The value of regional banks

By Joe Nocera and Michael J. de la Merced

Walk around any city in America and you can hardly miss the many branches of the Big Four banks: JPMorgan Chase, Bank of America, Wells Fargo and Citigroup. They’re almost as ubiquitous as gas stations. With their $1 trillion-plus in assets and national reach, the Big Four have dominated the banking landscape for the last quarter-century.

So it’s not surprising that following the failure of Silicon Valley Bank and other regional banks, some depositors raced to move their money to national banks, believing they offer more safety. The government won’t allow a “Too Big to Fail” bank to, well, fail, so customers know that even their uninsured deposits will be covered. But if a regional bank craters, uninsured deposits may not be recovered.

To some, this raises the question of whether the United States even needs regional banks. Wouldn’t letting the Big Four just buy all the regional banks make the banking system both safer and more efficient?

But banking experts are quick to defend the value of regional banks, and to understand why, a short history lesson helps. The country has long had a fear of big banks, and for decades banking law forbade banks from crossing state lines. The idea was that a local banker understood his community better than a big, impersonal bank and would make loans that the big bank wouldn’t. This was especially important to farmers, who often needed their banker to be patient in years when bad weather meant poor crops.

In 1994, Congress allowed banks to cross state lines while also allowing bank mergers. And merge the banks did — from 1995 to 2001, the number of banks shrank to 4,200 from 10,000. At the same time, the number of branches rose, to 72,000 from 59,000, as national banks spread.

If only deposits mattered, national banks would be all you need. But for farmers, startups, small businesses and companies in certain sectors, what matters most is the ability to get a loan. And here, experts say, is where the regional banks often make more sense than the Big Four.

“The big national banks are operating in the global capital markets,” said Robert Hockett, a professor at Cornell Law School and banking expert. “A lot of their assets are based on speculation. They’re not fueling economic growth. They’re not funding new companies. Or farms. You need patient capital for that, and capital at the Big Four is not patient.”

“Regional banks have a combination of regional knowledge and expertise that makes lending more efficient,” said C. Michael Zabel, a former executive at M&T, the Buffalo-based regional bank. “They’re also more likely to put deposits to work in their community.”

Silicon Valley Bank was a classic “sector bank.” It understood its sector — venture capitalists and technology startups — and made loans that national banks would never have countenanced. Its failure was caused by risk management mistakes, not its startup-heavy loan portfolio, which was sound and has been happily taken over by First Citizens Bank.

Comerica, the Dallas-based regional bank, offers another example. In addition to offering traditional mortgage lending, it has etched out specialties in female-owned businesses and renewable energy companies, among others. Nearly every regional bank is maniacally focused on specific sectors. That’s how they’ve survived during 25 years of bank consolidation.

The problem is that you can’t make loans if you don’t have deposits. Right now, said Mark Williams, who teaches finance at Boston University, “there is a giant sucking sound, with the big banks sucking up all the deposits from the regionals.”

And while that may bring about a sense of relief for depositors, it’s ultimately not healthy for the banking sector.

Why didn’t the credit rating agencies see chaos coming?

Those looking to assign blame for the collapse of Silicon Valley Bank, and the wave of chaos that arose from its failure, have pointed fingers at bank executives and regulators. But there’s another set of watchdogs that didn’t see the chaos coming: the major credit rating agencies, Moody’s, Standard & Poor’s and Fitch.

Fifteen years ago, they were blamed not only for failing to identify the dangers of the mortgage-backed securities that led to the global financial crisis but also for turning a blind eye. But how much blame they should shoulder this time is less cut and dried.

What did the agencies say in the run-up to the SVB crisis?

They correctly identified as risks some of the factors that led to Silicon Valley Bank’s demise months ago, including the effect of central banks’ raising interest rates on the assets that lenders held. Standard & Poor’s also revised Silicon Valley Bank’s rating outlook to stable, from positive, in November.

But none of the agencies actually moved to downgrade SVB until Feb. 27 — the first business day after the lender published its annual report — when Moody’s analysts said they were weighing a downgrade. Bank executives spoke with Moody’s the following week, urging the agency to hold off while they sought to raise $2.5 billion in capital that week. Moody’s eventually cut SVB’s rating by one notch on March 8, the day the bank announced its fundraising plan.

What took the agencies so long?

They say they take longer-term views on companies and don’t adjust based on potentially temporary factors like fluctuating values of banks’ asset holdings, an approach called rating through the cycle.

“Agencies tend to be reluctant to downgrade until they’re confident any increased risk isn’t fleeting,” said Samuel Bonsall, a professor at Penn State University’s Smeal College of Business.

Others take a blunter view: “The credit rating guys tend to be slow in changing their opinions,” said Lawrence White, a professor at the NYU Stern School of Business.

Would tighter regulation have prevented this?

Congress approved a number of ways to increase oversight of the ratings agencies via the Dodd-Frank banking overhaul in 2010. Yet many of those steps, including recommending alternative business models or increasing legal liability for bad ratings, weren’t actually put into practice, partly because of lobbying by the agencies.

“There is little penalty from ratings being stale or wrong,” said Frank Partnoy, a professor at the University of California, Berkeley, School of Law.

But others questioned whether those changes would have changed the outcome.

“Nothing the SEC could have done or will do would deal with the fact that the credit rating agencies weren’t paying attention,” White said.

From the perspective of the agencies, Silicon Valley Bank was the victim of an extraordinary bank run, and had its capital-raising succeeded, the lender would have survived.