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Is Bigger Necessarily Better in Community Banking?

53 Pages Posted: 21 Jun 2016  

Joseph P. Hughes

Rutgers, The State University of New Jersey - Department of Economics

Julapa Jagtiani

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Loretta J. Mester

Federal Reserve Banks - Federal Reserve Bank of Cleveland; University of Pennsylvania - The Wharton School

Multiple version iconThere are 2 versions of this paper

Date Written: 2016-06-10

Abstract

We investigate the relative performance of publicly traded community banks (those with assets less than $10 billion) versus larger banks (those with assets between $10 billion and $50 billion). A body of research has shown that community banks have potential advantages in relationship lending compared with large banks, although newer research suggests that these advantages may be shrinking. In addition, the burdens placed on community banks by the regulatory reforms mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act and the need to increase investment in technology, both of which have fixed-cost components, may have disproportionately raised community banks’ costs. We find that, on average, large banks financially outperform community banks as a group and are more efficient at credit-risk assessment and monitoring. But within the community bank segment, larger community banks outperform smaller community banks. Our findings, taken as a whole, suggest that there are incentives for small banks to grow larger to exploit scale economies and to achieve other scale-related benefits in terms of credit-risk monitoring. In addition, we find that small business lending is an important factor in the better performance of large community banks compared with small community banks. Thus, concern that small business lending would be adversely affected if small community banks find it beneficial to increase their scale is not supported by our results.

Keywords: Community Banking, Scale, Financial Performance, Small Business Lending

JEL Classification: G21, L25

Suggested Citation

Hughes, Joseph P. and Jagtiani, Julapa and Mester, Loretta J., Is Bigger Necessarily Better in Community Banking? (2016-06-10). FRB of Philadelphia Working Paper No. 16-15. Available at SSRN: https://ssrn.com/abstract=2798539

Joseph P. Hughes (Contact Author)

Rutgers, The State University of New Jersey - Department of Economics ( email )

75 Hamilton Street
New Brunswick, NJ 08901
United States

Julapa A. Jagtiani

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

Loretta J. Mester

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

University of Pennsylvania - The Wharton School

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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