We Could Use More Small BanksS

America now has 6,891 federally insured banking institutions. That's the fewest we've had since 1934. Though it may cause reflexive distaste, it is a fact: we could use more banks.

Why so few banks today, relatively speaking? Because of the aftereffects of the recession; because very few new banks are starting up; and, more generally, because of banking industry consolidation. Bigger banks buy smaller banks and get bigger. In banking, as in all industries, consolidation reduces competition and allows the remaining institutions to wield more power. At the very top end of the banking industry, consolidation contributes to the creation of "too big to fail" institutions, which cause a whole host of fucking problems, and which must always be bailed out by you and me and grandma when they fuck up, because their failure would create chaos.

Think of the classic little "community bank," like in It's a Wonderful Life. It's a part of the community. Its officers have personal relationships with people in the community. And its business depends on supporting the economic development of the community. Also, since its assets are relatively small, it will tend to watch and administer its loans with discretion. It has the flexibility to consider all aspects of loan requests (including the personalities of those involved), and it has a great incentive not to—just for example—toss out mortgages to any broke person who can sign their name. If a small bank like this (or other creative small lending institution) fails, it just fails. No one will bail it out. It must run itself well. Community banks are actually in the "classic" business of banking: taking in deposits, giving out loans, and making a modest but healthy living off of interest.

Huge international banking conglomerates, on the other hand, are in a zillion different businesses within the world of finance, relatively few of which depend on the conservative classic business of banking. They are constantly trying to magnify their profits, which adds to risk. They have no personal connection to the communities in which they operate. They are accountable to large shareholders and wealthy executives, not the interests of any particular community. As their competition erodes and their power grows, they are able to raise their fees more and more. And they operate on the unstated assumption that if and when they gamble too much and lose, they will be bailed out by the public.

This is a simplistic account of the top and bottom ends of banking (no banks are charities, after all), but it highlights real differences between a financial world mostly controlled by small community banks and a financial world mostly controlled by too big to fail megabanks. In general, consolidation in the banking industry is good for banks and bankers, and bad for consumers. It is not to be applauded. We should be looking for ways to break up the megabanks into smaller pieces. Not the other way around.

Some people disagree! Matt Yglesias, for example, who believes that America still has "way too many" banks. He raises three objections to small banks. Let's address them very briefly.

"1. They are poorly managed: You know how the best and brightest of Wall Street royally screw up sometimes? This doesn't get better when you drill down to the less-bright and not-as-good guys. It gets worse." Here, Matt Yglesias argues that the smaller the bank is, the dumber its employees. This is wrong, and elitist, and frankly embarrassing.

He also notes that at small banks, the "dubious decision-making doesn't get as complicated as what you see on Wall Street...but it creates all the same problems." Since small banks are not in nearly as many exotic financial business lines as megabanks, and since they are not too big to fail, they do not, by definition, create all the same problems.

"2. They can't be regulated: Since these banks are so small, they could be easily driven out of business by high regulatory compliance costs." Since smaller banks engage in fewer risky financial activities than megabanks, they do not need to be regulated with the same high level of detail. This problem should take care of itself.

"3. They can't compete: If you want the JPMorgan Chases and Bank of Americas of the world to be held to account, you need both regulation and competition. But a bank serving a handful of rural counties or a single midsized city doesn't offer any real competition." This is why JPM and Bank of America should be broken down into small enough parts that they are 1) not too big to fail and 2) will have to compete with more banks. This will benefit both taxpayers and consumers. Matt Yglesias' solution for too big to fail megabanks is to... create more too big to fail megabanks. Let's not.

Public discussion of important matters!

[Photo: AP]