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 Riegle-Neal Act of 1994 ∙ repealed McFadden Act (1927) =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 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

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

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

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

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

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

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

How will these changes affect the supply of capital to rural areas? Q1: Threat to survival of community banks from legalized branching? 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. 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.)

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