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Changing Rules and Opportunities for Community Banks

Changing Rules and Opportunities for Community Banks. AAEA 2000 Organized Symposium New Sources of Capital for Rural America Maureen Kilkenny Iowa State University. Rule 1. Riegle-Neal Act of 1994 ∙ repealed McFadden Act (1927) => legalized multistate branch banking. GLB permits.

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Changing Rules and Opportunities for Community Banks

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  1. Changing Rulesand Opportunitiesfor Community Banks AAEA 2000 Organized Symposium New Sources of Capital for Rural America Maureen KilkennyIowa State University

  2. Rule 1. Riegle-Neal Act of 1994 ∙ repealed McFadden Act (1927) => legalized multistate branch banking

  3. GLB permits subsidiaries of commercial banks to: underwrite and deal securities sell insurance financial holding companies to form and: own banks underwrite and deal securities underwrite and sell insurance conduct merchant banking

  4. Commercial banking Accept deposits & Make commercial loans FINANCIAL HOLDING COMPANY Investment banking Insurance agency Underwrite & sell securities Underwrite & sell insurance

  5. Opportunity: relationship lending Borrower Quality and Type of External Finance Low High relationship loans (from banks) transaction loans (banks & non-banks) capital market financing (now possible by FHCs under GLB) Community banks can now continue to serve clients as they mature value of relationships remain internalized Boot & Thakor (2000) "Can Relationship Banking Survive Competition?" The Journal of Finance 55(2):679-713

  6. Opportunity: scope & scale economies fixed costs in financial intermediation: Additional, new financial services can be provided at lower marginal costs Data sharing • Information acquisition • Marketing & distribution Cross-selling Spread overhead • Administration & back office

  7. Opportunity: diversification Higher and more stable overall returns Lower correlation • Wider range of securities • Supply alternative types of finance retain customers

  8. Opportunity: new sources of funds • GLB Act permits banks (with assets <$500 mil.) to obtain FHLB advances Community banks can still obtain cheap funds Continue to provide loans to small businesses, small farms, and small agribusinesses

  9. Numerous rural Banks were not members of the FHLB system in 1998

  10. How will these changes affect the supply of capital to rural areas? A1: Since Riegle-Neal, more banks, more offices, and more lending to small businesses. Q2: Threat to banks that thrive on relationship lending? H2: GLB = Boon, not threat. Q1: Threat to survival of community banks from legalized branching? Q3: Threat of rural savings outflow reducing available funds? H3A: GLB increases community banks access to other (FHLB) sources of funds. H3B:the less segmented are capital markets, the more sensitive credit flows are to local growth prospects. (Declining communities decline faster, growing communities grow faster.)

  11. Why change now? • Empirical evidence that commercial banks underwrite better performing securities (of more mature firms) • Experience: few problems with limited U.S. experience, or in other developed countries • Technological Change: increased profits from cross-selling based on information sharing

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