Financial Update (July-September 1998)


Cover Story

Choice of Capital Instruments

New Look for Financial Update

Check Growth

Bank Consolidation and Lending

Technology in Banking


Year 2000

Did You Know?

Data Bank

The Docket

Bank Consolidation Affects Lending
in Southeastern Rural Markets

by Lynn Woosley, senior economic analyst

A n easing in branching restrictions and continued consolidation have raised concerns about the loss of competition in the banking industry. Much attention has focused on the declining number of banking competitors located in rural markets and on the rising market share controlled by the largest institutions. Although there are benefits to consolidation, and at least some of the affected markets are arguably overbanked, loss of competition is still a concern, particularly as it affects small businesses.

Much attention has focused on the declining number of banking competitors located in rural markets and on the rising market share controlled by the largest institutions.

Small businesses are among the most locally limited customers of financial institutions, according to data from the Federal Reserve Board's National Survey of Small Business Finances. Therefore, any loss of competition could adversely affect small businesses' access to credit. This problem is potentially greater for rural markets, where there are fewer competitors initially and concentration tends to be greater. Rural markets are also generally considered less attractive to new banks.

New Data Provide Better
Picture of Lending

In 1996, banks and thrifts with total assets of $250 million or more or those affiliated with a holding company with assets of at least $1 billion began reporting small business and small farm loan originations in compliance with the Community Reinvestment Act (CRA). The small business loans reported are commercial or industrial loans with origination amounts of less than $1 million dollars. These loan originations are reported by the geographic location of the borrower, making it possible for the first time to clearly identify competitors lending to small businesses in a specific geographic market.

CRA data on small business loan originations and branch deposits for the states in the Sixth Federal Reserve District (data includes the entire states of Alabama, Florida, Georgia, Louisiana, Mississippi and Tennessee) show the extent of banking concentration in these states' rural markets. To analyze concentration at the local market level, three measures are useful: the number of competitors, the three-firm ratio and the Herfindahl-Hirschman Index (HHI). The three-firm ratio is the percentage of the market's deposits or loans held by the three largest competitors. The HHI uses a mathematical formula to determine whether a local banking market is unconcentrated (below 1,000 points), moderately concentrated (1,000 to 1,800 points) or highly concentrated (over 1,800 points).

Local Market Small Business Lending

Analysts typically base these market concentration measures on the deposits of the offices located in the banking market. CRA small business loan (SBL) data make it possible to determine whether small businesses are subject to competitive conditions different from those that affect depositors.

To calculate concentration statistics for this study, each county that is not part of a metropolitan statistical area (MSA) is used to approximate a rural market. Loan originations are taken from the CRA SBL originations for 1996. Deposit data are from the Federal Deposit Insurance Corporation's Summary of Deposits as of June 30, 1996.

The CRA SBL data show that rural market competition may be problematic. In 1996, the average rural county in the six southeastern states had four institutions with deposit-taking offices but had CRA SBL originations from 11 institutions. The three-firm ratio was 89.04 for deposits and 85.58 for CRA small business loans. The average CRA SBL loan-based HHI was 4,189, even higher than the mean deposit-based HHI of 4,075.

Market concentration may be overstated by the CRA SBL data, however, since smaller depository institutions are not required to report their CRA SBL originations. These small institutions are likely to have most, if not all, of their loans in the counties where they have branches. If these institutions were included in the concentration measurements, two competitors on average would be added to each market. The three-firm ratio and HHI would also change, but it is not possible to predict the direction or the magnitude of those changes because the nonfiling institutions may be among the largest lenders in a given county.

A Look at the States

On a state-by-state basis, using CRA SBL originations to calculate local market concentration measures yields varying results (see the table). In three states — Florida, Georgia and Mississippi — rural markets clearly appear more competitive when concentration is measured by CRA SBL originations instead of deposits. In these states, the typical number of competitors is higher for the small business loans than for the deposits, while the mean three-firm ratio and the average HHI are lower.

In the average non-MSA county in Florida, for example, CRA SBL data show that the number of competitors making small business loans is over two and one-half times greater than the number of deposit takers. The three-firm ratio and the HHI are 10 percent and 16 percent lower, respectively, for loans than for deposits.

In Georgia, the data show three times as many lending competitors as deposit takers, while the HHI and three-firm ratio are 12 percent and 7 percent lower, respectively, for loans than for deposits.

In Mississippi, the loan-based HHI and three-firm ratio are less than 95 percent of the deposit-based concentration figures, while the number of lending competitors is three times the number of deposit takers.

Although Alabama has two times more lending competitors than deposit-taking competitors, the loan-based HHI and three-firm ratio are higher than the deposit-based ones, by 20 percent and 5 percent, respectively. Louisiana has, on average, over two times more loan competitors than deposit takers, while Tennessee has three times more. Also, in the latter two states, the loan-based three-firm ratio is lower than the deposit-based three-firm ratio. On the other hand, the loan-based HHI is slightly higher than the deposit-based HHI in Tennessee and is 18 percent higher in Louisiana.

There are three likely explanations for these patterns of market concentration in the Southeast. First, many of the regional banks that have either a very small or no deposit-taking presence in a given rural county may be making significant loans in that county. For these institutions, particularly those in Alabama, their deposit market share understates their competitive impact on the county.

A second explanation, mentioned earlier, is that the SBL analysis omits 87 percent of the Southeast's community banks. One should note, however, that while many of the community banks may be significant lenders in a given rural county, these banks are generally small, with average assets of less than $100 million.

Third, some of the lenders filing CRA SBL origination data are relatively insignificant in terms of the total loans originated or the dollar volume of loans originated. Some out-of-market lenders with a wide distribution of customers may have only one or two loans in each market. As a result, the number of lenders in a given market may increase dramatically without a corresponding decrease in the three-firm ratio or the HHI.


This study of CRA SBL loan origination data reveals two significant points. First, many more bank lenders participate in rural loan markets than was previously known. The new data support anecdotal evidence from local bankers about competition from out-of-market lenders. The number of competitors in rural markets will likely increase further as credit scoring of small business loans becomes more prevalent. Some out-of-market lenders are already using credit scoring in marketing or underwriting.

Second, although some out-of-market lenders have a significant presence, others do not, so their effects on competition must be assessed on a market-by-market basis. In addition, even if the out-of-market banks are significant small business lenders, they cannot offer local access to some of the banking products and services important to small businesses and consumers unless they have a nearby branch. Thus, for any given market, evaluating both deposit and loan concentration data can result in a truer picture of market structure and competition than studying the deposit-based HHI alone.

Rural Market Concentration Measures1
  Number of Competitors   Three-Firm Ratio   Herfindahl-Hirschman Index
State Deposits SBL2   Deposits SBL2   Deposits SBL2

Alabama 5 12   82.13 86.60   3,282 4,095
Florida 5 13   89.92 81.15   4,265 3,593
Georgia 3 9   92.12 85.90   4,849 4,261
Louisiana 4 10   90.39 88.60   3,993 4,868
Mississippi 4 12   92.16 87.45   4,150 3,923
Tennessee 4 12   87.51 83.79   3,908 3,954
Regional Average 4 11   89.04 85.58   4,075 4,189
1 Based on 1996 Data 2 Small business loans
Source: Deposit data from Federal Deposit Insurance Corporation, compiled by SNL Securities. Loan data from the Federal Financial Institutions Examination Council.