After the collapse of several banks plunged the banking system, economy, and financial markets into uncertainty, I've heard some people wonder whether or not regional banks are more trouble than they're worth.
After all, I'm sure plenty of people had never heard of SVB Financial or Signature Bank prior to their impending failures and might be wondering if they are worth keeping around considering what has ensued. Why not just use the banks that are "too big to fail" like JPMorgan Chase?
While I can understand the frustration, I find this thinking to be severely flawed and misguided. Regional banks and community banks are the backbone of the U.S. economy. Here are three reasons why.
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1. Regional banks do the bulk of lending
In a note from Goldman Sachs, economists pointed out that banks with less than $250 billion in assets originate roughly half of all commercial and industrial loans, which are loans made to businesses and corporations to provide working capital for capital expenditures. These smaller banks also account for 60% of all U.S. mortgages, 80% of all commercial real estate loans, and 45% of all consumer loans.
Large banks like JPMorgan are absolutely vital to the economy, but regional and community banks know their prospective markets better and can form close customer relationships that, in many cases, allow them to make better underwriting decisions.
Furthermore, regional banks have the opportunity to carve out niches. Now, obviously, banks need to be careful about getting too heavily concentrated in one area like the way that SVB did, but there are banks that specialize in lending and can provide custom-tailored services for specific industries, whether it's pharmacies, veterinarians, long-haul truckers, or hospitals. Smaller banks have more incentive to do this in order to differentiate themselves from the larger banks, which I think is a good dynamic to have in banking.
2. The big banks can't get too big too fast
Make no mistake, with more than 4,700 banks there will continue to be consolidation in the industry, and I fully expect the big banks to get bigger. But growing too fast can be dangerous, and it's actually part of the reason that three banks collapsed earlier this year.
The reality is the big banks, while they do want to get bigger, would ideally like to do it in a more gradual and methodical manner. For one, if they grow deposits too fast they can run up against regulatory capital issues. During the pandemic, deposits at all U.S. commercial banks surged by nearly $5 trillion, ballooning bank balance sheets. This actually put pressure on large bank supplementary leverage capital ratio requirements (minimum 5% SLR), which look at a bank's tier 1 capital divided by its total on- and off-balance sheet assets.
Regulators actually granted large banks temporary exclusions on this during the earlier parts of the pandemic, but if banks run up against their regulatory requirements, measures they may have to take include raising capital or actually having to turn away deposits, and therefore business. Holding more cash also tends to hurt a bank's margins and lead to lower returns.
The last thing to consider is that despite all of the criticism banks have received, it is really safer for the bulk of lending activity to be done in the banking system. Banks are very highly regulated and have three regulators, including the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and either the U.S. Office of the Comptroller of the Currency (OCC) or a state banking regulator. A lot of banking activity has been pushed into the shadow banking system, where things are much less regulated and much more opaque.
3. Regional banks play a critical role in innovation and the economy
While it's true that many people likely have not heard of a lot of regional banks, they are critical players in the economy and in helping drive innovation, although it's mainly being done behind the scenes.
For instance, did you know that the super regional bank U.S. Bancorp has been providing the federal government with payment services for more than three decades? Or how The Bancorp, a small $8 billion asset bank, serves as the card issuing bank and payment facilitator for huge fintech firms like Paypal?
The fact of the matter is that these smaller and regional banks power a lot of the financial services and products offered by some of the most well-known brands in the world. They provide the plumbing and infrastructure that can't always be seen in plain sight but is absolutely critical to the economy and innovation.
