Why rural banks are sometimes a better source of credit

There was a time, not so long ago, when most banks were local. Until the early 1980s, most people conducted their financial transactions at a bank that was chartered and owned in the county in which they lived. As a result, these financial institutions were of the “small” and “local” variety (source).

Enter the deregulation that took place in the 1980s and 1990s, and suddenly you had a changing face of the entire industry. That’s why the number of banks has been cut in half since 1980, to around 6,000.

Big banks began to realize that the more branches they owned, the more they could spread out their fixed costs. As a result, some of them got to be very large – some too large for their own good, as they would find out later. They simply became too big and complex to manage.

Many of the small banks (single branches with less than $100 million in assets) went the way of the dinosaur, but the “lower-middle” tier (between $100 million and $1 billion in assets) stayed constant.

So, why are rural banks a better source of credit? Research has shown that this is partly because these smaller institutions do a better job of loaning money to people and companies that are a lesser credit risk than their larger counterparts. According to the FDIC, in every five-year period since 1991, a lower percentage of loans issued by rural “community” banks has gone bad. A follow-up study in 2012 showed that loans from rural banks to rural customers are only 70 percent as likely to default as loans taken from urban banks that are given to urban borrowers.

One reason for this is simple: The banks can’t put their customers in a bad loan, because there’s a good chance they might see them walking around town. And on the flip-side, when a consumer knows his banker, he’s more likely to meet his obligations.