Local Banks Could Leave Gaps That Are Hard to Fill

Regulators’ move last Sunday to protect depositors at SVB and Signature, and big banks coming together on Thursday to shore up First Republic with a $30 billion infusion of deposit cash, were aimed at avoiding such an eventuality. With hope, these fire lines will hold.

Even if any outflows are halted or reversed, small banks may now grow cautious, such as by simply sitting on more of their cash as a defensive measure. Doing so would effectively reduce their capacity to extend credit.

For small and midsize businesses that rely on smaller banks, this would be worrisome, says

Raghuram Rajan,
an economist at the University of Chicago’s Booth School of Business and former governor of India’s central bank. Loans to them are often based on so-called soft information that local lenders have built up over years. “These are loans built on strength of character and a handshake,” Mr. Rajan says.

So if deposits shift from a local bank to a big one whose nearest branch is the next county over, a small business can’t simply borrow from it. The big bank would have to conduct its own review of its creditworthiness, without soft information such as the owner’s reputation in the community. 

Mr. Rajan has found that even though the distance between small firms and their lenders has increased over the years, it is still quite short. In a recent paper using Community Reinvestment Act data, he, João Granja and Christian Leuz found that as of 2016 more than three-quarters of small-business loans—here defined as loans with a principal amount of $1 million or less—originated in the U.S. went to borrowers that were less than 50 miles from the closest branch of their lender. The median distance between small-business loan borrowers and their lenders’ nearest branch was less than 7 miles.

Smaller banks are particularly important in lending to commercial real-estate projects, which include things ranging from office buildings to strip malls to warehouses. Banks in the U.S. outside the 25 largest banks by domestic assets represent close to 40% of all bank lending—but about two-thirds of commercial real-estate loans, according to Federal Reserve data. They represent about 70% of construction and land development loans, and more than 90% of all loans secured by farmland.

Some of the information backing up the creditworthiness of these loans is inherently local, such as the attractiveness and history of a particular location for development. 

Smaller banks’ share of all U.S. commercial and industrial loans isn’t as high, as big banks remain the major lenders to the biggest global companies. But when it comes to C&I loans extended to small businesses, they pack a bigger punch. A survey of banks conducted by the Federal Deposit Insurance Corp. in 2016 and 2017 found that nearly 80% of banks with less than $10 billion in assets characterized “largely all” of their C&I loans as going to small-business borrowers. 

While a pullback in lending by smaller banks would weigh on small and midsize businesses throughout the country, the effects could be most keenly felt in places where there are fewer lending options, such as those that are far from major urban centers. For example, Community Reinvestment Act data show that in prepandemic 2019 about 60% of the dollar amount of small-business loans in Montana were originated by just three Montana-based banks. Roughly the same was true in Hawaii. In contrast, lending in Arizona was much more diverse, with the top three small-business lenders accounting for about 40% of loans. And the top two of those banks,
Wells Fargo
and
JPMorgan Chase,

are among the nation’s biggest.

Despite the troubles roiling banks, the U.S. might yet escape a recession. But for some businesses, and in some parts of the country, it could sure feel like one.

Write to Justin Lahart at [email protected] and Telis Demos at [email protected]