The Efficiency of US Community Banks

Abstract

Using a novel method to separate US community banks over the 1984-2013 period from their non-community counterparts we compare the two bank types on the basis of cost efficiency. We decompose cost efficiency into a persistent and a residual component; the former capturing the market structure and regulatory changes, the latter reflecting managerial performance. Our estimates show community banks to exhibit a 4.9% higher efficiency compared to their non-community counterparts. The decomposition further reveals that community banks benefit from superior managerial capabilities and from developments at the regulatory front. Size is non-linearly related to efficiency and large community banks are the most efficient. A strong positive link between profitability and efficiency exists for community banks, with the effect being muted in non-community banks. Participation in bank holding companies is harmful for community banks’ efficiency. Liquidity creation is positively (negatively) related to efficiency of (non-)community banks, and highlights the distinctiveness of the business models and the need for differentiated regulatory supervision. Community banks efficiency is positively (negatively) related to liquidity (credit) risk. Our results are robust to a series of salient checks.

Keywords: Bank business model, Community banks, Liquidity creation, Persistent efficiency, Residual efficiency, Stochastic Frontier Analysis

JEL Classification: G14, G21, G38