The Fall (and Rise?) of Community Banking: The Importance of Local Institutions

Bob Solomon, UC Irvine School of Law


Even before the banking crisis of 2008, the banking world was in the midst of a major transformation. Pushed by increasing competition and narrow profit margins, along with the need for more efficient and cost-effective back office operations, the industry adopted a bigger-is-better philosophy, and larger banks absorbed smaller institutions like sharks swimming through a school of fish. This consolidation has resulted in a banking system where products, especially at the lower end of the market, have become more standardized and, if not profitable in bulk, nonexistent, especially in smaller communities.

The premise of this Article is that there is a critical role in the banking system for community banks, especially community development financial institutions (CDFIs). A CDFI is a legally existing organization with a primary mission of promoting community development and serving eligible target markets. A CDFI cannot be a governmental entity or be controlled by a governmental entity. CDFIs are certified by the Department of Treasury as set forth in the CDFI regulations. In July 2012, there were 999 certified CDFIs. The question with CDFIs, however, is whether their importance mandates subsidizing them and whether they should be regulated differently from other financial institutions.

In this Article, I argue that U.S. banking policy wrongly privileges larger banks over smaller community-based institutions, which results in both a quantitative and qualitative loss of services. I start with a review of recent banking concentration. I follow with four principles on which I base the analysis that follows. I then review four banking experiences: ShoreBank in Chicago, Illinois; Start Bank, a de novo bank in New Haven, Connecticut; the romanticized Bailey Banking & Loan from It’s a Wonderful Life; and a long-standing community bank in Seneca Falls, New York. I conclude with proposals to turn the current privilege around, with suggestions of ways to preserve community banking. Specifically, I propose that the monolithic nature of bank charters disadvantages smaller institutions and that community-based institutions, in exchange for restricting their activities, should have the option of obtaining a special charter that is not subject to the same regulatory regime as larger banks.