I asked Grok:
"Loan officers of small city community banks normally attended the credit needs of the local small businesses and entrepreneurs. Once risk weighted bank capital requirements entered into effect, big city financial engineers took over. How has that affected small cities?"
Grok answered:
"The introduction of risk-weighted capital requirements, primarily through the Basel Accords starting in the late 1980s and evolving with Basel II (2004) and Basel III (post-2010), shifted banking from localized, relationship-based lending by community bank loan officers to more centralized, model-driven risk assessment and securitization by large financial institutions. This change aimed to enhance bank stability but imposed higher compliance costs and capital burdens, particularly on smaller banks, leading to several interconnected effects on small cities and rural areas.
Increased Bank Consolidation and Reduced Local Presence
These requirements contributed to a wave of mergers and acquisitions, as smaller community banks (typically with assets under $10 billion) struggled with the fixed costs of compliance, risk modeling, and reporting. For instance, the number of community banks declined by about 24% from 2010 to 2017, with regulations explaining up to 31% of merger activity during that period. Exit rates for community banks averaged over 4% annually from 2014 to 2019, highest among small, young, and metropolitan-area institutions, but also notable in non-metro (rural) areas. This consolidation often resulted in branch closures, with a 15% overall decline in branches from 2010 to 2017, disproportionately affecting rural counties where community banks hold the majority of deposits and are four times more likely to operate offices. In over 1,200 U.S. counties (home to 16.3 million people), the loss of community banks could severely limit physical access to banking services, as seen in cases like Harding County, New Mexico, which lost its last bank in 2014, forcing residents to travel hours for basic services.
Changes in Lending Practices and Reduced Credit Access
The shift favored large banks’ ability to use advanced internal ratings-based (A-IRB) models under Basel II and III, potentially lowering their capital needs for certain loans and giving them a competitive edge in pricing. Community banks, sticking to simpler Basel I rules, faced incentives to concentrate on riskier assets like commercial loans, while losing ground in lower-risk areas like mortgages. This led to stricter lending standards: from 2010 to 2017, 79% of community banks increased documentation requirements, 69% extended loan processing times, and 45% raised minimum credit criteria, attributing 60-97% of these changes to regulations. Access for “atypical” borrowers (e.g., self-employed or those reliant on asset income) decreased for 26% of banks, with 86% linking this to regulatory scrutiny.
Small businesses in small cities, often opaque or non-standard risks, bore the brunt. Community banks provide about 51% of small business loans nationwide, but their lending volume fell 11% from mid-2010 onward, with market share dropping 1.7%. In rural areas, where these banks are primary lenders, regulations like mortgage rules under Dodd-Frank exacerbated this, with over 30% of small mortgage lenders reducing holdings at an annualized rate of 5% or more from 2013 to 2019. Higher fees (reported by 38% of banks) and compliance costs (up to 12% of operating expenses, 2.5 times higher for small banks) further raised borrowing costs.
Economic Implications for Small Cities
These dynamics have broader ripple effects on local economies:
Impact Area | Description | Supporting Evidence |
Credit Availability | Reduced lending to small businesses and entrepreneurs, pushing them toward costlier alternatives like credit unions (which increased small business lending 109% from 2010-2017) or nonbanks. | A $1 capital reduction at small banks has a larger effect on local economic activity than at large banks, potentially causing credit crunches in downturns. |
Business Growth and Jobs | Slower expansion for local firms, as relationship lending—key for opaque borrowers in small towns—is replaced by standardized models, limiting investment and job creation. | Regulations contributed up to 23% of changes in total business lending from 2010-2016, with tighter standards affecting newer or riskier businesses. |
Overall Economic Activity | Potential stagnation in rural and small-city economies, with branch losses reducing mainstream banking access and diverting resources from lending to compliance. | Community banks' disappearance could lead to permanent credit falloffs in rural areas, where they are essential for financing local households and businesses. |
While some community banks gained small business loan market share post-consolidation (e.g., during 1994-2000 waves), the overall trend has been toward diminished local control and credit tailored to small-city needs, fostering economic concentration in larger urban centers.
I said: Thanks!
It said: You're welcome! If you have more questions, feel free to ask.
Note: The answers are copied exactly from those given to me by ChatGPT
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