Changing Rules and Opportunities for Community Banks

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Changing Rules and Opportunities for Community Banks AAEA 2000 Organized Symposium New Sources of Capital for Rural America Maureen Kilkenny Iowa State University

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Changing Rules and Opportunities for Community Banks. AAEA 2000 Organized Symposium New Sources of Capital for Rural America Maureen Kilkenny Iowa State University. Rule 1. Riegle-Neal Act of 1994 ∙ repealed McFadden Act (1927) => legalized multistate branch banking. GLB permits. - PowerPoint PPT Presentation

Transcript of Changing Rules and Opportunities for Community Banks

Page 1: Changing Rules and Opportunities for Community Banks

Changing Rulesand Opportunities

for Community Banks

AAEA 2000 Organized Symposium

New Sources of Capital for Rural America

Maureen KilkennyIowa State University

Page 2: Changing Rules and Opportunities for Community Banks

Small Business Finance1993 NSSBF data, Berger & Udell JBF (1998)

owner equity

owner debtdebt to other individuals

other equity

govtother non-financialother debt

commercial banks

trade credit

credit cards

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0-2 years 3-4 years 5-24 years over 25 yrs

maturity of firm

sour

ce s

hare

s

Page 3: Changing Rules and Opportunities for Community Banks

Distance from Primary Creditor1993 NSSBF Kilkenny & Kim (2000)

0.05.0

10.015.020.025.030.035.040.045.0

0 2 4 6 8 10 20 More than40

MILES

FRE

QU

EN

CY

(%)

MSA

NONMSA

tertiary creditor for NonMet biz

Page 4: Changing Rules and Opportunities for Community Banks

Rule 2. Gramm-Leach-Bliley (GLB) Act of 1999· repeals parts of Glass-Steagall (1933-6)· repeals parts of Bank Holding Co Act (1956)

Rule 1. Riegle-Neal Act of 1994∙ repealed McFadden Act (1927)

=> legalized multistate branch banking

=> legalizes broad banking, but not universal banking=> extends Federal Home Loan Banking system=> modifies Community Reinvestment Act

Page 5: Changing Rules and Opportunities for Community Banks

GLB permitssubsidiaries of commercial banks to:

underwrite and deal securities

sell insurance

financial holding companies to form and:

own banks

underwrite and deal securities

underwrite and sell insurance

conduct merchant banking

Page 6: Changing Rules and Opportunities for Community Banks

Underwrite & sell securities

Accept deposits & Make commercial loans

Underwrite & sell insurance

FINANCIAL HOLDING COMPANY

Commercial banking

Investment banking Insurance agency

Page 7: Changing Rules and Opportunities for Community Banks

Regulations on Mixing Commercial Banking,Securities, Insurance, and Commerce; By Country

country securities insurancebank ownershipof commercial

firms

commercialfirm ownership

of banks

UK unrestricted permitted unrestricted unrestricted

France permitted permitted permitted permitted

Canada permitted permitted restricted restricted

Germany unrestricted restricted unrestricted unrestricted

Japan restricted prohibited restricted prohibited

USA before GLB restricted prohibited prohibited prohibited

USA now permitted permitted prohibited prohibited

Barth, James, R. Dan Brunbaugh, and James Wilcox (2000) "The Repeal of Glass-Steagall and the Adventof Broad Banking," Journal of Economic Perspectives 14(2):191-204.

Page 8: Changing Rules and Opportunities for Community Banks

Opportunities:

1) relationship lending2) economies of scope & scale

· data sharing and cross-selling· diversification

3) FHLB alternative source of funds (Federal Home Loan Bank)

Page 9: Changing Rules and Opportunities for Community Banks

Boot & Thakor (2000) "Can Relationship Banking Survive Competition?" The Journal of Finance 55(2):679-713

relationship loans(from banks)

transaction loans(banks & non-banks)

capital market financing (now possible by FHCs under GLB)

Low High

Opportunity: relationship lendingBorrower Quality and Type of External Finance

Community banks can now continue to serve clients as they mature

value of relationships remain internalized

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Relationship with Primary Credit Institution1993 NSSBF, Kilkenny & Kim (2000)

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.00 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

>20

YEARS

FRE

QU

EN

CY

(%) MSA

NONMSA

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• Information acquisition

Opportunity: scope & scale economies

Additional, new financial services can be provided at lower marginal costs

Data sharing

• Administration & back office

Spread overhead

fixed costs in financial intermediation:

• Marketing & distribution

Cross-selling

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• Wider range of securities

Opportunity: diversification

Higher and more stable overall returns

Lower correlation

• Supply alternative types of finance

retain customers

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• GLB Act permits banks (with assets <$500 mil.) to obtain FHLB advances

Opportunity: new sources of funds

Continue to provide loans to small businesses, small farms, and small

agribusinesses

Community banks can still obtain

cheap funds

Page 14: Changing Rules and Opportunities for Community Banks

RCaT(2000) 11(1):44

Numerous rural Banks were not members of the FHLB system in 1998

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How will these changes affect the supply of capital to rural areas?

Q1: Threat to survival of community banks from legalized branching?A1: Since Riegle-Neal, more banks, more offices, and

more lending to small businesses.

Q2: Threat to banks that thrive on relationship lending? H2: GLB = Boon, not threat.

Q3: Threat of rural savings outflow reducing available funds? H3A: GLB increases community banks access to other (FHLB) sources of funds.

H3B:the less segmented are capital markets, the more sensitive credit flows are to local growth prospects. (Declining communities decline faster, growing communities grow faster.)

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Commercial Banks:

· provide ~half of debt finance· 3/4 of SBIC equity by bank holding cos. (Small Business Investment Companies)

· play key roles in communitiesmoneyinformation

banks

Business

Publicsector

Voluntaryorgs

Page 17: Changing Rules and Opportunities for Community Banks

Why change now?

• Empirical evidence that commercial banks underwrite better performing securities (of more mature firms)

• Experience: few problems with limited U.S. experience, or in other developed countries

• Technological Change: increased profits from cross-selling based on information sharing