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Community banks: Small enough to fail

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Economic Snapshot for June 3, 2009

by Nancy Cleeland

While federal agencies devote trillions of dollars to keep major banks afloat on fears that their failure could unravel the global financial system, small banks that serve local communities—and account for the vast majority of the nation’s 8,000 banks—are feeling the full brunt of the financial crisis.

For the first time since the Savings and Loan scandals rocked the industry in the late 1980s and early 1990s, bank failures are becoming a serious concern. The numbers are still relatively small, but they are growing at an accelerating pace. So far this year, 36 banks and savings institutions have failed, compared to 25 in all of 2008, and only three the year before (see Figure).

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More worrisome is the growing number of banks deemed to be in trouble by the Federal Deposit Insurance Corporation (FDIC), which insures deposits and collects premiums from all banks to cover the cost of failures. In its recently released report for the first quarter of 2009, the FDIC declared that 305 insured financial institutions faced serious problems—the most since 1994. And with many commercial real estate loans coming due this year and next, the number of troubled banks is almost certain to grow.

Community bankers claim they have been unfairly disadvantaged by the federal government’s response to the financial crisis, leading to further concentration of assets in the hands of a few mega-banks. Acknowledging those concerns, FDIC Chairman Sheila C. Bair announced the creation of a community banking advisory committee on May 29, saying: “Community banks are the lifeblood of our nation’s financial system, supplying much-needed credit to countless individuals, small businesses, nonprofit organizations, and other entities in large and small towns around the country.”

The fate of community banks in the bailout will be explored further in a panel discussion at EPI on Wednesday, June 10.


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