KANSAS CITY, Mo. — Despite a decades-long decline in their numbers and share of industry assets, community banks continue to play a critical role in the U.S. financial system, particularly in serving rural communities, small businesses and agricultural borrowers, according to research published by the Federal Reserve Bank of Kansas City.
The study, Community Banks’ Ongoing Role in the U.S. Economy, authored by Matt Hanauer, Brent Lytle, Chris Summers and Stephanie Ziadeh, concludes that while industry consolidation has reduced the number of community banks, the institutions remain essential providers of relationship-based banking services that larger financial institutions often do not replicate.
According to the report, community banks have faced mounting pressure over the past several decades from industry consolidation, technological advances, demographic shifts and increasing regulatory costs. Their share of U.S. banking assets has steadily declined as larger banks have expanded through mergers and acquisitions.
Punching Above Their Weight
However, the researchers found community banks continue to punch above their weight in several key areas.
Among the report’s findings:
- Community banks remain the dominant providers of banking services in rural America, where they often maintain the only physical banking presence.
- They account for a disproportionately large share of agricultural lending and commercial real estate lending, despite holding a relatively small percentage of overall banking assets.
- Small businesses continue to rely heavily on community banks because of their emphasis on relationship lending and local market knowledge.
- During periods of financial stress, including the 2008 financial crisis and the COVID-19 pandemic, community banks continued extending credit to local borrowers, helping support economic activity in their markets.
The authors said community banks possess competitive advantages that larger institutions often cannot easily duplicate, including local decision-making, close customer relationships and detailed knowledge of local economies. Those strengths enable them to serve borrowers who may not fit standardized underwriting models commonly used by larger banks.
The Headwinds
The report acknowledged that community banks continue to face significant headwinds, including population declines in many rural markets, growing competition from larger banks and financial technology companies, rising technology investment requirements and an increasingly complex regulatory environment.
Even so, the researchers concluded the industry’s long-term outlook remains favorable in many communities because of continued demand for personalized banking services and relationship-based lending.
Rather than disappearing, community banks are likely to remain an important component of the U.S. banking system, particularly in markets where local knowledge and personal relationships are critical to meeting the financial needs of consumers, farmers and small businesses, the study found.
