FRBSF Economic Letter
99-03; January 22, 1999
 Economic
Letter Index
Small Business Lending Patterns in California
Western Banking Quarterly is a review of banking developments
in the Twelfth Federal Reserve District, and includes FRBSF's Regional Banking Tables.
It is published in the Economic Letter on the fourth Friday of
January, April, July, and October.
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The recent trend of bank consolidation in California has once again focused
attention on how regulators analyze the competitive effects of mergers.
Traditionally, the Federal Reserve has defined banking markets to be local
in scope. This practice originates from a Supreme Court decision in 1963
(U.S. v. PNB, 374 U.S. 321) where banking was affirmed to be a "cluster"
of activities, such as transactions, deposit-taking, and lending. At that
time, deposit accounts were primarily administered through bank branches,
so it was reasoned that market boundaries should be drawn to include all
banks (with branches) that would affect each other's pricing decisions.
Competition was then measured by the concentration of deposit market shares
of the in-market banks.
Bankers have argued and regulators have acknowledged that some components
of the banking activities cluster are provided by out-of-market firms
(that is, competitors with no branch presence in a local area), and regulators
have attempted to control for these outside influences in their competitive
analysis. Now it is possible to assess the extent of outside competition,
at least in the area of small business lending, in a much more precise
way. In this Letter we use a newly available dataset to summarize
the basic patterns of small business lending in California in 1997. We
also touch briefly on some implications of these data for assessing competition
in merger analysis.
The data on small business loans
As a result of recent changes in the regulations for the Community Reinvestment
Act of 1977 (CRA), banks and savings associations are now required to
report the amount and location of small business and farm loans originated
each year. A small business loan is defined to be a loan of less than
$1 million that is designated by the reporting institution as either a
commercial and industrial loan or a loan secured by nonfarm or nonresidential
real estate. The reports include total originations of various size categories
of loans by census tract.
One limitation of the CRA data is that they do not draw from the entire
universe of lenders--for example, finance companies are conspicuously
absent. Furthermore, the data do not include loans originated by small
institutions--only institutions with assets greater than $250 million
(or of any size if owned by a holding company with greater than $1 billion
in assets) are required to file reports. However, the small business lending
of the small institutions that are exempt from the CRA filing requirements
can be estimated from their balance sheet data; these loans are then allocated
to markets according to the size of the institutions' branches in those
markets, as measured by deposits. This approximation is reasonable for
small institutions, which typically have very few branches.
Out-of-market lending
Using these data, we investigate the extent to which lending institutions
face competition from out-of-market competitors in both small (deposits
less than $500 million) and large (deposits greater than $3 billion) banking
markets in California. By these criteria, there are 22 small markets and
12 large markets in California. The market definitions employed here are
the same as those used by the Federal Reserve in its bank merger analysis.
The market boundaries have been drawn to account for factors such as patterns
of commerce and commuting (see Cyrnak 1998 for a nationwide study at the
county level).
It is clear from Figure
1 that out-of-market banking institutions make up a majority of the
total number of lenders in most markets. On average, 70% of the lenders
are out-of-market for both small and large markets. For a small banking
market like California City (which consists of California City, Mojave,
and Tehachapi) the activity of out-of-market firms is quite significant
in that it raises the number of lenders from two to twenty. In the large
markets, as well, out-of-market institutions significantly increase the
number of lenders. In the Los Angeles market, for example, out-of-market
lenders raise the number of lenders from 115 to 276.
While the out-of-market lenders may be numerous, the extent of their
lending varies considerably by market (see Figure
2). In two small markets, Firebaugh-Mendota and California City, out-of-market
lenders account for 70% or more of the dollar volume of small business
lending; by contrast, in Tehama County, Porterville, and the Mendocino
Coast market (which consists of Fort Bragg, Gualala, Mendocino, and Point
Arena), out-of-market lenders account for less than 10%. In large markets
there is much less variability. For example, the highest share of lending
by out-of-market institutions is 25% for the Palm Springs area. In Los
Angeles and San Francisco, the shares are 18% and 12%, respectively. On
average, the percentages of loans originated out-of-market are 27% for
small markets and 15% for large markets.
Who are the out-of-market lenders? For the case of small markets, the
most active lenders are usually large banks with a branch presence in
nearby markets. These banks often capture leading shares of these markets'
small business loans. Other key lenders in small markets are large, nationally
recognized credit card banks. In fact, in the Mendocino Coast market,
credit card banks are the only out-of-market lenders. In large banking
markets, credit card banks are also among the major out-of-market participants.
For these markets, it is quite common to find low-level activity by large
banks with no branch presence in the state or region.
Conclusion
The CRA data reveal that out-of-market competition for small business
lending can be significant in some banking markets. But we also must keep
in mind that these out-of-market institutions may not offer other components
of the banking cluster. These data, then, do not provide regulators with
easy tests of whether a given market is currently competitive or not.
But, at the very least, the data give regulators a better picture of how
the lending demands of a business community are being served in a region.
John Beauchamp
Banking Analyst
John Krainer
Economist
Reference
Cyrnak, A. 1998. "Bank
Merger Policy and the New CRA Data." Federal Reserve Bulletin
84 (September) pp. 703-715.
Opinions expressed in this newsletter do not necessarily reflect
the views of the management of the Federal Reserve Bank of San Francisco
or of the Board of Governors of the Federal Reserve System. Editorial
comments may be addressed to the editor or to the author. Mail comments
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Research Department
Federal Reserve Bank of San Francisco
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