The second factor hampering the District's smallest banks is a lack of fee income growth. While midsized banks increased their fee income just 3 basis points to 0.95 percent of average assets between 1994 and 1998, small banks' noninterest income remained unchanged at 0.63 percent. Flat fee income reflects small banks' practice of underpricing services relative to their administrative costs because bankers fear that high fees will offend their customers. Small banks also do not offer the range of sophisticated products like trust and brokerage services that generate fee income for larger banks because they lack the personnel expertise and sales volume to exploit economies of scale. Asset quality remains the bedrock of bank stability, and small banks with sound loan portfolios will begin the 21st century in excellent shape, despite their lower profitability.
Many small banks are reluctant to push their efficiency ratios lower by reducing staff.
Community bankers argue that the higher staffing costs are needed to maintain the personalized service that sets small banks apart. Although earnings at small banks may continue to lag those at midsized banks, consumer demand for personal attention should help to ensure a place in the future for community-focused banks. Thomas A. Pollmann provided research assistance.