How Smaller Commercial Banks Are Dying

At least, that's what the Federal Reserve should have titled the report (.pdf) it released today. Instead, it went for the incredibly boring-sounding name, "Profits and Balance Sheet Developments at U.S. Commercial Banks in 2009." But despite the awful title, it actually has some pretty fascinating information and charts. The major theme is that times are still difficult for smaller commercial banks.

Let's start with its chart for bank profitability:

Fed Bank profitability 2009.PNG

This probably goes against the predominate theme you hear in the news that banks are doing great again. That's because most of the banks reaping huge profits these days are the big guys. The smaller banks continue to struggle. The report says:

Profitability diverged between the largest banking institutions and the rest of the industry, primarily reflecting the ability of large banks to generate income from specialized activities in which other banks do not generally participate.

Those other activities are mostly trading and other capital markets-based profits. And that change gives you the next pair of charts:

fed bank assets 2009.PNG

Lots of banks have been failing or consolidating over the past, well, 20 years. There around half as many now as there were in 1990. Moreover, the market share of the 10 largest banks has risen to around 55%, from around 20% in 1990. The top 100 have around 82%. That 18% left over doesn't provide a whole lot of business for the other 6,800 smaller banks to spread around.

One reasons why banks are having so much trouble has to do with commercial loan volume. This market is traditionally a major source of revenue for commercial banks, but it has dried up with lackluster demand for commercial and industrial loans. These loans plummeted nearly 19% in 2009:

fed cre changes 2009.PNG

The first chart below shows the general lack of demand that commercial banks are sensing. Demand was growing stronger, but still quite low by the end of 2009:

fed bank demand 2009.PNG

But the second graph is more telling. It's important to read it carefully, however. The chart likely still indicates that lending standards are much tighter now than they were before the financial crisis, as it just says that banks have stopped tightening, and a few even began loosening. In fact, the latter part of 2009 marks the first time since early 2007 that some banks were loosening standards. They likely felt the need to do so in order to compete for the few loans being applied for out there.

The 37-page report contains a lot of other detail about the commercial banking industry, so you may want to give it a read if you find this subject fascinating. But one thing is clear: small commercial banks still have a rough road ahead. Until high-quality commercial loan applications pick up, it's going to be increasingly difficult for them to compete with the big banks.