America's 6,900 Banks: Too Many Or Not Enough?

Editor's note: A version of this post originally appeared on LinkedIn.  

Covering banking sometimes feels like covering the shootout at the O.K. Corral, given the way industry factions are forever taking potshots at one another. People at big banks scorn the community bankers as yahoos. Community bankers blame the money center folks for setting off the financial crisis, the regulatory backlash and the reputational nightmare that's left banks more unpopular than even airlines and phone companies.

One thing bankers of all stripes agree on is that credit unions compete unfairly by not paying taxes. Credit unionists, in turn, portray bankers as greedy con artists more devoted to serving shareholders than customers. They all detest the regulators and politicians, until they need a favor.

Lately, the big-versus-small bank debate has flared up on the pages of American Banker. The spark came from Slate where blogger Matthew Yglesias published an item arguing that the nation's 6,900 community banks should be euthanized. The gist of his argument is that the little guys are poorly managed, impossible to regulate and unable to compete. His solution is for the big regionals, like U.S. Bank and PNC, to gobble them up, leaving America with the same sort of financial oligopoly found in most other countries.

Rob Blackwell, my colleague and American Banker's Washington bureau chief, countered with a piece in which he argued that Yglesias was "dead wrong" and doesn't really get what small banks do (provide an outsized amount of credit to small businesses) or how they make money.

American Banker's community banking editor, Paul Davis—who clearly has a horse in this race—joined in by arguing that if 99% of banks went away (leaving us with around 68 nationally) it would reduce the supply of credit, innovation and crisis leadership.

Cogent as the arguments are in favor of a large and diverse banking system, the trend has been unmistakably in Yglesias' direction for three decades. Since the number of banks in the U.S. peaked in 1984 at 17,900, more than 60% have disappeared, leaving 6,891 in existence at the end of the third quarter—the lowest figure since the feds began keeping track in 1934.

The number of small banks will continue to decline, by all accounts as, economic and regulatory pressures force them to merge or shut down. The outlook for new-bank formation — once an engine of industry growth — is grim. Amish backers managed to gain approval this month to establish Bank of Bird-in-Hand, the first de novo institution created in three years. To satisfy skittish regulators, they had to file 18 inches of paperwork (up nine-fold in two decades). How many entrepreneurs have lined up to do the same? One – and it's in American Samoa, the Wall Street Journal reports.

I agree philosophically with my colleagues that many small banks are well managed and provide value to their customers and investors. In that sense they're a lot like your favorite family-run restaurant, which manages to turn out a good meal, a profit and a very satisfied clientele amid all the national chains.

The more profound question for the economy is what effect the little guys have on the stability and efficiency of the U.S. financial system. On that score, the evidence is more mixed.

From a systemic perspective, it's disturbing that we're living in a post-crisis era when big banks are widely seen as posing a grave risk—yet have been aided and abetted by our government in getting bigger than ever. Three decades ago, when the number of banks peaked, those with $10 billion or more in assets controlled 24% of the industry total. Today, their share is about 80%. As we learned in 2008, when giant banks begin to totter, even the folks with the printing presses had to struggle to prop them up. And that was before they presided over the marriages of JPMorgan Chase with Bear Stearns and Washington Mutual, Wells Fargo with Wachovia or Bank of America with Merrill Lynch.

Small banks cannot possibly provide protection from the systemic risks these Goliaths pose, but they do provide shock absorbers. Even if it involves a minority of industry assets, at least some are held on balance sheets that are possible for mortals to understand and only lightly mixed up with the Wall Street casino. The intra-industry bickering between the bigs and smalls also provides push-back against those institutions that are too big to fail or jail or say no to.

As for efficiency, small banks are not as profitable as large ones, based on their generally lower returns on assets. Community banks earned an average ROA of 1.05% between 1985 and 2011, which was 26 basis points less than for big-banks, according to the Federal Deposit Insurance Corp.

But as a group they do make money. They also tend to cater to different markets than the giants. That includes lending to small businesses and in rural areas where the big banks might earn no more — if they were there at all. In Bank of America's case, as Rob Blackwell points out, its "national" branch network leaves out large swaths of Kansas, Nebraska and Wyoming, plus the entire state of Mississippi.

As the number of small banks dwindles survivors will no doubt fill the breach and Mississippi shall not be bank-less. But as consolidation leads the banking business to look more like the airline, phone and cable TV businesses, it's hard to believe the result will be better pricing, service or stability.

Neil Weinberg is the editor-in-chief of American Banker. The views expressed are his own.