Community Banks in Decline, Struggle With High Regulatory Burden

(The Epoch Times)—The number of community banks—small financial institutions that are locally owned and operated—has significantly declined over the past 25 years, from more than 8,500 to around 4,000 today.

Banking experts have alluded to these companies’ various day-to-day business challenges, from the immense regulatory burden to high capital requirements and compliance costs.

“Community banks know their communities best, and research shows that when they close their doors, Americans suffer,” House Financial Services Committee Chairman French Hill (R-Ark.) said at a recent hearing.

He said community banks remain critical engines for local economies, but, they’re disappearing. During the hearing, industry leaders testified that many community banks enjoy deep roots in their communities and have survived economy-shattering systemic shocks over the years.

However, despite enduring various headwinds, many of these smaller outfits continue to struggle in today’s climate because of excessive red tape.

Rebecca Romero Rainey, the president and CEO of the Independent Community Bankers of America, said that she doubts many of the small institutions of yesteryear would have formed in the current regulatory climate.

One example she cited was the implementation of Section 1071 of the Dodd-Frank Act, an amendment that mandates financial institutions to collect, report, and maintain data on applications for credit for women or minority-owned businesses.

The objective is to ensure the enforcement of fair lending laws and facilitate an environment of opportunities for business and community development. She says this has increased compliance costs and compromised the privacy of small business applicants.

Additionally, Rainey says she believes the government needs to enact regulatory policy proportionate to the risk represented by community banks.

Forty percent of community bank executives viewed the federal government as a “significant” threat to the banking industry, according to a 2024 What’s Going On In Banking study by Cornerstone Advisors.

Ken Wilcox, the former CEO of Silicon Valley Bank and former member of the board of directors of the Federal Reserve Bank of San Francisco, does not blame them for feeling the way they do.

While he views bank regulations as necessary, they “annoyed me to no end.”

“There were numerous times during my tenure as CEO when I felt that the regulation was unnecessary and problematic and, frankly, just getting in my way of success,” Wilcox told The Epoch Times.

In his experience, regulators have typically been harder on small banks than larger entities.

“It’s easier to regulate a small bank,” Wilcox said, adding that the big banks tend to devise sophisticated business models, making it harder for the regulators to understand.

However, while community banks face an onslaught of rules and regulations, consumers are signaling that they still prefer local banks.

According to Federal Reserve data, deposits at small commercial banks have increased since the historic bank failures two years ago, which included Silicon Valley Bank. Today, deposits total more than $5.53 trillion, up from about $5.14 trillion in March 2023.

By comparison, deposits at large commercial banks are approximately $11 trillion, little changed from when several banks failed.

One potential reason for this trend is that community banks are typically the only physical financial institutions in many counties, meaning that they may be the only option available.

Susanna Marshall, the commissioner of the Arkansas State Bank Department, says that a community bank could be the lone entity in one-quarter of counties and represent two-thirds of all rural deposits.

“Those largest institutions don’t reach those areas,” Marshall said in her prepared remarks. “Their business models are not an adequate substitute for the relationship lending model so crucial to local small businesses and entrepreneurs.”

However, Kansas City Fed economists say that community banks can be more vulnerable at the slightest sign of trouble.

Writing in a Dec. 2023 paper, they noted that community banks could be more susceptible to trouble since they depend more on deposit funding than larger banks “due, in part, to their limited ability to access broader funding markets.”

Additionally, the Federal Reserve raising interest rates and keeping them elevated since early 2022 has also created a “potentially less stable situation.”

“As depositors shift funds out of low-yielding savings and noninterest-bearing deposit accounts and into more lucrative alternative investments, community banks have increasingly turned to longer-maturity deposits and borrowings to finance their balance sheets,” the regional central bank economists said.

“Although these funding sources allow banks to retain their asset size, they are both more expensive and potentially less stable.”

It might seem counterintuitive—and contradictory to testimony from industry experts at last week’s committee hearing—but the current administration’s deregulatory push could harm community banks more than Wall Street banks, Wilcox said.

“Deregulation will help bigger banks,” he said.

“It will not help smaller banks. In fact, it may have a negative effect on smaller banks, because it will encourage depositors to go to bigger banks.”

Over the years, regulators have adopted one-size-fits-all approaches that have disproportionately affected smaller institutions.

With a new administration and a Republican-controlled Congress, community bank leaders hope the conversation can shift toward a tailored approach to rules and regulations that considers the unique challenges and risk profiles of these small banks.

“The concept of one size fits all is not what we need when it comes to bank regulation,” Marshall said.