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The demise of community banks? local economic shocks aren't to blame

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  • Timothy J. Yeager
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    Abstract

    A potentially troubling characteristic of the U.S. banking industry is the geographic concentration of many community banks* offices and operations. If geographic concentration of operations exposes banks to local market risk, we should observe a widespread decline in their financial performance following adverse local economic shocks. In addition, geographic diversification should help banks reduce risk significantly. By analyzing the performance of geographically concentrated U.S. community banks exposed to severe unemployment shocks in the 1990s, I find that banks are not systematically vulnerable to local economic deterioration. Indeed, differences in performance at banks in counties that suffered economic shocks relative to those that did not suffer economic shocks are either statistically insignificant or economically small. These findings suggest that banks are unlikely to engage in mergers and acquisitions primarily to reduce local market risk because that risk source is already low. This result bodes well for the continued existence of geographically concentrated community banks, though scale and scope economies will continue to reduce their numbers relative to larger banks.

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    File URL: http://www.stlouisfed.org/banking/pdf/SPA/SPA_2002_03.pdf
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    Bibliographic Info

    Paper provided by Federal Reserve Bank of St. Louis in its series Supervisory Policy Analysis Working Papers with number 2002-03.

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    Date of creation: 2002
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    Handle: RePEc:fip:fedlsp:2002-03

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    Keywords: Community banks ; Regional economics;

    References

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    1. Jith Jayaratne & Philip E. Strahan, 1997. "The benefits of branching deregulation," Economic Policy Review, Federal Reserve Bank of New York, issue Dec, pages 13-29.
    2. Allen N. Berger & Robert DeYoung, 2000. "The effects of geographic expansion on bank efficiency," Working Paper Series WP-00-14, Federal Reserve Bank of Chicago.
    3. Mitchell A. Petersen & Raghuram G. Rajan, 2002. "Does Distance Still Matter? The Information Revolution in Small Business Lending," Journal of Finance, American Finance Association, vol. 57(6), pages 2533-2570, December.
    4. Ben Craig & João Cabral dos Santos, 1997. "The risk effects of bank acquisitions," Economic Review, Federal Reserve Bank of Cleveland, issue Q II, pages 25-35.
    5. Jeffery W. Gunther & Kenneth J. Robinson, 1999. "Industry mix and lending environment variability: what does the average bank face," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, issue Q II, pages 24-31.
    6. McAllister, Patrick H. & McManus, Douglas, 1993. "Resolving the scale efficiency puzzle in banking," Journal of Banking & Finance, Elsevier, vol. 17(2-3), pages 389-405, April.
    7. William R. Emmons & R. Alton Gilbert & Timothy J. Yeager, 2001. "The importance of scale economies and geographic diversification in community bank mergers," Working Papers 2001-024, Federal Reserve Bank of St. Louis.
    8. Liang, Nellie & Rhoades, Stephen A., 1988. "Geographic diversification and risk in banking," Journal of Economics and Business, Elsevier, vol. 40(4), pages 271-284, November.
    9. Rebel A. Cole & Jeffery W. Gunther, 1995. "FIMS: a new monitoring system for banking institutions," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jan, pages 1-15.
    10. Michelle Clark Neely & David C. Wheelock, 1997. "Why does bank performance vary across states?," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 27-40.
    11. David C. Wheelock & Paul W. Wilson, 1997. "New evidence on returns to scale and product mix among U.S. commercial banks," Working Papers 1997-003, Federal Reserve Bank of St. Louis.
    12. Benston, George J & Hunter, William C & Wall, Larry D, 1995. "Motivations for Bank Mergers and Acquisitions: Enhancing the Deposit Insurance Put Option versus Earnings Diversification," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(3), pages 777-88, August.
    13. Andrew P. Meyer & Timothy J. Yeager, 2001. "Are small rural banks vulnerable to local economic downturns?," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 25-38.
    14. Elizabeth S. Laderman & Ronald H. Schmidt & Gary C. Zimmerman, 1991. "Location, branching, and bank portfolio diversification: the case of agricultural lending," Economic Review, Federal Reserve Bank of San Francisco, issue Win, pages 24-38.
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