The number of commercial banks in the United States dropped from 14,400 in 1984 to 4,492 at the end of 2019, according to the Federal Financial Institutions Examination Council. This statistic (and others like it) have been used for years to warn consumers and policymakers of the dangers of the massive consolidation of the U.S. banking industry, and cite the need for decentralized banking.
These warning have, historically, been dire (even apocalyptic) in tone, but a little light on specifics. It’s difficult to argue for a counterfactual, especially when the factual (a highly consolidated banking market) is one that consumers are generally satisfied with.
Crises have a useful ability to illustrate, in sharp relief, beliefs that people hold but struggle to prove. The COVID-19 pandemic and associated economic downturn have reinforced the following belief – having fewer community banks during a crisis hurts consumers and small businesses.
The Value of Decentralization
It shouldn’t surprise anyone that during economic recessions, a majority of companies either fail or suffer significant setbacks that severely impact their performance for years afterward.
What might be surprising is that, according to research by the Harvard Business School and others, approximately 10% of companies actually emerge from recessions stronger than they were going in.
One of the factors that characterizes this 10% is a decentralized approach to making decisions. Executives at these companies resist the temptation to hoard decision making authority and, instead, empower colleagues lower down in the organizational hierarchy – the ones with better “on the ground” information – to make decisions. The result is more agile organizations with the ability to move fast in response to rapidly changing market conditions.
While this research focused on the benefits of decentralization for individual companies, the underlying lesson is applicable more broadly.
Round One Knockout
The COVID-19 pandemic has been a disaster of historic proportions for the country’s small businesses. Before the pandemic forced millions of people to stop shopping at stores and sitting down in restaurants, small businesses were already on the edge – nearly half of U.S. small businesses in urban areas had two weeks or less of cash liquidity.
So, as it does in times of disaster, the government stepped in to help. Between April 3 and April 16, banks loaned $349 billion to small businesses through the Small Business Administration’s Paycheck Protection Program. That’s roughly the equivalent of 14 years’ worth of SBA loans (in normal times), granted in just 14 days.
Looking past its myriad of implementation problems, the sheer speed and scale of the first round of the Paycheck Protection Program is impressive. And it wouldn’t have happened without community banks.
According to the Small Business Administration, banks with under $10 billion in assets approved about 60% of loans in the first round and banks with $1 billion or less in assets (which account for just 6% of all U.S. banking assets) approved nearly 20% of loan dollars. While the largest banks delayed taking applications until online portals could be set up and Paycheck Protection Program rules clarified, many small banks jumped straight in, reassigning staff and working nights and weekends to manually submit as many applications (from existing and new customers) as possible.
The ability of smaller banks to quickly adapt to the chaotic rollout of the Paycheck Protection Program led to significant benefits for the communities where smaller banks still flourish. According to analysis of the first round of the Paycheck Protection Program by The Institute for Local Self-Reliance, nearly three times as many relief loans were made per capita in the ten states with the most community banks per capita, compared to the ten states with the fewest.
These numbers don’t prove that small banks are inherently more virtuous than large banks. Nor do they mean that the competitive advantages that big banks have built through their scale and investments in digital technology don’t matter.
What the numbers do indicate is that a distributed market (many small players) can move faster than a consolidated market (a few big players).
And in a crisis, speed matters.
The Need for Countercyclical Competitive Policies
The trouble with a crisis is that, by the time it starts, it’s too late for large-scale, structural fixes. Reversing course on the consolidation of the U.S. banking industry will take years, decades, to bear fruit. Today’s small businesses – nearly half of whom in the U.S. say they will run out of cash within one month — obviously don’t have that kind of time.
But if you accept the premise that a more decentralized industry could respond more quickly to help customers during the next such crisis, then the problem you need to solve for is how to encourage decentralization when every market driver—cost, customer preference, competitive pressure—naturally results in consolidation.
I believe the answer starts with countercyclical competitive policies. Regulatory actions that protect and nurture smaller market participants during times of economic expansion. Such regulation can take many forms – postal banking, bank charters for fintech companies, a digital payments infrastructure to level the playing field for smaller banks, updates to existing regulations like the Community Reinvestment Act – but it needs to be a priority not just in bad times, but in good times as well.
The key to ensuring that the banking industry meets its responsibility to help all consumers and small businesses during a crisis is to diffuse that responsibility across a larger number of banks.