The front cover of the May 17, 2009 issue of the New York Times Magazine asked “Are Small Banks the Future?” As noted in the article, lending may have slowed at the largest banks, but at the other end of the financial system, there are 8,500 community banks, and most remain very strong.
In the midst of the worst banking crisis since the Great Depression, community banks have generally fared well. That’s because they typically shunned the lending practices that led to high default rates. They rarely participated in the securitization of loans, credit-default swaps and other overvalued financial products that put the global financial system in crisis. Instead, they stuck to the fundamentals. They considered the character and history of their borrowers. They required collateral. Without community banks, the current financial crisis would be a lot worse.
The focus of the mainstreet press, and the Treasury Department, continues to be on the largest institutions, whether it be the initial nine TARP Capital recipients, or the nineteen that underwent the stress test. There is some rationality for this focus, the majority of assets, deposits and loans are held by these institutions. But just like small businesses generally, community banks play a critical role in the American economy.
Community banks may have weathered the current crisis better than larger banks, but they remain an American oddity. Most other countries have 5 or 10 national banks, and when they get in trouble, as they did in Iceland, it can be devastating. The balance in this country is tipped toward big institutions (the four largest control half the assets held by American banks and 40 percent of all deposits), but community banks still make 43 percent of all small business loans under $1 million. Since January 2008, fewer than 1 percent of all community banks have failed.