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Community Banks: An Essential Role

Ours is the only country in the world with a community banking system. Throughout America’s history, the diversity and local leadership of small and medium-sized community banking institutions has been the engine of our economic prosperity. In particular, community banks are the primary source of funding for small businesses seeking capital for growth, innovation, and job creation. Remarkably, 96 percent of all the businesses in the U.S. have fewer than 100 employees and the largest banks do not tend to give them much attention. So it is left to community banks in cities and towns across America to play this vital and irreplaceable economic role.

Most community banks have made only sound mortgages, maintained those loans in their own portfolios, carefully managed their risks, and pursued a local business model that focuses on customer needs. Indeed, most of the 6,450 institutions classified as community or small regional banks under $10 billion in assets never made one toxic subprime loan. A few large banks control most of the assets in the banking industry, but community banks represent 99 percent of the total number of banks. And although community banks had nothing to do with creating the financial crisis, they have been taking a pounding nonetheless.

Some of the damage has been to the reputation they value. When the federal government announced what was originally called a “bank bailout”, community bankers had to scramble to explain to their customers that most of the entities in trouble were not commercial banks, but large investment banks on Wall Street.  Perhaps Lehman Brothers might still be in business had they been willing to make loans to “Joe the Plumber”.  Community bankers saw their image tarnished as politicians and the media used the words “bank” and “bank failure” to describe what was happening to nonbanks.

The Treasury’s Capital Purchase Program (CPP), intended to increase lending, does little to help the vast majority of community banks that remain well capitalized and have money to lend. More than a few community bankers have expressed frustration that the capital infusion program is essentially a “subsidy” for reckless (mostly larger) competitors who would not need assistance had they managed their institutions properly in the first place.

The Treasury has sought to overcome community bankers’ resistance to the CPP by urging all healthy banks of every size to participate, even if they don’t issue preferred shares or need capital -and more recently, even if they are non exchange-traded public companies or are privately held. This pressure has triggered anxiety for community bankers as they wrestle with whether or not to sign up for the program. If they do, their customers could misperceive them as weak and in need of a government handout. Moreover, they will be subject to all manner of government restrictions that could discourage private investment.

The fallout from the missteps of a few large financial players could result in heavy-handed regulation that drives up costs, increases the number of incomprehensible disclosures and pushes community banks out of the market. Community banks should not be forced to atone for the sins of others. Let’s design regulatory reforms with an eye toward making community banks more competitive and better able to support small business.

Any federal solution cannot be a hasty one-size-fits-all regulatory “fix” that may have a further negative effect on community banks. Community bankers deserve a seat at the table as decisions about the ongoing financial crisis are being made and as Congress begins the work of reforming our financial regulatory system. Bankers have an intimate knowledge of the needs of small businesses whose continued access to funding is critical to economic recovery. Community banks and their common-sense approach to management hold important lessons for all financial service organizations.

Most of all, our leaders should be reminded of the essential role of the U.S. community banking system in a strong and well functioning economy. Our country’s economic recovery and the preservation of the American dream depend on it.