Financial Update (First Quarter 2002)


Cover Story

Bank Securitization

Subordinated Debt

Board Appointments

Small Banks

Atlanta Fed Board

Guynn’s Speech

2002 Outlook


Did You Know?

Data Bank

The Docket

Small Banks Hold Their Own

Mergers that increased the size and scope of large banks, competition from mutual funds, and new nonbank players have ostensibly threatened the competitiveness of traditional small banks. But a recent survey of small banks over a 15-year period finds that the expansion of deposits and assets at these institutions has exceeded the growth rate of large banks.

In their study “The Economic Performance of Small Banks, 1985–2000,” William F. Bassett and Thomas F. Brady of the Federal Reserve Board’s Division of Monetary Affairs note that “the profitability of small banks has risen to high levels” over this period.

Success with loans
The key reason for small banks’ continuing success seems to be their ability to do well with loans. According to the study, small banks have not only been able to earn relatively high rates of return on loans, they have also increased the percentage of loans in their portfolios.

It would seem that the consolidation in the banking industry in recent years had the potential to damage the competitive position of small banks. Yet quite the opposite effect appears to have occurred. Small banks, well known in their communities, have benefited from local experience and knowledge. On the loan side, larger banks have been unable to compete effectively in local loan markets mainly because of their real and perceived geographic distance. On the funding side, local depositors are often wary of banks out of their area. Bassett and Brady report that these consumers have often reacted to mergers and local bank acquisitions by moving their deposits to small, locally headquartered banks.

In favor of small banks
Several other factors have contributed to a favorable environment for small banks. Certainly, the contraction in the savings and loan industry in the 1980s reduced competitive pressures. The strong economy and low rate of bank failures increased consumer confidence, and many depositors grew less concerned about deposit insurance — witness the growth in money market mutual funds, which have no federal insurance.

To further support their findings, the authors note: “The robust growth and high profitability we find at small banks have not gone unnoticed by investors that have formed significant numbers of new banks in recent years.”