When Community Banks Die: How Small Businesses Are Affected

When it comes to financing, community banks have been providing support to small businesses for decades. However, a problem is emerging that’s affecting small business: Community banks are closing and consolidating due to pressure from regulation and an uneven lending playing field.

“The success of the American economy was built in part on the backs of small businesses that were financed by small banks,” said Stephen Andrews, a former president of a few community banks based on the West Coast. “Removing the community banks from the equation upsets and diminishes the potential of small business to compete effectively.”

When the 2008 financial crisis hit, the U.S. government responded with a bank bailout and increased regulation. In Washington’s eyes, it was time to hold Wall Street accountable and stop any future economic turmoil that could be spurred by big institutions. But the reach of Dodd-Frank, Washington’s answer to the 2008 crisis, extended beyond just the big banks on Wall Street. Local community banks suddenly had a whole host of regulation to adhere to.

“The sins of big banks brought on a crush of new regulations with Dodd-Frank legislation that disproportionately impacted smaller community banks,” Andrews said. “Community banks were forced to invest in new software, technology infrastructure, and compliance personnel, creating an unavoidable high level of fixed costs that are disproportionate to larger institutions.”

But Dodd-Frank is just the tip of the iceberg for an area of banking that’s been on a slow decline for decades. Between 1994 and 2015, community banks’ share in bank lending and assets fell by 40 percent, according to a Harvard Kennedy School study on the state of community banking in 2015.

Community banks are going away – they’re consolidating, being purchased by big banks or just closing. As the community banking market erodes, small businesses are being squeezed – businesses that can’t meet conventional lending requirements from big institutions are having to turn to fintech lenders, which often charge higher interest rates on shorter terms compared to what a community bank could offer.

“Small businesses suffer to a degree financing with a FinTech player,” Andrews said. “If they do fit the [lender’s] criterium, they would likely pay a premium finance rate verse the rate a community bank would have charged.”