Community Banks and Credit Unions Have Declined in Number but Remain Important for Small Businesses and Agriculture

The number of community banks and credit unions has declined in recent  decades, as smaller institutions have expanded, merged with, or been  purchased by larger institutions. However, community banks and credit unions still play an  important role in the economy. Community banks and credit unions  allocate more of their lending to small businesses and rural areas than  large banks, which research suggests is due to their focus on  relationship-based lending. Another factor that may have contributed to consolidation is economies of  scale, which refer to how a bank’s or credit union’s scale of operations, or  size, is related to its costs. Importantly, the existence of economies  of scale in banking has been subject to debate. Many Dodd-Frank Act Provisions May Affect Community Banks and Credit Unions, but the Full Extent of Their Impact Is Uncertain

The Dodd-Frank Act’s reforms are directed primarily at large, complex  U.S. financial institutions, and the act exempts small institutions, including  community banks and credit unions, from several of its provisions. However, federal regulators, state regulatory associations, and industry  associations collectively identified provisions within 7 of the act’s 16 titles  that they expect to impact community banks and credit unions. We  analyzed the impact of a number of these Dodd-Frank Act provisions and,  in brief, found that:  some provisions, including the depository insurance reforms and  CFPB supervision of nonbank providers of financial services and  products, have benefited or may benefit community banks and credit  unions; certain of the act’s mortgage reforms are expected to impose  additional costs on community banks and credit unions, but their  impact depends on future rule makings; the act’s risk retention provision for securitizations is expected to  initially have a limited impact on community banks and credit unions;  and other provisions, including those covering proprietary trading,  remittance transfers, and executive compensation, are expected to  impose additional requirements on community banks and credit  unions, but their impact depends partly on future rule makings. Industry officials told us that determining which provisions will affect small  institutions is difficult, because the impact may depend on how agencies  implement certain provisions through their rules, and many of the rules  needed to implement the act have not been finalized.reason, regulators and industry officials have noted that the full impact of  the Dodd-Frank Act on community banks and credit unions is uncertain. Nonetheless, regulators and industry officials have noted that they expect  that some of the act’s regulations will increase regulatory requirements on  community banks and credit unions and disproportionately affect them   For the same  relative to larger banks because of their size. As recognized by federal regulators, industry officials, and others, the  Dodd-Frank Act contains several provisions to help minimize certain  regulatory requirements on small institutions. Officials from  industry associations told us that they viewed this change as positive for  community banks overall. Section 989G of the Dodd-Frank Act amended the Sarbanes-Oxley Act to  exempt non-accelerated filers from section 404(b). The Dodd-Frank Act established CFPB and  authorized it to supervise certain nonbank financial companies and large  banks and credit unions with over $10 billion in assets and their affiliates  for consumer protection purposes. Industry officials also have noted that it generally is too soon to  determine the act’s overall impact on community banks’ and credit unions’  ability to lend to small businesses. Although  any provision in the Dodd-Frank Act that affects these institutions could  impact their customers (including small businesses), officials from federal  agencies, state regulatory associations, and industry associations we  interviewed identified only one provision in the Dodd-Frank Act  (discussed below) that may directly impact community banks’ and credit  unions’ ability to lend to small businesses. The provision serves, among other purposes, to facilitate the  enforcement of fair lending laws. CFPB and NCUA generally agreed with our report. In addition, CFPB,  FDIC, OCC, and SEC staff provided technical comments, which we have  incorporated, as appropriate. Key contributors to this report are listed in appendix V.

Appendix I: Scope and Methodology

Our objectives in this report were to examine (1) significant changes that  community banks and credit unions have undergone in the past decade,  including the factors that have contributed to such changes, and (2) the  Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd- Frank Act) provisions that regulators, industry associations, and others  expect to impact community banks and credit unions, including their small  business lending. We also analyzed a number of the Dodd-Frank Act  provisions that regulators, industry officials, and others expect to impact  community banks and credit unions.
Why GAO Did This Study

The Dodd-Frank Act includes numerous reforms to strengthen oversight of financial services firms and consolidate certain consumer protection responsibilities within CFPB. To help minimize its regulatory burden on small institutions, including community banks and credit unions, the act exempts such institutions from several of its provisions. However, the act also contains provisions that impose additional requirements on small institutions. Although no commonly accepted definition of a community bank exists, the term often is associated with smaller banks. Historically, community banks and credit unions have played an important role in providing credit to small businesses and other local customers.
This report examines (1) the significant changes community banks and credit unions have undergone in the past decade and the factors that have contributed to such changes, and (2) Dodd-Frank Act provisions that regulators, industry associations, and others expect to impact community banks and credit unions, including their small business lending. GAO analyzed regulatory and other data on community banks and credit unions; reviewed academic and other relevant studies; and interviewed federal regulators, community banks, credit unions, state regulatory and industry associations, academics, and others. CFPB, federal banking regulators, and the Securities and Exchange Commission provided technical comments on this report, which GAO incorporated as appropriate. CFPB and the National Credit Union Administration generally agreed with the report.

What GAO Found

While the number of community banks and credit unions has declined in recent years, they have remained important lenders to small businesses and other local customers. From 1985 through 2010, the number of banks under $10 billion in assets and credit unions declined by over 50 percent to 7,551 and 7,339, respectively. The decline resulted largely from consolidations, which were facilitated by changes in federal law that made it easier for banks and credit unions to expand geographically. Another factor that may have contributed to consolidations is economies of scale, which refer to how an institution's size is related to its costs. Although the existence of economies of scale in banking has been subject to debate, some recent research suggests that banks can save costs by expanding. Despite the decline in their number, community banks and credit unions have maintained their relationship-banking model, relying on their relationships with customers and local knowledge to make loans. Such institutions can use their relationship-based information to make loans to small businesses and other borrowers that larger banks may not make because of their general reliance on more automated processes. About 20 percent of lending by community banks can be categorized as small business lending (based on a commonly used proxy), compared to about 5 percent by larger banks. Community banks and credit unions also play an important role in rural areas, using relationship-based lending to serve customers with limited credit histories.
Although the Dodd-Frank Wall Street Reform and Consumer Protection Act's (Dodd-Frank Act) reforms are directed primarily at large, complex U.S. financial institutions, regulators, industry officials, and others collectively identified provisions within 7 of the act's 16 titles that they expect to have positive and negative impacts on community banks and credit unions. Industry officials told us that it is difficult to know for sure which provisions will impact community banks and credit unions, because the outcome largely depends on how agencies implement certain provisions through their rules, and many of the rules implementing the act have not been finalized. Thus, regulators and industry officials also have noted that the full impact of the Dodd-Frank Act on these institutions is uncertain. Nonetheless, some regulators and industry officials expect some of the act's provisions to benefit community banks and credit unions and other provisions to impose additional requirements on community banks and credit unions that could affect them disproportionately relative to larger banks. GAO analyzed a number of the Dodd-Frank Act provisions that regulators, industry officials, and others expect to impact community banks and credit unions. Several of the act's provisions, including its deposit insurance reforms, exemption from Section 404(b) of the Sarbanes-Oxley Act, and the Bureau of Consumer Financial Protection's (CFPB) supervision of certain nonbanks, could reduce costs and/or help level the playing field for community banks and credit unions. Other provisions, such as the act's mortgage reforms, may impose additional requirements and, thus, costs on generally all banks and credit unions, but their impact will depend on, among other things, how the provisions are implemented. Finally, industry officials generally told us that it is too soon to determine the Dodd-Frank Act's overall impact on small business lending and identified only one provision that contains a data collection and reporting requirement as potentially having a direct impact on such lending.