Building community: a new look at the role of U.S. regional banks

Key takeaways

• The COVID-19 pandemic highlighted the importance of community and regional bank lending to small businesses.
• U.S. community and regional banks play a pivotal role in providing banking services to customers in rural and underserved regions nationwide.
• Despite the critical services these banks provide, they rarely receive adequate recognition from financial ratings agencies and the news media. 

For most, banks are seldom viewed as an industry that drives positive social change, yet many banks offer critical services that improve conditions for consumers and small businesses.

The institutions that stand out to us are the roughly 4,900 community and regional banks with assets of less than $50 billion. When it comes to lending and investing in small businesses, community banks are often the sole capital providers to these enterprises. Supporting small businesses is critical to the health of local communities and to the economic vitality of the nation as a whole. Just under half of the working population is employed by a small business as tallied by the U.S. Census Bureau and, according to the U.S. Bureau of Labor Statistics, small businesses created 65% of the net new jobs added from 2000 to 2019. 

In addition to originating loans, banks frequently partner with government wealth-building initiatives in underserved areas, acting as consultants and disbursement agents to local businesses and consumers. Although their support is critical to fostering growth in otherwise overlooked regions, regional banks rarely gain adequate recognition for their efforts from either the public, financial ratings agencies, or policymakers.

In our analysis, community and regional banks are driving positive social change in three key areas: small business lending, operating in rural banking deserts, and serving low-income, diverse communities. 

1 Small business lending—bringing capital to critical links of the economic ecosystem

The issue

The COVID-19 pandemic brought new attention to the value of America’s small businesses. The business interruptions and public health measures triggered by the pandemic weighed on millions of employers—and their employees—in industries ranging from restaurants and hotels to fitness studios and retailers.

For many employers, access to commercial credit from banks is critical—not only to endure hardships such as those experienced during the pandemic, but also to invest in future growth.  

What’s being done about small business lending

Although community banks (defined as institutions with less than $10 billion in assets) make up a smaller portion of total loans than their larger peers, they account for a proportionally larger share of lending to smaller businesses, according to data from the U.S. Federal Deposit Insurance Corp. (FDIC). For example, community banks account for only 16% of gross loans in the U.S. banking system but 45% of small-dollar business loans.

Further analysis of this data shows that community banks accounted for a disproportionately large share of lending across every commercial loan segment. Small banks are also a far bigger source of financing for farm and agricultural loans than large banks.

A good case study regarding the positive impact of community banks on small businesses is illustrated by their participation in the Paycheck Protection Program (PPP), a government initiative instituted during the pandemic that injected capital into small businesses. The PPP provided small businesses with funds to pay up to eight weeks of payroll costs, including benefits; proceeds could also be used to pay interest on mortgages, rent, and utilities.

While the PPP was a government initiative, it relied on banks as the distributors of this capital. As discussed earlier, community and regional banks have a much lower share of overall bank loans compared with larger ones; however, smaller players’ PPP lending activity was nearly three times greater than their overall market share, highlighting their importance to small businesses and local communities.

A December 2020 U.S. Federal Reserve (Fed) study found the key role that community banks played in the PPP program “helped meet the funding needs of small firms at a time when banks otherwise curtailed lending in response to uncertain economic conditions.”

2 Rural banking deserts¹—extending the financial industry’s reach beyond urban and suburban America

The issue

The urban-rural divide persists in America, and one area in which it appears to have widened in recent history is access to traditional banking services. While pockets of underinvestment can be found within large cities and across suburbs, the lack of access to capital is more endemic in sparsely populated areas.

A study by the Fed showed that a majority of rural U.S. counties lost branches between 2012 and 2017. The report identified 44 “deeply affected” counties that had 10 or fewer branches in 2012 and lost at least half of them by 2017. Thirty-nine of those counties are rural, the Fed said. The authors concluded that “these deeply affected rural counties tend to be poorer, composed of residents with fewer years of education, and have a greater proportion of African American residents relative to other rural counties.”

The negative impact from branch closures in underserved rural areas has been mitigated somewhat by the expanded availability of digital technology to access banking services. However, an FDIC study found that rural bank customers visit branch tellers nearly twice as frequently as urban and suburban clients, despite typically having to travel farther to visit a branch. With few nearby bank branches, rural consumers often resort to using nonbank services such as payday lenders, check-cashing services, and private ATMs that typically charge high interest rates and fees.

What’s being done about rural banking deserts

Our analysis shows that smaller banks are more committed to rural areas than larger banks. Industry consolidation has reduced the number of U.S. banks and contributed to a decline in the number of branches. Nevertheless, we found that smaller banks have been less likely to close branches than their larger peers, with some of the largest banks curtailing their branch count, particularly in rural areas. The FDIC found that more than 600 U.S. counties—almost 1 in 5—had no physical bank offices other than those operated by community banks.

Using data from the U.S. Consumer Financial Protection Bureau and tracking branch-level deposit data provided by the FDIC, our analysis found that the deposits of the nation’s largest banks are overwhelmingly based in urban America, with few in rural markets. Of the 10 largest U.S. banks in the S&P Composite 1500 Banks Index, only 3—U.S. Bancorp, Truist Financial Corp., and Fifth Third Bancorp—exceeded the weighted average rural deposits level of 1.70% for all banks in the index, according to our analysis.

In contrast, we identified that the banks in the S&P Composite 1500 Banks Index with the greatest weighting toward rural deposits were generally smaller in size with concentrated regional footprints. Further, we found that many smaller banks that aren't included in the index have an even greater weighting toward rural footprints, often having greater than 50% of their deposits in rural markets.

In both rural areas and small cities, community banks play an outsize role relative to larger peers in extending commercial real estate (CRE) loans, which provide opportunities for businesses to own commercial property, create housing, and provide retail and other services. The FDIC found that community banks headquartered in rural and small metropolitan areas held more than two-thirds of the CRE loans made by all banks in those smaller geographic areas. Going forward, we expect that smaller banks will continue to lead in addressing financial access to rural areas.

3 Low-income and racially and ethnically diverse communities—extending financial access to traditionally underserved areas

The issue

Financial progress has come slowly to low-income neighborhoods across America, and a disproportionate share of these poorer communities has high concentrations of ethnic and racial minority populations.

Within banking, a 2019 FDIC survey showed that 5.4% of U.S. households were unbanked in 2019, meaning that no one in the household had a checking or savings account at a bank or credit union. The survey also indicated that minority households were more likely than white households to be unbanked.

What’s being done about the unbanked

One way that banks are playing a bigger role in traditionally underserved communities is through the Community Development Financial Institutions (CDFI) Fund, a federal program designed to promote economic growth in low-income communities through tax credits. Banks and other financial institutions applying to the program must be mission-driven organizations with at least 60% of their financing activities targeted to low- and moderate-income populations or underserved communities. These entities must have a defined community development mission and a reputation for lending responsibly in low-income communities. As of August 2022, there were over 300 banks and bank holding companies with CDFI designations. Most of them are quite small, with about 10% of the asset size of the average U.S. bank.

Additionally, banks may also become a designated Minority Depository Institution (MDI). To qualify, they must serve a predominantly minority community and have a majority of voting stock owned by minority individuals or a majority of its board made up of minority individuals.

A 2019 FDIC study found that MDIs originated a greater share of their home mortgages for minority borrowers and those living in low- to moderate-income census tracts than did institutions that lacked MDI certification. In addition, MDIs originated a greater share of Small Business Administration-backed small business loans for minority borrowers and for businesses in low- to moderate-income areas.

In response to the pandemic, the U.S. Department of the Treasury in 2021 launched the Emergency Capital Investment Program to encourage low- and moderate-income community financial institutions to augment their efforts to support small businesses and consumers in their communities. Under the program, the government is providing capital directly to CDFIs and MDIs to support small businesses, minority-owned businesses, and low-income consumers. 

As with rural residents who often have limited access to local banking services, consumers in these urban communities may frequently receive financial services from higher-cost capital providers such as payday lenders or check-cashing shops. We believe that CDFIs and MDIs—as well as community banks more broadly—can introduce traditional banking that offers superior services at a lower cost.

Shining a brighter light on banks’ social impact

From our perspective, positive societal benefits can be traced to ongoing initiatives by many community and regional banks to expand access to underserved areas and to small businesses. Despite this, these benefits and the banks’ contributions are often overlooked. We believe the reasons are twofold.

First, we’ve found that few smaller institutions publicly promote the beneficial services that they provide to their communities; this is the case even for banks that we know are active on this front. This lack of disclosure may in part be attributed to the reality that the smaller banks have fewer resources than their larger peers to highlight these initiatives.

Second, we believe that financial ratings agencies and bank industry data aggregators haven’t identified the proper way to analyze the potential positive social impact that banks can have. Such effects tend to be qualitative in nature, which makes them harder to identify and evaluate than traditional metrics of banks’ financial health. In our view, the ratings’ agencies inattention to social factors in effect penalizes banks with admirable records in this regard.

Generally, we find that smaller community and regional banks serve as cornerstones of their communities and provide significant value to their constituents in areas in which there are often few lenders. We believe that smaller banks and ratings agencies alike should expand their efforts to highlight these values to the public, policymakers, and investors.

Finally, we view many banks that are making a positive social impact as attractive investments offering the potential to generate not only strong returns but also broader societal benefits for all stakeholders involved. 

1 Banking deserts are defined by the Fed as zones in which no bank branches can be found within 10 miles of populated areas. A 2017 Fed study identified 1,132 bank deserts across the United States, with nearly two-thirds in rural areas.