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Community Bank Research Conference Looks at the Changing Nature of Competition
by Julie L. Stackhouse, Senior Vice President, Banking Supervision, Credit, Community Development and the Center for Learning Innovation, Federal Reserve Bank of St. Louis

The Community Banking in the 21st Century¹ research and policy conference marked its third consecutive year in October 2015, with Federal Reserve Chair Janet Yellen hailing the 2015 event as a milestone.² The conference, cosponsored since its inception by the Federal Reserve System and the Conference of State Bank Supervisors, is an invitation-only event. This year more than 175 academics, bankers, and regulators attended, with hundreds more participating via webcast.

The academic proceedings of the conference supported views often voiced by community bankers and, in particular, discussed how the relationship lending model of community banks is still indispensable for communities and businesses across the country. Current realities, however, pose continued challenges to the community bank business model. Among other factors, some of these realities include the impact of new and existing regulations, the lack of new community bank entrants since the peak of the financial crisis, and the impact of the extended low interest rate environment on bank profitability. Data suggest that industry consolidation could continue and could lead to a fundamentally different community banking landscape in the next 20 years.

Research Sessions

Conference papers were presented in three panels: Small Business and Farm Lending, Community Bank Performance, and Community Banking: Pre- and Post-Crisis.

Small Business and Farm Lending

The Small Business and Farm Lending panel looked at the traditional strengths of community banks and assessed both the opportunities and challenges posed to their traditional lending lines. Among the panel’s findings:

• Community banks are seeing increasing competition from large banks for small business loans due to better information available on borrowers and new lending technologies. This increase in competition from large banks is prompting single market banks to increase their shares of intermediate-size small business loans, especially for borrowers that are seeking a more tailored loan product.
• Nonbank lenders are increasing their volumes of loans to consumers and small businesses — areas that have been traditional lines of business for community banks. Some of these alternative lenders, in turn, sell their loans to banks, providing opportunities for community banks to book loans in markets that might well be difficult for them to reach.
• The lack of financial statements and other documents necessary for effective loan underwriting limits the ability of community banks to serve the credit needs of some small business customers. However, mature and successful small businesses are better positioned to access community bank credit.
• Small banks have been able to provide liquidity insurance to their relationship borrowers during times of financial stress. Large banks, due to their reliance on transactional lending technologies, are less effective at alleviating financial constraints for their borrowers when economic conditions worsen.
• The current deposit-based measures of banking market concentration may be understating the true level of competition in agricultural communities where the Farm Credit System’s agricultural credit associations have a strong lending presence. When a lending-based measure of banking market concentration is used, competition increases.

Community Bank Performance

The second research session, Community Bank Performance, examined changes in banking industry structure, regulation, and types of lending to determine their relative impact on overall community bank performance. The panelists in this session highlighted several findings:

• In the event of a significant decline in agricultural land values, most agricultural banks today would not suffer significant loan losses.
• Despite some challenges in raising external capital, closely held and widely held banks demonstrate similar performance characteristics. However, closely held banks have more difficulty in finding and recruiting senior bank management.
• The Prompt Corrective Action provisions of the 1990s, combined with higher capital requirements, ultimately reduced the bank failure rate during the recent financial crisis. These factors were not, however, as effective at mitigating losses to the Federal Deposit Insurance Corporation’s Deposit Insurance Fund.
• From 2008 to 2013, default rates on residential construction loans and owner-occupied commercial real estate loans (generally perceived to have lower default risk) were in fact similar to the default rates for nonresidential and nonowner occupied loans.

Community Banking: Pre- and Post-Crisis

The final research session, Community Banking: Pre- and Post-Crisis, studied how community banking has changed since the beginning of the financial crisis until today. The papers looked at changes in community banks’ market share, asset size distribution, compliance costs, and residential mortgage lending activity. Some of the findings from this session are as follows:

• Despite the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd–Frank Act) changes to the supervision and regulation of mortgage lending and mortgage loan origination, community banks with significant exposure to this asset class generally have higher returns on assets and equity than do larger banks with similar mortgage exposures.
• Despite a nearly 50 percent decline in community banks’ share of the U.S. lending market from 1994 to 2014, community banks still provide 77 percent of the agricultural loans and more than 50 percent of the small business loans today.

• The percentage of banks that either failed or merged out of existence from 2008 to 2013 is similar to the percentage from 2002 to 2007. At least two-thirds of the decline in the total number of banks can be explained by the lack of new community bank entrants.
• On average, salary-to-asset ratios and average pay per employee increased at community banks following the passage of the Dodd–Frank Act. In the wake of the Dodd–Frank Act, the number of loans per employee also increased. This suggests that the higher-paid staff hired by the community banks, while more costly, were more productive.

The 2015 conference agenda, presenter biographies, videos, and presentation materials are available on the Community Banking in the 21st Century’s website at www.communitybanking.org. The site also features a section that tracks research on community banks. Additional conference resources include:

• Town hall publication: This publication contains the results of the 2015 nationwide survey and key findings from the town hall meeting and roundtable discussions with community bankers and includes the Community Bank Case Study Competition.
• Research and analysis papers: These published papers, working papers, and articles focus on the community banking industry or on issues that directly impact community banks.
• Community banker videos: During the summer of 2015, members of the Community Banking in the 21st Century conference planning committee filmed seven videos in which community bankers provide their perspectives on the importance of community banks and what functions community banks serve today. The bankers reflect on their experiences and highlight some of their business endeavors, including community projects that would not exist if not for the relationships between communities and their local banks.

Findings from the 2015 National Survey of Community Banks

The conference also presented the findings from the 2015 National Survey of Community Banks conducted by 39 state banking commissioners during the spring and summer of 2015. Twenty-seven state commissioners supplemented their survey findings with qualitative information obtained during town hall meetings and associated roundtable discussions held with community bankers in their respective states.

In response to concerns expressed during the 2014 research conference about the impact of new regulations on community banks, questions were included in the 2015 national survey to help understand the costs of regulatory compliance at community banks. In terms of these costs, community bankers reported that regulatory compliance, on average, accounted for 11 percent of their overall personnel costs, 16 percent of their data processing expenses, 20 percent of their legal expenses, 38 percent of their accounting and auditing expenses, and 48 percent of their consulting expenses. These data establish a baseline that will be helpful in understanding changes in compliance costs at community banks in future years.

One area in which community bankers reported a change between the 2014 and 2015 surveys is in mortgage lending. Sixty-nine percent of the respondents reported offering one- to four-family mortgages in 2015 compared with 75 percent in 2014. The respondents attributed the decline to fewer community banks offering nonqualified mortgages, which expose the bank to more legal risk than qualified mortgages.

Finally, this year’s survey showed that banks are continuing to embrace technology in order to expand their product offerings. More than 70 percent of the respondents reported offering mobile banking services, with another 20 percent stating that they plan to do so within the next three years.

Future Research: What’s Next for Community Bank Research?

This year’s attendees encouraged academics to consider research focused on technology. In particular, many bankers are interested in the future of the branch model in light of technology and changing consumer preferences, particularly in rural communities. Other participants expressed interest in learning more about the advantages and disadvantages of the relationship lending model and the extent to which technology could enable larger banks and nonbanks to overcome the current disadvantage they have compared with community banks in obtaining “soft” information on borrowers. These topics, as well as the impact of competition and regulation, are all items for which academic research could inform policy decisions affecting community banks.