On a local St. Louis street corner sits a family grocery store called Freddie's Market, where older residents recall shopping as children. Nothing is particularly unusual about this small store except, perhaps, that it is still in business. Just down the road is a regional chain store that dominates the local grocery market. The chain's better selection and cheaper prices have driven nearly every other independent grocery store in town out of business.
A few years ago, some claimed that community banks would follow a similar fate, suggesting there would be only a few thousand community banks left at the turn of the 21st century. Yet, here we are in the spring of 2003 with more than 7,000 U.S. community banks in operation.
Despite a wave of consolidation, we have seen community banks thrive using a business model built on personal relationships and trust. Typically, large banks can deliver lower prices and better selection, but they lack the personal relationships that set community banks apart. Indeed, some Internet-only banks are struggling because they are unable to develop this trust relationship.
The personal relationship with borrowers gives community banks an edge in small-business lending. Intangible information, such as an entrepreneur's reputation in the community, is obtained more easily by a local, community banker. Additionally, community banks often are more flexible in tailoring their loan policies to small-business customers. Because small-bank loan officers are closer in the chain of command to senior managers, they generally deal with less bureaucracy and, therefore, have more discretion in lending with "exceptions."
Despite these advantages, community banks still must overcome significant hurdles. Larger banks will continue to lure customers who value wider product selection and lower prices. Moreover, by tailoring loan and deposit terms to individual customer needs, community banks may find themselves with higher levels of liquidity and interest-rate risk than they experienced previously. The challenge for community banks will be to provide excellent customer service while incorporating more advanced risk-management strategies.
From all that we have seen, our community banks are up to the challenge!
Fed in Print: An index of the economic research conducted by the Fed.