Archive for March 2016

“Too Big to Fail” or “Too Small to Succeed”?

March 21, 2016

Community banks’ share of the U.S. banking market has declined significantly over the past two decades but since 2010, around the time the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed, community banks’ share of all U.S. banking assets has shrunk at a much faster rate.  Dodd-Frank may be offering consumers greater protections (data on that issue is not readily available and is less straightforward in any case), but the data clearly show that legislation designed to prevent another “too big to fail” financial crisis is also accelerating the declining market share of community banks, contributing to consolidation in the banking industry, and perhaps helping to create more “too big to fail” institutions.  The chart below shows how the volume of assets and loans have changed since the passage of Dodd-Frank for community banks (defined here as those with less than $1 billion in assets), banks with $1 to $10 billion in assets (some researchers consider these banks to be community banks), as well as banks with over $10 billion in assets.

assets and loans

Other than bankers and their regulators, nobody really cares about the market shares of different sized banks, but the out-sized role community banks play in lending to small businesses and the critical role community banks play in smaller communities and rural regions of the country make it an important economic issue for a large slice of the U.S. economy.  In almost one-third of the nation’s counties the only depository institutions located in the county are community banks according to a study by the U.S. General Accountability Office (GAO).  Small businesses also depend disproportionately on community banks.   The chart below shows that despite holding only 14 percent of all loans in the banking industry in 2006, community banks held 42 percent of all small business loans across the country.  The chart also shows how the rate of decline in the share of all loans held by community banks, as well as small business loans, have accelerated since 2010.

community bank shares

More troubling than the loss of market share by community banks (after all, does it matter as long as lending to small businesses increases?) is the sharp absolute decline in small business lending by community banks since the passage of Dodd-Frank.  I think it matters a lot that community banks’ share of lending is declining because of the traditional role of relationship banking and the willingness to consider “soft information” has played in community bank lending decisions and the implications for access to credit by small businesses.  As the chart below shows, as recently as 2006, community banks were the largest source of small business lending by the banking industry.  Since 2010, however, small business loans at community banks have fallen sharply.


small business loans

Some of this is the result of consolidation, smaller community banks being acquired by larger, non-community banks. But even that is influenced by Dodd-Frank.  Any regulatory requirement is likely to be disproportionately costly for community banks, since the fixed costs associated with compliance must be spread over a smaller base of assets.  As the GAO reports, regulators, industry participants, and Federal Reserve studies all find that consolidation is likely driven by regulatory economies of scale – larger banks are better suited to handle heightened regulatory burdens than are smaller banks, causing the average costs of community banks to be higher.

The implications for small businesses and for the economies of smaller and more rural communities are clear. As regulations require more standardized lending and reflect bigger bank processes and practices, community bank lending will be constrained and because they are a major source of small businesses loans and major source of local lending in most rural areas, small business and the economies of smaller, more rural communities will be disadvantaged.  Automobile, mortgage, and credit card loans have become increasingly standardized and data driven.  These loans are increasingly made without any personal interactions, via the internet and by less regulated institutions, or by larger banking institutions with the infrastructure to make exclusively data driven lending decisions.  Business loans are different.  Community banks have had to focus to a greater extent on small business and commercial real estate lending – products where community banks’ advantages in forming relationships with local borrowers are still important – as more types of loans have become increasingly standardized.  Community banks generally are relationship banks; their competitive advantage is a knowledge and history of their customers and a willingness to be flexible.  Community banks leverage interpersonal relationships in lieu of financial statements and data-driven models in making lending decisions, allowing them to better able to serve small businesses.  Regulatory initiatives such as Dodd-Frank are more reflective of bigger bank lending processes which are transactional, quantitative and dependent on standardization.   Understanding the financials of a business, its prospects, the local community in which it operates, or the prospects for its industry, are hard to standardize.  Community banks ability to gather “soft information” allows them to lend to borrowers that might not be able to get loans from larger institutions that lend with more standardized lending criteria.  The less “soft information” is incorporated into lending decisions, and the more costly become the regulatory requirements on banks, the more community banks will diminish and with it an important asset for small business, and small communities across the country.  It is possible that someday small business lending can be more standardized, less interpersonal, in a way similar to credit card or auto loans and in a way that does not disadvantage small businesses, but I am skeptical.

The debates surrounding financial services regulation since the “great recession” have focused on the safety and soundness of the financial system and on consumer protections, both important objectives, and to be fair, the banking industry too often  appears only self-interested in regulatory debates.  But far too little consideration has been  given to the impact of new financial services regulations on small business, communities, and rural regions of the country.

Authors Note:  I have done some studies for the banking industry in the past.  This post is not an effort to shill for their interests.  This blog is about timely topics that interest me and a place where I can write about them free of any compensated interests.  It is an outlet for my analytical interests and opinions.   I do confess, however, an affinity for community banks and the people who run them because of the strong commitment that they demonstrate to the people, businesses, and communities in which they operate.    


How Much of a Benefit is Low Oil Prices?

March 7, 2016

Low oil prices have provided an economic windfall to households in New Hampshire and across the nation. Based on actual 2014 energy consumption and expenditure data for NH, changes in 2015 energy prices, and forecasts of 2015 energy consumption (actual data won’t be released for another year), I estimate that businesses and households saved about $1 billion in 2015 as a result of lower oil prices (Figure 1).

NH savings

Households saved over $800 million – largely as a result of lower gasoline prices – and businesses saved nearly $200 million. In 2015 households in NH spent about $665 million less on gasoline than they did in 2014 and about $800 million less than they did in 2012 (Figure 2).
gasoline savings

Here I am talking about the monetary impacts of lower oil prices, the distribution of impacts among states, between business and households, by different income levels, and how increased U.S. oil production is changing the demand for imported oil. While the overall impact is a net positive on the U.S. economy – especially consumers – the net benefits to our nation’s economy have been smaller than many anticipated. This is not a full accounting, I do not consider any environmental implications (I will write about some of those in future posts on carbon emissions, carbon taxes and climate change that are sure to incite the unstable) or the fact that low oil prices make Vladimir Putin only slightly more scary or any number of petroleum states that much less stable.

There was a time not long ago when low oil prices would have provided a stronger stimulus to the U.S. economy, as every dollar saved by businesses and individuals as a result of lower oil prices translated into nearly a dollar of benefits to the U.S. economy as more of the dollars saved were dollars not being sent overseas. But today many more of the petro dollars saved are dollars that would have gone to U.S. businesses and workers, reducing the overall net benefits that lower oil prices have on the U.S. economy. Figure 3 shows the dramatic increase in U.S. oil production beginning late in the last decade along with a concomitant decline in oil imports.
production and imports

Regional Impacts

Make no mistake, lower oil prices are a good thing for U.S. economy overall, but the boom in oil and gas production in the U.S. includes states that are relatively new to energy production, spreading the negative impacts of a downturn in energy markets more broadly across the U.S., as well as some states who have gone from very small to more significant energy producers, deepening the negative impacts from low prices in those states. Texas, Oklahoma, Alaska, Louisiana are used to economic disruptions caused by fluctuations in oil prices (although much of Texas is now much more diverse) , North Dakota and other states not so much. Figure 4 shows the volume of oil production in 2014 by state and thus the relative exposure that these state have to fluctuations in oil prices.

state production

The increase in U.S. oil production was spurred by high world oil prices that made it economically viable to extract oil using more costly methods, as well as improved technologies that made it possible to extract oil that could not be obtained through traditional drilling techniques. A few years ago I worked on an energy project in the Permian Basin of West Texas and Eastern New Mexico that involved enhanced oil recovery (EOR) techniques. At that time the price of oil was around $100 bbl while the break-even price of EOR was approximately $67 bbl. In that environment it is not surprising that a boom in production would occur in areas with even difficult to extract oil reserves. Continued improvements in technology have no doubt lowered the break-even price of EOR below the $67 that it was back in 2012, but probably not as low as the $48 per bbl that was the average price for U.S. crude in 2015, and certainly not as low as the $32 bbl average of January 2016. The sharp decline in oil prices since 2014 is affecting the profitability, production, and employment of energy companies and those that service and supply them. Low oil and gas prices don’t help energy producing states the way they help NH and other non-energy producing states because the benefits of lower oil and gas prices to households and businesses are mitigated by the reduction in investment and employment in oil and gas extraction, transportation, and the industries that support them – including financial industries, professional and technical industries (engineering etc.) and many others. Figure 5 shows states at the bottom of private sector job growth in 2015 – all but Vermont and Illinois are significant energy producing states.
state emp  change

Income Support

The benefits of lower energy prices on households nationally have been large. Energy spending dropped from 6.1% of total expenditures of households in 2008 to 4.4% through mid-2015. All households benefit from lower energy prices but the benefits are not evenly distributed. Low-income consumers devote a larger share of their budgets to energy and thus lower energy prices provide a greater relative benefit to households lower on the income scale. Data from the Consumer Expenditure Survey of the U.S. Bureau of Labor Statistics show that consumers in the bottom half of the income distribution devoted 10.7% of their budget to energy expenses, while consumers in the top half of the distribution devoted 8.1% of their budgets to energy (the figures are higher in the Northeast where households spends more on heating and much more on oil heat than the national average). To some extent these differences may overstate the benefits of lower energy prices to lower-income households because the largest difference in the percentage of household expenditures on energy by income level is for electricity; lower oil prices have had little impact on electricity prices, but the benefits to lower income households are still signficant. Figure 6 shows the percentage of total household expenditures in the U.S. that are devoted to energy among households in four different income ranges.

exp by income level


The most important implication of U.S. oil production may be for U.S. foreign policy. Not only are oil imports on the decline as U.S. production has increased, but the sources of imported oil are also changing. Persian Gulf states are a declining source of oil imported in the U.S., while Canada is a rapidly increasing source (Figure 7).

imports by region

The historical role that concerns about oil supplies have played in U.S. policies toward Persian Gulf states is debatable but a declining dependence on Persian Gulf oil at least offers the possibility that whatever U.S. involvement continues in the region will be less energy dependent. If current trends in U.S. production and imports continue, it is possible that the only country that the U.S. imports oil from in 10 years is Canada. If I have learned one thing from this presidential primary season it is that not all Canadian imports are a good thing. But, I grew up along the Canadian border and I would be pretty comfortable only relying on the great white north to meet our nation’s demand for imported oil.

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