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The writer is co-author of The Smartest Guys in the Room and The Big Fail: What the Pandemic Reveals About Who America Protects and Who it Leaves Behind
Legislators and regulators often emphasize the importance of small banks and small businesses, but in reality, their actions consistently favor large banks at the expense of small ones. However, small businesses heavily rely on small banks to thrive.
Since the 1980s, when bank deregulation took place, and especially after the global financial crisis, big banks have been prioritized over small banks. This is despite the fact that the crisis was caused by the big banks, not the small ones (and the small ones did not require bailouts). The number of banks insured by the Federal Deposit Insurance Corporation has decreased by nearly half from 2002 to 2022.
The unofficial policy of the US Treasury, although not Congress, has long been to consolidate banks, believing that bigger banks are safer. Even before Congress abolished the Glass-Steagall Act in 1999, which mandated commercial and investment banking separation, the Treasury had proposed its plan to achieve a similar outcome by removing interstate banking restrictions and expediting consolidation. Wall Street shares a similar sentiment. Following the collapses of Silicon Valley Bank and Signature Bank, some questioned the need for small banks altogether.
“Perhaps the comments about the value of small and medium-sized banks (and their small and medium-sized clients) is just lip service, and the goal is to make our system resemble the one in Europe,” states a lobbyist for a medium-sized bank. “Otherwise, it doesn’t add up.”
Robert Kaplan, former president of the Dallas Fed, adds: “The big have gotten relatively stronger, and the small and mid-sized banks are at a competitive disadvantage.
“This is the opposite of what we wanted to achieve after the 2008 financial crisis, which was to avoid creating a system where power is concentrated in the hands of banks that are too big to fail.”
Many small banks believe that the response to the Silicon Valley Bank (SVB) crisis exacerbated their situation. The government demonstrated that if a bank is large enough and its depositors are influential enough, there is no limit to deposit insurance. However, the government could not or would not insure all deposits, leaving small banks at a severe competitive disadvantage. This explains why small banks lost $120 billion in deposits during the turmoil surrounding SVB.
“If we’re really trying to compete against institutions that essentially have a free pass, where the top five are not required to offer insurance on their deposits, what can I do?” questions Scott Hildenbrand, a bank analyst at Piper Sandler, in an interview with Bloomberg’s Odd Lots podcast. He predicts that the number of US banks could decrease from around 4,000 to possibly a couple of hundred in the next 10 to 15 years. A small bank CEO expresses concerns that just as there are food and healthcare deserts, there could be bank deserts – unbanked areas of the country.
Regulatory policies have also led to money flowing into non-banks. For instance, non-bank lenders now originate more mortgages than banks, despite the known risks associated with the less regulated shadow banking system. Under the guise of helping small banks by removing loans from their books, so-called “private credit” is also encroaching on bank market share.
The pandemic has further highlighted the limitations of support for small businesses. The government provided assistance to small businesses through policies like the Paycheck Protection Program. However, the rollout of this aid was chaotic compared to the targeted bailout of large industries. The Federal Reserve’s rescue packages primarily benefitted big companies in accessing the markets. Lockdowns and supply chain disruptions disproportionately affected small businesses that lacked an online presence and lacked the influence to obtain necessary supplies.
Those who argue against the need for small banks are mistaken. Big banks are not interested in providing small loans to local companies, and small companies lack the scale to raise funds in the markets. As Kaplan states, small and midsize banks are a lifeline for the small and midsize businesses that create numerous jobs in the US.
“Many of the nation’s small and midsized banks are ‘scrubbing’ their loan books in an effort to preserve capital,” adds Kaplan. “This has raised the bar for loans to small and midsize businesses that heavily depend on these banks for funding and growth.”
Following the pandemic, there has been a surge in start-ups. It is these businesses that will potentially lead the way out of a recession, if one occurs, as small businesses historically play a key role in economic recovery. Therefore, we must develop policies that protect them and small banks.
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