What are Local Community Banks About?

The following is a conclusion of the above video interview.

Businesses need cash to grow. Small firms usually depend on banks for their external borrowing. But large banks tend to be reluctant to work with small or medium sized businesses as it is often more efficient for them to provide loans to big businesses only. The banking system will ultimatively shape your economy. If it is dominated by a small number of large banks, then in most industries there will be strong pressure to end up with a small number of large firms. By contrast, with many small local banks, also many small local firms will thrive. This results in greater employment, as small firms hire more staff per pound invested, and a thriving local economy. If banking is dominated by few big banks however, the small firms will whither, unable to secure loans.

The crucial role of banks in shaping the economy cannot be overstated, because banks have one critical advantage: they create money and allocate it as they see fit. Their crucial role will have a long-term impact on the economic landscape.

So one might ask: is there something wrong with the UK banking system? It has long been recognised that it is too concentrated and there is a lack of meaningful competition. A different type of banks is needed.

In many ways the UK is an extreme case – compared to another major economy, Germany, the differences become clear: the top 5 banks in Germany only have about 12% market share. The majority of banking consists of about 1,500 small banks with headquarters in smaller towns. Because each bank is smaller, they want to deal with smaller companies, often family-owned.
There are two types of banks that make up for the majority of the economy: the over 1,000 local community-based co-operative banks, locally owned by their members (holding about 30% of all deposits), and the local public savings banks owned (holding almost 40% of all deposits in Germany).

The local banking model functions differently from what is happening in the UK, where concentrated big banks use automated and anonymous credit scoring systems to arrive at loan decisions. Instead, community banks are based on trust between customer and the bank. The customer knows the bank and the bank staff (who do not constantly change or get rationalised away); the bank knows the customers (and their families, where they live and what they do).

Another important aspect of the local community banking model is that it avoids the unsustainable excesses of the big banks. The boom-bust cycles and banking crises are due to banks creating credit for asset transactions and speculation (this is true in the UK as much as in Ireland, Portugal, Spain, Greece, the US or Japan). In Germany there have been fewer such problems – no significant asset bubble and subsequent banking crisis in the entire post-war era – because of the dominance of local community banks. Large banks often lend to large-scale asset purchasers, fuelling asset bubbles and hardly contributing to national income. Locally headqurtered banks tend to lend more for productive purposes, contributing to GDP, instead of fuelling asset transactions.

A banking system consisting of many small banks leads to more economic growth, fewer economic cycles and greater stability in the system. In the UK, there is a distinct lack of local community banks, while the US and Canada as well as Germany have benefitted from having diverse banking sectors with a large number of local community banks.

Often regulations favour large banks and encourage concentration in banking, however. It seems the regulators are not learning from the positive example seen in Germany.

To make the local economy thrive and make it more sustainable, we need local community banks, which are authorised full-service banks, but aimed at the benefit of the local community. Locally headquartered banks will serve local needs much better, and the problem of out-of-control large banks that are unaccountable for their actions can be avoided.

Post by LocalFirst Team

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