Fed Report: Community Banks Matter More as They Get Smaller
While community banks have steadily lost market share by almost every conventional metric, they have simultaneously become more systemically important to the parts of the economy that cannot easily be standardized. Despite holding a fraction of U.S. banking assets, they remain the financial infrastructure for rural economies, agricultural borrowers and small businesses that national lenders struggle to serve.
And that’s not just common sense. It’s supported by a new report just put out by economists at the Kansas City Federal Reserve. The report, “Community Banks’ Ongoing Role in the U.S. Economy,” argued that America’s small banks are becoming fewer, larger and less visible in industry-wide statistics. The Fed also said these small lenders are becoming harder to replace.
The decline is notable. Community banks’ share of U.S. banking assets fell from 28.3% in 2000 to 13.5% in 2020. Their share of deposits dropped from nearly 33% to less than 14%, while their portion of industry loans declined from 29% to roughly 18%.
The institutions themselves have also disappeared rapidly. The number of U.S. commercial banks fell nearly 70% between 1984 and 2020, from more than 14,000 to approximately 4,400. Much of that reduction came through mergers, internal charter consolidation and a prolonged decline in new bank formation.
But national asset share is a poor measure of community banks’ economic function.
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America’s Small Banks Are Shrinking Into Something Systemically Important
Community banks increasingly anchor the parts of the economy where financial relationships cannot be easily standardized, automated or managed from a national lending center. A community bank branch is not interchangeable with a mobile app when it serves as the principal credit institution for an agricultural county or small-business ecosystem.
As of 2020, community banks operated nearly 72% of rural bank branches and held about two-thirds of rural deposits. In one-quarter of U.S. counties, they represented the only commercial banking presence. Their footprint was particularly significant in states including Kansas, Iowa, North Dakota, Oklahoma and Nebraska, where they accounted for large majorities of local branches.
That makes their future about more than whether small banks survive another round of consolidation. It is about who finances rural America when the remaining borrowers become larger, more complex and more consequential to their communities.
That creates a more complicated future for small-town lending. Community banks will need technology, loan-participation networks and partnerships that allow them to retain customer relationships while distributing larger exposures. The institutions most likely to endure may be those that separate relationship ownership from balance-sheet capacity.
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Small Banks Finance the Hard-to-Standardize Economy
Community banks retain their strongest position in lending markets where borrower information is incomplete, business conditions are local and credit decisions depend on judgment.
They provide 81% of farm real estate debt held by commercial banks and 74% of bank-held agricultural operating debt. Their share rises further for smaller loans. Community banks originate close to 90% of commercial bank farmland loans of $500,000 or less. Their role in business lending is similarly disproportionate. Despite holding less than 14% of bank deposits, community banks account for approximately 32% of commercial real estate loans. They hold more than three-quarters of bank-originated commercial real estate loans of $100,000 or less.
Community banks cannot match the technology budgets of the country’s largest financial institutions. Nor do they need to replicate their infrastructure. Cloud platforms, FinTech partnerships and outsourced compliance tools are making sophisticated banking capabilities available without the balance sheet or headcount once required to support them. Automated workflows can reduce manual processing. Digital account opening can expand a bank’s addressable market. Modern fraud and risk tools can be purchased rather than built.
Separate findings in “AI at the FI: Inside Credit Unions’ Demand-Execution Gap,” a PYMNTS Intelligence and Velera report that examines how credit unions (CUs) are responding to growing demand for AI-powered financial services, reveal that 57% of top-tier CUs expect to offer AI-enabled payments by 2032, up from 20% that offer them today, representing one of the largest planned expansions among AI capabilities. At the same time, more than two in three top-tier CUs (67%) plan to provide AI-powered financial advice by 2032, compared with 22% today, signaling a major shift toward personalized financial guidance.
The strategic opportunity is not to transform community banks into smaller versions of national banks. It is to use technology to remove the operational disadvantages of being local while preserving the informational advantages.
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