Federal Policy Threatens Local Banks, a Top Fed Official Says

Date: 25 Aug 2010 | posted in: Banking | 0 Facebooktwitterredditmail

A top Federal Reserve official said yesterday that locally owned banks do a better job of serving communities and small businesses, but they are threatened by federal policies that favor their big competitors.

In testimony before a U.S. House of Representatives subcommittee, Thomas Hoenig, president of the Federal Reserve Bank of Kansas City and the Fed’s longest-serving policy-maker, said that community banks as a whole have held up better than megabanks over the course of the recession, but warned, “The more lasting threat to their survival concerns whether this model will continue to be placed at a competitive disadvantage to larger banks.”

Because of their local ownership and the local focus of their operations, community banks have a vested interest in the success of their communities, Hoenig said. This creates a powerful alignment between what’s in the bank’s best interest and what’s in the community’s best interest. “It is the very ‘skin in the game’ incentive that regulators are trying to reintroduce into the largest banks,” said Hoenig.

“There is no better test of the viability of the community bank business model than the financial crisis, recession, and abnormally slow recovery,” said Hoenig. “The community bank business model has held up well when compared with the megabank model… Community bank earnings last year were lower than desired but on par with those of larger banks. However, community banks generally had higher capital ratios that put them in a better position to weather future problems and support lending.”

“Data show that community banks have done a better job serving their local loan needs over the past year,” Hoenig added. “Community banks, as a whole, increased their total loans by about 2 percent as compared to a 6 percent decline for larger banks… Business lending in particular stands out, with community bank loans dropping only 3 percent as compared with a 21 percent decline for larger banks.”

While community banks are as viable, if not more so, in today’s market than big banks, their survival is challenged by the government’s too-big-to-fail policies and financial support for megabanks. “Because the market perceived the largest banks as being too big to fail, they have had the advantage of running their business with a much greater level of leverage and a consistently lower cost of capital and debt,” said Hoenig, who has been a persistent critic of policies that favor the nation’s largest banks.

“Despite the provisions of the Dodd-Frank Act to end too-big-to-fail, community banks will continue to face higher costs of capital and deposits until investors are convinced it has ended,” Hoenig said.


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Stacy Mitchell

Stacy Mitchell is co-director of the Institute for Local Self-Reliance and directs its Independent Business Initiative, which produces research and designs policy to counter concentrated corporate power and strengthen local economies.