Changing Rules and Opportunities for Community Banks

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Changing Rulesand Opportunitiesfor Community
Banks

• AAEA 2000 Organized Symposium
• New Sources of Capital for Rural America
• Maureen KilkennyIowa State University

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Rule 1. Riegle-Neal Act of 1994
repealed McFadden Act (1927) gt legalized
multistate branch banking
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GLB permits
subsidiaries of commercial banks to
underwrite and deal securities
sell insurance
financial holding companies to form and
own banks
underwrite and deal securities
underwrite and sell insurance
conduct merchant banking
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Commercial banking
Accept deposits Make commercial loans
FINANCIAL HOLDING COMPANY
Investment banking
Insurance agency
Underwrite sell securities
Underwrite sell insurance
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Opportunity relationship lending
Borrower Quality and Type of External Finance
Low
High
relationship loans (from banks)
transaction loans (banks non-banks)
capital market financing (now possible by FHCs
under GLB)
Community banks can now continue to serve clients
as they mature
value of relationships remain internalized
Boot Thakor (2000) "Can Relationship Banking
Survive Competition?" The Journal of Finance
55(2)679-713
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fixed costs in financial intermediation
Opportunity scope scale economies

• Information acquisition

Additional, new financial services can be
provided at lower marginal costs
Data sharing

• Marketing distribution

Cross-selling
Spread overhead

• Administration back office

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Opportunity diversification
Higher and more stable overall returns

• Wider range of securities

Lower correlation

• Supply alternative types of finance

retain customers
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Opportunity new sources of funds

• GLB Act permits banks (with assets lt500 mil.) to
  obtain FHLB advances

Community banks can still obtain cheap funds
Continue to provide loans to small businesses,
small farms, and small agribusinesses
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Numerous rural Banks were not members of the FHLB
system in 1998
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How will these changes affect the supply of
capital to rural areas?

• Q1 Threat to survival of community banks from
  legalized branching?

A1 Since Riegle-Neal, more banks, more offices,
and more lending to small businesses.
Q2 Threat to banks that thrive on relationship
lending?
H2 GLB Boon, not threat.
Q3 Threat of rural savings outflow reducing
available funds?
H3A GLB increases community banks access to
other (FHLB) sources of funds.
H3Bthe less segmented are capital markets, the
more sensitive credit flows are to local growth
prospects. (Declining communities decline
faster, growing communities grow faster.)
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Why change now?

• Empirical evidence that commercial banks
  underwrite better performing securities (of more
  mature firms)
• Experience few problems with limited U.S.
  experience, or in other developed countries
• Technological Change increased profits from
  cross-selling based on information sharing