The EU banking system can be an excellent source of finance for small businesses if national options don’t meet your needs. So what does its decline mean for small businesses?
- Community banks have fewer branches than domestic banks and are usually located in a city or region.
- The EU banking system can be an excellent source of finance for small businesses if national options don’t meet your needs.
- The community banking sector is in decline due to the regulations introduced by the Dodd-Frank Act and the rise of fintech.
- This article is for small business owners interested in how community banks affect their financing options.
mediaindonesia.net– When it comes to financing, community banks have been supporting small businesses for decades. However, a problem is emerging that affects small businesses: Community banks are closing and consolidating due to regulatory pressures and an uneven playing field for lending. Here’s what you need to know about how the decline in the community banking sector could affect your small business. [Are you thinking of financing your business? Read our guide on how to get a small business loan.]
What is the community banking system?
A community bank is an institution that caters to a smaller local audience rather than the broad national audience of larger banks. These banks often develop close relationships with their customers, and this personal connection is often a strength for community banking.
In particular, there is no accepted dimension that defines the term “community banking”. However, in general, a community bank has only a few branches, all of which are located in the same city.
Why is the community bank important for small business financing?
The personal connections that underpin community banking can be very significant to your business. That is, if you need a loan but can’t meet traditional bank credit score criteria, community banks may be more willing to help.
The positive impacts of community banking can extend beyond your business to the entire local economy. If a community bank in your area regularly lends to many businesses, it is actually funding small businesses. This means you can directly trace local economic growth all the way back to community banks. Also, because community banks often know their neighborhoods and the people who live there very well, they can consider and approve loan applications more quickly.
The history of the community bank
The EU banking system is far from new. Indeed, its history is intertwined with the story of how the American economy first thrived.
“The success of the US economy has been built in part on small businesses financed by small banks,” said Stephen Andrews, former president of some community banks based on the West Coast. “Removing community banks from the equation disrupts and diminishes the potential for small businesses to compete effectively.”
However, in recent years, the prevalence of community banking has declined. The fault can be of an event.
The modern presence of community banking
When the financial crisis hit in 2008, the US government responded with a bank bailout and more regulation. In Washington’s eyes, it was time to hold Wall Street accountable and stop any future economic turbulence that might be caused by large institutions. But the scope of the Dodd-Frank Act, Washington’s response to the 2008 crisis, extended beyond the big Wall Street banks. Local community banks suddenly had a series of regulations to abide by. “The sins of the big banks have sparked a flood of new regulations with the Dodd-Frank legislation that has disproportionately affected smaller community banks,” Andrews said. “Community banks have been forced to invest in new software, technology infrastructure and compliance personnel, creating an inevitably high level of fixed costs that are disproportionate to larger institutions.”
But Dodd-Frank is just the tip of the iceberg for a banking area that has been in slow decline for decades. Between 1994 and 2015, the share of bank lending and community banking assets fell by 40%, according to a 2015 Harvard Kennedy School study of the state of community banks.
In recent years, this trend has continued. In the third quarter of 2021, for example, there was a net reduction of 130 community bank cards, leaving only 4,752 community banks active nationally, according to a Banking Strategist report.
Why are community banks disappearing?
Regulation is an important part of the decline in community banking, but it is only one factor that has led to its erosion. According to Andrews, the rise of fintech lenders, tax considerations for credit unions, and pressure for consolidation have hit community banks.
All of these factors contribute to creating uneven conditions for community banks. They are regulated like big banks, taxed like big banks and other lenders can provide the same services to small businesses without going through the same circles. Credit unions, for example, enjoy a different tax structure than traditional banks. However, credit union lending practices have begun to mirror community banks. Some credit unions enjoy the same functionality as a community bank with no tax or regulatory burden.
“Credit unions walk and talk like banks,” Andrews said. “And while their small business lending powers have been expanded, the level playing field isn’t even compared to credit unions, as they enjoy tax advantages that community banks don’t. And this translates into a price advantage with tax advantages “.
How fintech affects community banking
Community banks are leaving: they consolidate, are bought by the big banks and close. With the erosion of the community banking market, small businesses are being squeezed. Businesses that cannot meet the conventional lending requirements of large institutions must turn to fintech lenders, which often charge higher interest rates on shorter terms than a community bank might offer.
“Small businesses suffer to some extent from funding with a fintech player,” Andrews said. “If they meet [the lender’s] criteria, they are likely to pay a higher funding rate than a community bank would have charged.”
Fintech lenders, online lenders with overnight authorizations and automated underwriting processes, provide the same services as banks, but don’t have to put up with the same overwhelming regulations that community banks need.
“On the regulatory side, there has been an increase in fintech that has not received the same scrutiny as banks in terms of oversight,” Andrews said. “This creates an operating price disparity and a compliance disparity that favors new entrants to the market.”
In addition to an uneven playing field, banks suffer from a talent shortage, according to SBA loan advisor and BOLD Lender president Alex Espinosa. He said that generational shifts within community banks are encouraging CEOs of larger banks to take over and consolidate rather than hand the keys to inexperienced executives. He also said that the best and brightest minds are likely to work for tech companies rather than banks.
These factors have slowly undermined the EU banking market for years, and their demise is hitting small businesses the hardest. [Related: SBA Loans vs. Conventional Loans]
How small businesses are affected by the decline of community banks
Community banks provide 77 percent of farm loans and more than 50 percent of small business loans, according to the Harvard Kennedy School study. What community banks offer small businesses in the lending process is almost intangible: because banks know the community, they can lend to businesses based on information not found only in a business’s financial data. Learn more about managing your business’ cash flow.
Instead of meeting strict requirements through a fintech lender or going to a large conventional bank only to be turned down due to financial problems, small businesses can turn to a local community bank to get the financing they need at an acceptable rate. Because bankers are rooted in the community, they can consider additional factors related to a borrower’s situation that go beyond basic financial data. Community banks are more personal and, as a result, provide more informed loans. According to the Harvard Kennedy School study, the default rate for household loans with community banks was 3.47% in 2013. In the same year, the largest banks recorded a default rate of 10%. 42%.
“Community banks are generally relationship banks; their competitive advantage is the knowledge and history of their customers and a willingness to be flexible,” the study reads.
Where can small businesses look for finance without the EU banking system?
The decline of the EU banking system has a direct impact on small businesses. With fewer and fewer community banks to turn to for funding, small businesses need to partner with larger banks or fintech lenders. It can be difficult to get approval from a larger bank, and fintech lenders typically have higher interest rates and shorter terms than conventional bank loans.
The business that has suffered the most from all of this is the one that does not meet the needs of fintech lenders or large banks.
“Those companies that require personal and labor-intensive credit underwriting attention for loan approval will not adapt to the automated underwriting process,” Andrews said. “Community banks … catch borrowers who don’t have standard funding requirements.” [Read related article: Best Government Grants for Small Businesses]
Will this problem be solved?
Andrews said major changes need to occur with taxes and regulation. The relaxation of the regulation that was intended for large banks will allow local banks to catch their breath. Adjusting fiscal practices to credit unions will also help level the conditions for community banks.
“Community bankers are not afraid of competition or market disruption, but they want a level playing field when it comes to tax and regulatory burdens,” Andrews said. Espinosa agrees, stating that the regulation needs to be changed so that community banks have a chance to be competitive. Whatever the right course of action, the EU banking system is in decline, which means that small businesses may not be able to get the finance they need.