The Bank of Delight, which operates three branches in a sparsely populated patch of western Arkansas, does not qualify as a systemically important financial institution, but it holds a place of special importance for people who live nearby.
Funded overwhelmingly by local deposits, Delight is a crucial lender to loggers and livestock farmers in a handful of nearby towns.
“I’m in the timber business myself on the side,” said Darwin Hendrix, the bank’s chief executive. “One of my loan officers has a poultry farm. We understand our economy. I make a lot of loans on my phone, just like I’m talking to you.”
With $165mn in assets, the lender that Hendrix runs is a mere speck on the $23tn balance sheet of the US banking system. Yet it is among thousands of small institutions that together play a crucial role in financing the small businesses that account for nearly half of US economic activity.
Turmoil at several midsized US banks last week has focused attention on the economic significance of these smaller institutions. It has also shaken regulators out of a consensus, forged after the last financial crisis, that the greatest peril lies in uncontained losses at the very largest banks.
The four US banks that have balance sheets larger than $1tn have so far suffered relatively little damage from the funding squeeze prompted by rising interest rates; on average, their shares have fallen by 10 per cent since the beginning of March.
Regional banks have fared worse, even setting aside Silicon Valley Bank and Signature Bank, which failed a little more than a week ago. The KBW regional banking index, which tracks 50 sizeable banks outside the top tier, has lost 21 per cent of its value over the same period.
Harder to judge is the condition of a third tier of smaller banks comprising nearly 4,000 institutions that have assets of less than $1bn, most of them privately held. All now face headwinds from the rising cost of deposits and wholesale funding.
While the 25 biggest banks account for about two-thirds of all bank credit in the US, smaller institutions have an outsized presence in some important markets, for example accounting for about 70 per cent of commercial property lending by US banks, according to data from the Federal Reserve.
Whether for reasons of geography or because they are in unusual lines of work, the customers of small banks often have few other places to turn, according to Aaron Klein, a Brookings Institution scholar and former US Treasury official during the 2008 financial crisis.
“For people and businesses that live just outside of the box of mass-market credit, small and community banks have unique information and relationships that enable them to provide capital,” he said.
Those banks must now compete for capital with money market funds and other higher-yielding vehicles, potentially spelling trouble for midsized businesses whose access to funds depends on the health of local banks geared towards their particular niche.
“Money market mutual funds don’t invest in small businesses and start-ups,” said Klein. “It used to be an advantage for banks that they had federal deposit insurance, but the Federal Reserve has bailed out money market funds twice in the last 15 years.”
Venture capital-backed businesses are among the hardest to bank for because they typically have little history, no revenues and large upfront costs. Yet First Community Bank and Trust on the outskirts of Chicago is among the banks that actively seek out such customers.
“In my 37 years I have banked many companies that have basically been two guys or gals and an idea,” said Greg Ohlendorf, First Community’s chief executive, who oversees a $204mn balance sheet that is only a little larger than that of Bank of Delight.
Shut off from some larger institutions, many small businesses that survived the pandemic found that the support of a local banker was the deciding factor. Community banks processed 60 per cent of the funding awarded during the first phase of the Paycheck Protection Program, a federal scheme that provided funding for businesses that kept paying workers during the forced shutdowns.
But the long-term growth prospects of some of those institutions may be tested, as rising interest rates and a possible recession challenge the economics of banks everywhere.
Like its Arkansas counterpart, First Community relies on local depositors, a factor that Ohlendorf reckons may turn out to be an economic advantage.
“We’re funded by folks we do local business with,” he said. “With a community bank and relationship bank, it’s more than just the interest rate.”
Klein, too, believes deep local roots may provide some banks with an alternative to seeking resilience in financial heft.
“The community bank often sponsors the local little league team,” he said.
“No one wants to be the type of person who pulled their money out, where their kid plays little league with the bank’s name on their back. Do you want to be that guy?”