Federal Reserve System and the Conference of State Bank Supervisors

Community Banking in the 21st Century

October 2, 2013, Federal Reserve Bank of St. Louis

Kenneth Spong, Small Business Lending and Social Capital: Are Rural Relationships Different?

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Kenneth Spong, an assistant vice president and economist at the Federal Reserve Bank of Kansas City, presents his paper “Small Business Lending and Social Capital: Are Rural Relationships Different?” co-written with Robert DeYoung of the University of Kansas School of Business, Dennis Glennon of the Office of the Comptroller of the Currency and Peter Nigro of Bryant University. The authors find that loans made by rural community banks and/or borrowed by rural business have lower default rates. Also, loans made outside banks’ markets have higher default rates than loans made within the local market.

Bank Failure, Relationship Lending and Local Economic Performance (PDF)

Abstract: Rural communities often are described as places where “everyone knows each other’s business.” Such intracommunity information is likely to translate into a stock “social capital” that supports well-informed financial transactions (Guiso, Sapienza and Zingales 2004). We investigate whether and how the “ruralness” of small banks and small-business borrowers influences loan-default rates, using data on more than 18,000 U.S. Small Business Administration loans originated and held by rural and urban community banks between 1984 and 2001. These data provide a good test of the value of soft information and lending relationships because (a) these borrowers tend to be smaller, younger and more credit-challenged than other small businesses and (b) these loans were originated largely before the advent of small business credit scoring and securitization, hence they were held in portfolio and put some bank capital directly at risk. We have two main findings. First, loans originated by rural community banks and/or loans borrowed by rural businesses default substantially less often than loans made by urban banks and/or in urban areas. Second, loan-default rates are significantly higher when borrowers are located outside the geographic market of their lenders, even after accounting for the physical distance between the bank and the small business. Thus, we conclude that loan defaults are lower in communities arguably expected to have large amounts of inexpensive soft information and at banks likely to have a high level of personal knowledge about their customers. Our findings offer an explanation for why community banks—and in particular, rural banks—continue to exist despite operating at such a small scale; why small local banks play a critical role in lending to small, informationally opaque borrowers; and why small rural banks are less likely to use small business credit scoring than their small urban counterparts. Moreover, our findings are consistent with the idea that a high stock of social capital is conducive to financial activity and development.

Conference Videos

Welcome & Overview (Oct. 2)
Moderator: Julie Stackhouse (5:29)

Opening Remarks
John Ryan (4:58)
James Bullard (4:39)
Ben Bernanke (8:40)

Research Session 1: The Role of Community Banks
Research Session 1 Moderator: Scott E. Hein (5:35)
Do Community Banks Play a Role in New Firm Survival? (Smith Williams) (18:27)
Equipment Lease Financing: The Role of Community Banks (Mohammed Khayum) (13:24)
Equipment Lease Financing: The Role of Community Banks (Charles Kelly) (14:03)
Small Business Lending and Social Capital: Are Rural Relationships Different? (Kenneth Spong) (25:08)
Bank Failure, Relationship Lending and Local Economic Performance (John Kandrac) (22:32)
Q&A (16:07)

Evening Keynote Address
Dorothy Savarese (38:04)

Community Banking Performance (Oct. 3)
Moderator: Richard Brown (5:07)
Financial Derivatives at Community Banks (Shelly Shen) (11:12)
Lessons from Community Banks that Recovered from Financial Distress (Andrew P. Meyer) (22:40)
The Effect of Distance on Community Bank Performance Following Acquisitions and Reorganizations (Timothy J. Yeager) (20:43)
Performance of Community Banks in Good Times and Bad Times: Does Management Matter? (Dean F. Amel) (17:02)
Research Session 2 Question and Answer Period (21:41)

Supervision and Regulation of Community Banks
Moderator: Lamont Black (4:09)
Estimating Changes in Supervisory Standards and Their Economic Effects (William F. Bassett) (17:23)
The Impact of Dodd-Frank on Community Banks (Tanya D. Marsh) (15:39)
Capital Regulation at Community Banks: Lessons from 400 Failures (Robert R. Moore) (14:39)
A Failure to Communicate: The Pathology of Too Big to Fail (Harvey Rosenblum) (18:15)
Research Session 3 Moderator Wrap-up (14:43)
Audience Question and Answer Session (14:46)

Afternoon Keynote Presentation
Federal Reserve Governor Jerome Powell (28:27)

Panel Discussion and Presentation of Results from Town Hall Sessions
Presenter: Mike Stevens (13:20)

Panel Discussion: Community Banking in the 21st Century: Opportunities, Challenges and Perspectives
Moderator: Charles A. Vice (13:32)
Curt Hecker (7:38)
Bobby P. Martin (12:24)
Thomas E. Spitz (8:30)
Claire W. Tucker (9:14)
Community Banking Panel Question and Answer Period (1:04:29)
Julie Stackhouse, Closing Remarks (11:13)

Conference of State Bank Supervisor