Earlier this week, the American Banker focused on a new FedFin paper looking at the impediments to new bank charters. Based on hard experience working to charter a new bank, the brief reminds policy-makers warring over who gets to charter a bank that this issue isn’t all about them – if investors don’t see profit in a bank, they won’t try to open one. However, there’s more than investor profits at stake – economic equality also has a stake in seeing new banks opened to serve local and under-served markets.
Another recent FedFin paper builds on our prior economic-equality work to focus on the mortgage market. We noted there that commoditized products by definition do not work for small market segments. When three government agencies control ninety percent of mortgage originations, housing finance will serve the highest common denominator, leaving younger and low/moderate-income borrowers to fend for themselves – that is, to rent.
So too it is with bank financial-product delivery. Large banks try to serve local markets, but economies of scale standardize their product offerings. Managerial structures also sharply constrain local decision-making. This is an essential internal control at large banks but one that nonetheless limits if not destroys their capacity to offer what used to be called “character” loans or to spend the time counselling first-time borrowers with limited educational or English proficiency.
To be sure, local banks have long been dominated by local families, some of whom had scant interest in lending to anyone they didn’t know or who didn’t look like them. That said, there is a rich history of small banks chartered to serve immigrant and minority communities along with thousands of community banks meeting non-standard agricultural, manufacturing, and housing needs.
Where does income inequality come in? Local banks are by definition attuned to and thus increasingly essential for local economic development and therefore to employment and opportunity. Large banks look at the economies of scale cited above and open or close branches as local conditions warrant; small banks headquartered in or near the same community are there to stick it out if they can.
Unsurprisingly, wealthier communities are more likely to have bank branches than lower-income ones. Using FDIC data, The Economist recently found that the top fifth of household-income zip codes lost approximately three percent of branches from 2009 to 2016. The bottom fifth by income saw branches drop by ten percent – i.e., over three times more. The Economist’s analysis also shows that, despite relatively easy access to remaining branches for everyday services, small-business lending drops sharply when a branch closes. When these branch closures are in low-income areas, small-business lending is shown to erode precipitously.
Correlation isn’t causation. It thus could be that the correlation between branch closures and reduced small-business lending is a symptom of a common causal factor. It’s also possible that reopened large-bank branches that replace closed small banks could reverse this trend, although we’re unlikely to know given the growing shift of large-banks to mobile and other non-branch delivery options for transaction services which may or may not come to include small-business lending.
What we do know is that small banks are critical small-business lenders despite their small share of overall U.S. banking assets. It’s thus reasonable to infer that fewer branches means less of a small-bank presence and a lot less small-business lending. Given that small-business lending is also the critical employment engine, the economic-equality impact of less branches is all too clear.
Economic inequality is a complex phenomenon with many causes often outside the ambit of bank regulators. The dearth of new charters is one inequality driver the FDIC and other agencies can quickly address without creating new safety-and-soundness problems. Our paper posits a couple of ways to do so. These and others require immediate attention if the FDIC and OCC really want to see new banks chartered that make a meaningful difference to under-served communities.