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Banks are inherently a 'bigger the better' business. A bank serving a single town goes down with the town, so you diversify to the next town over. Diversifying

Banks are inherently a 'bigger the better' business. A bank serving a single town goes down with the town, so you diversify to the next town over. Diversifying means now your depositors are less correlated and you have more scale for things like apps and online stores, and you have much more predictable losses on your credit portfolio. Bigger banks are more able to adapt to new technology (community banks have been the biggest lobbyists against most technological innovations in banking, and is part of why FedNow is taking so long to roll out). It's kind of like insurance: they can only exist because they offload some of their risk to bigger companies; the bigger you are the more efficient you become. I mentioned in another comment about how most small banks closely tied to the local business environment and especially CRE markets. The difference between a single CRE developer being 5% of your portfolio when you're one tiny bank and 0.5% when you're a slightly larger bank is massive. You scale that up even more and banking gets more reliable and easier to manage the larger the banks are. The fewer banks there are, the easier it is to provide oversight and regulate them. You have fewer institutions to coordinate when trying to push big changes, and what fewer institutions do exist are more resilient and able to absorb larger losses.

taeric 3y ago
I don't buy it, right off. A bank serving a single town does go down with the town. But the big banks don't do anything to help the town stay up, as it were. That is, sure, the bank disappears if the town does. But the question is if local banks help towns not disappear? There are tangible goods for having value pumped locally into the place that has it. Versus the larger banks that have no reason to invest in smaller towns.
- throw9away6 3y ago
  Local banks can help towns not disappear if they are allowed to actually bank. They could in theory loan to the local plumber to start his shop, the auto body shop for a paint hanger etc. The problem is that all those loans are risky and risky in a correlated way such that if a local anchor company goes up so does the rest of the lending portfolio. Over a long enough period of time a local adverse event will happen and the bank will get hit by a liquidity crisis and get shut down. The too big to fail banks are also prone to this but in theory because they are regionally diversified less so. Still without government guarantees about half or more would have failed in 2008/2010 time period. Still with government guarantees these banks have access to much cheaper capital and more liquidity when a crisis happens to they can out compete smaller banks.
  - taeric 3y ago
    I get that, on paper. Most of the risks shouldn't be correlated in a systemic way, though? If a local plumber goes up on their loan, why would that mean a local construction company is going down? If you over lend, sure, but otherwise? One going down should be somewhat shiftable to another. Unless you are lending to people that have absolutely no assets that can be liquidated? But, that just seems to say that we only lend on leveraged value nowadays? That is a depressing thought. And again, any systemic risk to a town seems to still exist. Just now there is nothing keeping money made on interest in the town. Literally all profits from localities are shifted out to wherever the bank is located.
btilly 3y ago
The problem is that you are trading institutional risk (your local bank goes out of business) for systemic risk (the entire financial system goes under). There are other ways to mitigate that institutional risk. Such as FDIC insurance. And the availability of securitization for loans. The bank makes the loan, sells it off to Wall St, where it becomes part of a bond deal. And now the bank is insulated from default risk, and can make another loan. Before securitization, when a local crash hit, lending became hard, and the downturn would stretch out. After securitization, towns began to bounce back more quickly after local hard times (eg a factory closing). On the other hand "too big to fail" is a huge problem with the biggest banks. And regulation stops being meaningful when the institutions engage in regulatory capture. As an example, in the leadup to 2008, a ton of new financial regulations were enacted. But all benefited the same 5 Wall St firms. Who, when they ran into trouble, nearly destroyed our financial system. (I know people think it was overblown. But we were actually within 1 day of "ATMs will stop working" when TARP was passed.)
rndmwlk 3y ago
>A bank serving a single town goes down with the town This isn't necessarily a bad thing from the perspective of the town.
- taeric 3y ago
  Exactly my point. :D And it creates a great incentive for the bank to invest back into the town. At least on paper?

taeric 3y ago

I don't buy it, right off. A bank serving a single town does go down with the town. But the big banks don't do anything to help the town stay up, as it were. That is, sure, the bank disappears if the town does. But the question is if local banks help towns not disappear? There are tangible goods for having value pumped locally into the place that has it. Versus the larger banks that have no reason to invest in smaller towns.

throw9away6 3y ago
Local banks can help towns not disappear if they are allowed to actually bank. They could in theory loan to the local plumber to start his shop, the auto body shop for a paint hanger etc. The problem is that all those loans are risky and risky in a correlated way such that if a local anchor company goes up so does the rest of the lending portfolio. Over a long enough period of time a local adverse event will happen and the bank will get hit by a liquidity crisis and get shut down. The too big to fail banks are also prone to this but in theory because they are regionally diversified less so. Still without government guarantees about half or more would have failed in 2008/2010 time period. Still with government guarantees these banks have access to much cheaper capital and more liquidity when a crisis happens to they can out compete smaller banks.
- taeric 3y ago
  I get that, on paper. Most of the risks shouldn't be correlated in a systemic way, though? If a local plumber goes up on their loan, why would that mean a local construction company is going down? If you over lend, sure, but otherwise? One going down should be somewhat shiftable to another. Unless you are lending to people that have absolutely no assets that can be liquidated? But, that just seems to say that we only lend on leveraged value nowadays? That is a depressing thought. And again, any systemic risk to a town seems to still exist. Just now there is nothing keeping money made on interest in the town. Literally all profits from localities are shifted out to wherever the bank is located.

btilly 3y ago

The problem is that you are trading institutional risk (your local bank goes out of business) for systemic risk (the entire financial system goes under). There are other ways to mitigate that institutional risk. Such as FDIC insurance. And the availability of securitization for loans. The bank makes the loan, sells it off to Wall St, where it becomes part of a bond deal. And now the bank is insulated from default risk, and can make another loan. Before securitization, when a local crash hit, lending became hard, and the downturn would stretch out. After securitization, towns began to bounce back more quickly after local hard times (eg a factory closing). On the other hand "too big to fail" is a huge problem with the biggest banks. And regulation stops being meaningful when the institutions engage in regulatory capture. As an example, in the leadup to 2008, a ton of new financial regulations were enacted. But all benefited the same 5 Wall St firms. Who, when they ran into trouble, nearly destroyed our financial system. (I know people think it was overblown. But we were actually within 1 day of "ATMs will stop working" when TARP was passed.)

rndmwlk 3y ago

>A bank serving a single town goes down with the town This isn't necessarily a bad thing from the perspective of the town.

taeric 3y ago
Exactly my point. :D And it creates a great incentive for the bank to invest back into the town. At least on paper?