About the author: Earl Wright Co-Founder and Chairman of the Board of Directors of AMG National Trust, a community bank and wealth management firm based in Colorado.
The Federal Reserve is fighting gamely to contain the worst inflation America has seen in nearly 40 years without sparking a recession. It can only win that battle if community banks and small businesses are healthy. If the Fed is not careful as it continues to chase its preferred inflation rate of 2%, there could be unintended consequences for the nation’s smallest economic players.
Community banks, both small and medium-sized enterprises, are essential to the financial well-being of our country because they primarily serve small businesses, which are the backbone of the economy. Small businesses will make up 99.9% of all US businesses in 2022 and 46.4% of the nation’s workforce. Small businesses and community banks are closely linked. No one succeeds without the other. And now, both of them are facing a challenge.
The Fed has been aggressively raising interest rates for more than a year to curb inflation, which peaked at 9.1% in June. And the Fed appears to be winning: inflation is now at 4.9% and heading lower. But this success came at the cost of higher interest rates. The federal funds rate now stands at 5%-5.25%, up from 0.25%-0.50% in March 2022.
The few big failures in recent weeks show the increasing pressure of interest rates on banks. These closures had little to do with community banks, which hold more short-term local loans than their larger counterparts. Many of those big banks loaded up on Treasuries and mortgage-backed securities, only to see them fall in value due to higher federal interest rates.
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But community banks are still feeling the pressure of rising interest rates. The longer they stay in a high position, the more difficult the challenges. Here are just a few:
- Deposits cost more. New loans and renewals cost more for local companies, entrepreneurs, and real estate developers. Community banks serve most businesses in the country with 150 employees or fewer, providing nearly 60% of small business loans and more than 80% of all agricultural loans. About half of all community banks are located in rural counties of less than 50,000 people.
- Rapidly rising wages pose a challenge for small business borrowers. Hard to find workers for any wages. The unemployment rate in the United States is 3.4%, the lowest in 54 years. In Nebraska, the rate is 2.1%, which indicates that almost everyone who wants a job has a job.
- Nationally, commercial real estate, or CRE, will mature about $270 billion worth of loans in 2023. Over the past few years, CRE projects have seen higher vacancy rates resulting in lower operating income due to pandemic-related business failures and new work in- Home option for many employees. Small and medium-sized US banks handle two-thirds of all investment trade loans made by banks. These loans usually have maturities of no more than seven to 10 years and represent about 40 to 50% of community bank loans.
In this challenging business environment, our deposits cost much more. We have no choice but to charge more for new loans and renewals. Refinancing is likely to be 50% to 100% more expensive, while lower operating profits for borrowers. This is a difficult situation for everyone.
With the fear of losing deposits over the FDIC’s $250,000 ceiling, some major banks will be wary of rolling over loans to accommodate these stressful situations.
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This is where midsize and community banks have an advantage and why we are important to economic growth and stability in the United States. We are an integral part of our communities. Often owned by local residents, community banks usually have closer links with borrowers and depositors. We shop their business and buy their products. We keep money local. The borrower and the banker understand that their community depends on their mutual success.
Even before this inflationary episode began, community banks were grappling with an increased regulatory environment, including new accounting requirements known as current expected credit losses, additional reporting of capital ratios, and focused oversight of generally accepted banking practices that disproportionately affected on small banks. From 2000 to 2021, the number of banks nationwide decreased from 8,315 to 4,236. From 1985 to 2011, an average of 183 new banks were started each year, but only four were started annually between 2012 and 2019 as the industry consolidated .
The last thing America needs is another round of consolidation, resulting in fewer community banks.
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The coming months will be a challenging time as societal bankers and borrowers look for creative solutions to the challenges of a high interest rate environment. Many experts expect rates to remain high until the Fed achieves its 2% inflation target, which may not last until 2025.
this is a long time. The Fed is wise to remember that small businesses and community banks are the backbone of the nation’s economy, and their success is America’s success. Inflation can be tamed without stagnation only through a sound community banking system.
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