Evan Soltas
Jan 2, 2012

Where’d They All Go?

The disappearance of small banks in America

Graph is in logarithmic scale. Source: Federal Financial Institutions Examination Council via St. Louis Federal Reserve.

There are nearly 8,000 fewer small banks in the United States today than there were in 1988. Since then, roughly half of the nation's small banks closed, were acquired, merged with a competitor, or grew to the point where they had above $300 million in assets.

It has been war of attrition of sorts, with a steady annual loss of around 4.5 percent of small banks, for one reason or another, disappearing. Amid the recessionary panic over banks which were "too big to fail," the story of America's shrinking class of small banks has been too readily obscured.

But what, exactly, is going on?

A Federal Reserve Bank of St. Louis paper furnishes us an additional datapoint: in 1984, there were approximately 15,000 banks. Back-of-the-envelope calculations confirm that this adds four years to the consistent period of losses. Within the period of 1984 to 1993, the paper's authors David C. Wheelock and Paul W. Wilson said, 80 percent of the small-bank closures are the result of acquisitions, with the remaining 20 percent the result of explicit bank failure, counting the acquisition of an insolvent bank as a failure.

In short, the larger banks are gobbling up the nation's small banks. Profit maximization, it seems, is driving the trend, a report by banking-industry consulting firm Celent suggests.

"Running a bank requires a certain amount of scale, and that floor is rising due to increasing regulatory requirements, channel support, and product support."

There is certainly something to say about the community bank being a relic in an age where capital can flow around the world with little in terms of transaction fees and where even small and midsize businesses compete globally. Along with online banking, these are services wholly out of reach for that entire class of banks, which places them at a significant competitive advantage.

It also appears that the considerable regulatory burden on banks works against the smallest ones, which have a lesser ability to spread compliance costs over their pool of borrowers and depositors. "I must spend half my day making sure that we are in compliance with current regulations and the other half of my day trying to be prepared for the new regulatory changes to come. Somewhere in there, I need to take care of some customers," one small bank CEO said to D. Bianucci of BAI Banking Strategies, a publication of a financial services industry group.

For now, at least, the banking industry seems to still be working through this decades-long evolution in market structure, driven largely by a dramatic change in consumer preferences but also by hefty regulatory compliance costs.

It seems rather unlikely, however, that the small bank will be driven to extinction. Niche demand from small businesses, who may prefer dealing with a loan officer who will be more involved in their business development, seems likely to keep the small bank alive in the new market structure, albeit in a reduced capacity.