved in economic development or
city or county management, or live in a community served by a community bank, your
own experiences likely provide anecdotal evidence regarding the answers to these
questions, but research can provide more comprehensive and systematic evidence,
leading to more definitive answers. So I need your help. To begin, let's look at the
questions.
Community banks provide a variety of benefits to their communities, but these
benefits can be difficult to quantify and measure. Therefore, economists and
policymakers would like to be able to define and understand the full economic effects of
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a community bank in an area that relies on it and identify the different channels by which
a community bank finances spending, investment, economic development, and job
creation. In addition, what happens to a community when a bank headquartered or
chartered in that community is acquired by a financial institution located elsewhere? Can
we calculate the cumulative contribution of community banks to U.S. investment,
employment, and economic output? I hope that presentations at future community
banking research conferences can help answer some of these questions and provide a
stronger foundation for policy development.
Perhaps as a baseline for this discussion, we can start by looking at what has
happened to the structure of the banking industry since the financial crisis. While
community banks face considerable challenges, in general they have emerged from the
last decade as strong competitors: On average, they have grown somewhat larger and
have expanded their geographic footprints. In other words, we have a more resilient,
stronger community banking sector, but one with fewer locally headquartered banks.
With that in mind, let's look at what leads me to these conclusions. As seen in
figure 1, it is true that there are now many fewer small community banks-those with
less than $250 million in assets-than there were in 2011.2 At the same time, the
numbers of both large community banks and banks over $10 billion in assets (non-
community banks) haven't changed much.
What do we find when we dig a little deeper? As shown in figure 2, very few
small community banks failed or were liquidated in the past eight years-just over
100 banks, or 2 percent, of the total number in this size category as of 2011. About
2
Assets are in constant 2018 dollars.
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2,800 banks, well over half of this original group, had no change in ownership and stayed
below $250 million in assets. About 470 banks, or 10 percent of the initial number, had
grown and are now above $250 million in assets.
And over this time, just over one-fourth of the smallest community banks, nearly
1,200 of them, were acquired by other banks. That is certainly a large number of
acquisitions. But, again, let's look a little deeper. A fair share of those acquired banks-
one in five-were acquired by another bank within the same holding company (figure 3).
You could consider that more of a reorganization at the holding company level rather
than an acquisition by a competitor. The remaining banks-20 percent of the smallest
banks operating in 2011-were acquired by another financial institution. Seventeen of
the acquisitions, about one and a half percent, were acquisitions of a small community
bank by a credit union, while 14, just over one percent, involved a non-community bank
acquirer with over $10 billion in assets. In other words, approximately four out of five of
the small banks that were acquired during this period, or about 930 banks, were acquired
by another community bank.3
To better understand what is happening with these institutions, we looked at
several potential differences between small community banks that have been acquired
and those that were not. Was it the smallest community banks, or those with the smallest
markets, that were most likely to be acquired? It turns out that the key difference
between these banks was not their geographic reach or their size, but rather their
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profitability. We find that small banks that were acquired by another institution were, on
average, about the same size and geographic scope as other small banks but they were
less profitable. This fact challenges the notion held by some that small scale or operating
in a very limited geographic area is a disadvantage and it shows that many small, locally
focused banks are performing well in a changing and challenging marketplace.
Bank regulators should understand how the evolving structure of community
banking has affected customers and how regulations can be tailored to limit the extent to
which consolidation is driven by unnecessary, ineffective, or excessive regulatory
burden. Unfortunately, current research does not provide enough evidence to
conclusively answer these questions. Earlier research has shown that technological
change and the removal of regulatory restrictions on interstate banking in the 1980s and
1990s have played important roles in driving consolidation.4
We can gain more insight into the factors that underlie changes in community
banking by asking community bankers. My former colleagues at the Conference of State
Bank Supervisors (CSBS) have done that in their community bank survey and the
companion "Five Questions for Five Bankers" interviews.5
Results of the 2019 survey will be revealed during the next session, but I don't
think I am giving too much away to share that the factors mentioned as driving
consolidation this year remain consistent with previous results. The 2018 survey shows
that among banks indicating that they had received and seriously considered accepting an
acquisition offer from another institution during the previous 12 months, a large majority
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say the cost of regulations or the lack of economies of scale at their current size are
"important" or "very important" in their decision to consider the offer. About half
mention succession issues. The survey did not ask which factor bankers consider most
important, and there are many possible reasons a bank would consider selling. But it
should not be surprising that the cost of regulation is cited as a leading factor by nearly
75 percent of these respondents.
What about those who made an offer to buy another bank during the past year? A
majority, 8 out of 10, cite economies of scale as a factor in making an acquisition offer.
Other common motivations include the desire to enter a new market, the ability to exploit
underutilized potential at the target institution and the desire to expand within an existing
market. I find these results very encouraging, reflecting an industry that believes in the
future of community banking and is taking steps to invest in that future.
While it was not addressed in this part of the survey, it seems to me that the cost
of regulation could have been a factor in making acquisition offers, possibly based on the
theory that there could be efficiency gains by spreading fixed regulatory costs over a
larger firm. It is possible these savings may have been a factor for the roughly 80 percent
who cited "economies of scale." More detailed questions in future surveys could provide
firmer evidence about the effect of regulatory costs on decisions related to consolidation.
The "Five Questions for Five Bankers" initiative provides many additional
insights into the forces driving change in community banking. I find this initiative
particularly valuable, because it is conducted by state banking commissioners who I
know from my experience have deep insights into conditions in their states. Last year,
28 commissioners conducted structured interviews with a small number of community
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bankers in their states. The results show that bank consolidation is widely viewed as a
trend that will continue into the future. Many bankers see that as a concern, but others
see consolidation as an opportunity. Bankers from many states cited regulatory burden or
compliance costs as major factors driving consolidation. Other frequently mentioned
motives for consolidation were the costs of keeping up with technological change and the
need to scale up in order to compete in a technology-focused landscape and with non-
bank fintech firms in some service areas. Succession planning and finding employees
were other common concerns, and bankers in a few states mentioned population decline
in some rural areas as a significant issue driving the consolidation trend.
The Five Questions interviews provide a wealth of anecdotes about industry
trends, and I would encourage researchers to consider utilizing the detailed interview
approach in exploring the causes and effects of community bank consolidation.
It is important to point out that many of the changes to community banking
through consolidation that I have described, in a general sense, are a natural and often
desirable consequence of competition in a vibrant market economy. However,
consolidation is less desirable when it limits access and choice for customers without
other benefits, or when it is an unintended effect of government regulation and the cost of
that regulation rather than a result of vigorous competition.
This isn't news to community bankers or to community banking researchers. It is
not news to many people who live in small towns or urban areas who have lost access to
community banks with deep roots in the community. And it is a major challenge for
those who live in areas that lack access to service from any bank.
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Acquiring banks need to consider that when you purchase a community bank and
enter into a new market, along with the new customers and opportunities come a
responsibility to be a part of and to support that community. That is why I believe it is
critical that we work together to find ways to preserve the benefits provided to
communities by well-managed, strong financial institutions that are deeply grounded in
the areas they serve-including the communities that they expand or merge into.
Now let's consider how the changes I have described in the banking industry have
affected the benefits provided to local communities across the United States. One might
expect that the decline in the number of banks over the past few decades would mean
communities would see fewer banks operating within the average local banking market.
In fact, when viewing the data in a national perspective, the number of banks per local
market has been quite stable over time in both urban and rural areas. There may be two
factors that explain this outcome. First, many bank mergers combine firms that do not
operate in the same local area, so they don't reduce the number of competitors in any
market. Second, many banks continue to expand their geographic scope by opening
branches in new markets, leading to an increase in the number of banks in those local
areas that offsets the decline from bank mergers in the same market.
Of course, stability in the average number of banks across a large number of
markets does not imply stability locally within each market. Many local markets have
seen declines in the number of banks, while others have experienced increases. And even
if the number of banks in a community does not change, there is a difference for
customers and communities between a branch of a bank with numerous locations and the
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headquarters of a bank that is strongly rooted in a community. For example, does bank
consolidation influence the availability of credit to local small businesses?
A number of studies have addressed this question and have yielded mixed results.
The effect of a merger on small business lending depends on a number of factors,
including the size of the merging banks, whether the acquirer is focused on small
business lending, and the response of other local banks to the merger.6 Studies have also
shown that the post-merger bank tends to be healthier than the target institution was
before the merger, which could to lead to an increase in the availability of credit in the
community.7 The bottom line is that some studies find small business lending goes up
after mergers, and others find it goes down. Given the wide range of results, this is
another topic where policymakers and the public would benefit from further research and
analysis.
One very clear trend in the United States is a decline in the number of bank
headquarters. Acquisitions have resulted in the conversion of many bank headquarters
into new branches of the acquiring institution. Unfortunately, some evidence suggests
that these conversions may adversely affect the local communities that are no longer
home to a headquarters. The impacts extend well beyond the availability of credit. Bank
executives and staff who serve on the local chamber of commerce or on the boards of
local hospitals or nonprofits may move to the new headquarters location, creating a
leadership void in their old hometown.
Unfortunately, community involvement like this is difficult to measure. We
turned to Community Reinvestment Act (CRA) performance evaluations in the hope that
they would offer some insights into local involvement by banks. Because certain
institutions are subject to community development tests, their performance evaluations
include information on the bank's qualifying loans, investments (including donations)
and services, grants, and certain community service activities.8
Comparing performance evaluations from CRA exam reports before and after an
acquisition can provide some limited, case-specific evidence on the potential
consequences of the loss of a bank headquarters. Several examples from the past decade
show that local donations and community service activity decline in communities that
lost a bank headquarters following a merger. Pre-merger CRA evaluations detailed
donations to organizations targeting initiatives such as child care, job training, homeless
shelters, and scholarship programs for low- and moderate-income (LMI) individuals.
Other notable activities included in-kind donations of real estate to Habitat for Humanity
and monetary contributions to food pantries, Meals on Wheels, and Big Brothers Big
Sisters of America. Bank officers and employees also donated significant time to
community service including through financial education to LMI individuals, mentoring
programs, and service on the boards of local housing development agencies. Many of
these benefits were lost after a merger. The wealth of information that supervisors
include in the CRA reports offers a unique look into the type of involvement that
communities potentially stand to lose when headquarters move or are eliminated. More
research into the effects of losing a bank headquarters could help determine whether
these examples are isolated or a predictable result of consolidation.
In closing, let me return to the question of what we know and what we would like
to know. We know that consolidation accelerated after the Congress removed barriers to
interstate banking, and that it has proceeded more or less steadily since that time. We do
not know if and to what extent other factors-such as achieving a desired level of
economies of scale, for example-have been driving consolidation. We have recently
seen a rising number of acquisitions by credit unions, and we do not fully understand the
implications of this trend, which seems likely to continue to accelerate. We know that
profitability is a more important factor in predicting acquisitions than bank size or
geographic area, but more research on why some smaller banks are more profitable than
others could be valuable. We know from the CSBS surveys that regulatory costs are
motivating banks that are considering selling or merging, and we could learn more about
what is motivating buyers.
Deeper and more creative research is certainly needed to understand how
acquisitions affect many communities, small businesses, and consumers. One factor is
the vital leadership and supporting role many small banks play in their communities.
While that benefit may be hard to measure, I think it is essential that researchers try to do
so. Communities need leaders and institutions that are deeply rooted in their cities,
towns, and rural areas. Strong relationships and extensive experience are not easily
replaced.
Finally, it is important that we understand why so few new banks have been
created. Are asset thresholds too high? Are regulations too burdensome? Or have low
interest rates meant that net interest rate margins are just too narrow? Understanding the
lack of new bank formation is as important as understanding the extent of consolidation
and competition.
I am sure you have noticed that I have given you more questions than answers
today. That was one of my goals, because I am confident that as researchers you have the
skills and creativity to focus on the best questions and find the most insightful answers.
And when you do uncover new insights, my colleagues and I will always be eager to
learn from and act on what you have found.
References
Avery, Robert B., and Katherine A. Samolyk (2004). "Bank Consolidation and Small
Business Lending: The Role of Community Banks," Journal of Financial
Services Research, vol. 25 (April), pp. 291-325.
Berger, Allen N., Rebecca S. Demsetz, and Philip E. Strahan (1999). "The Consolidation
of the Financial Services Industry: Causes, Consequences, and Implications for
the Future," Journal of Banking and Finance, vol. 23 (February), pp. 135-94.
Berger, Allen N., Anthony Saunders, Joseph M. Scalise, and Gregory F. Udell (1998).
"The Effects of Bank Mergers and Acquisitions on Small Business Lending,"
Journal of Financial Economics, vol. 50 (November), pp. 187-229.
Focarelli, Dario, Fabio Panetta, and Carmelo Salleo (2002). "Why Do Banks Merge?"
Journal of Money, Credit and Banking, vol. 34 (November), pp. 1047-66.
Jagtiani, Julapa, Ian Kotliar, and Raman Quinn Maingi (2016). "Community Bank
Mergers and Their Impact on Small Business Lending," Journal of Financial
Stability, vol. 27 (October), pp. 106-21.
Peek, Joe, and Eric S. Rosengren (1998). "Bank Consolidation and Small Business
Lending: It's Not Just Bank Size That Matters," Journal of Banking and Finance,
vol. 22 (August), pp. 799-819.
Advancing Our Understanding of
Community Banking
Michelle W. Bowman
Member
Board of Governors of the Federal Reserve System
St. Louis, Missouri
October 1, 2019
Asset Size Range - 2011:Q3 and
Figure 1: Number of Banks by 2018:Q4
Number of banks
5,000
4,569
4,000
2011:Q3
2018:Q4
3,000 2,887
2,000
1,354
1,075
1,000
731
651
620 625
132
113
0
Under $250 million $250 million to $500 million $500 million to $1 billion $1 billion to $10 billion Over $10 billion
Asset size range