R. Alton Gilbert *
Until recently I thought the consensus view on the future of the
banking industry included the idea that there would continue to
be thousands of small banks. The owners of these small banks would
be independent of the large, nationwide banks that are emerging
through mergers with regional banks. According to this view, the
customers of small banks value personal service and their opportunities
to have personal relationships with the top decisionmakers in their
Recently John McCoy, President and CEO of Bank One Corporation,
challenged this consensus view by claiming that the Internet has
undermined the future of small banks (McCoy, 1999). The following
are some quotes from this speech: "When you combine the power
of the Internet as a new delivery channel [and] the partnerships
that have developed [among] a broad range of product providers,
it is difficult for me to
define what role community banks
will play in the future. It's even difficult to predict the future
viability of banks up to $20 billion in assets. This is a scale
business and smaller institutions won't be able to compete since
they simply won't have a competitive access to either products or
the new delivery channels."
Later he said, "Because this is a scale business, smaller
[credit] card programs are no longer profitable and many banks are
now trying to sell their portfolios to the larger players. So, it
is important that you don't think about the Internet as technology.
Think about the Internet as the future of the banking system."
McCoy also mentioned that some lenders are originating small business
loans over the Internet.
I do not agree with this pessimistic view of the future of community
banks. Briefly, I will explain why, discussing four points:
First, if the Internet has eliminated the future of the community
bank, many bankers and investors have not got the message. Many
new bank charters are being granted: 77 commercial bank charters
in 1997, 110 in 1998, and through mid-May of this year, 43 charters,
about the same pace as in 1998.
My second point deals with the statement that economies of scale
are driving community banks out of the credit card business. If
community banks were getting out of the credit card business, selling
their credit card loans to larger banks, credit card loans would
be disappearing from their balance sheets. Table 1 indicates the
percentages of banks in various size groups that had credit card
loans on their call reports as of the fourth quarters of 1993 and
1998. About 80 percent of community banks with total assets over
$100 million had credit card loans on their balance sheets in both
periods. Table 1 does not indicate a tendency for community banks
to get out of the credit card business.
The third point involves making small business loans over the Internet.
Loans to small businesses originated over the Internet by banks
without offices near the small businesses would be a significant
threat to the viability of community banks.
I have some questions about how Internet banks could offer this
type of service to small businesses without networks of offices
located near their small business customers. Can they really get
all of the information they need to judge credit quality from national
databases? How can they monitor the operations of their small business
borrowers? If the loans become past due, how can the Internet banks
work with their borrowers to maximize the return on the problem
loans without staff located near the small business borrowers?
In attempting to answer these questions, I looked at the home pages
of banks that offer their services only through their Internet sites.
The loans offered by these Internet banks are limited to credit
card and mortgage loans. The closest thing I found to small business
loans was equipment leasing.
I have some additional information about loans to small businesses
by banks with no offices near the locations of the small businesses.
In recent years large banks have been required to report information
on the locations of their small business borrowers to their supervisors,
under the Community Reinvestment Act (Bostic and Canner, 1998).
We look at this information in some banking antitrust cases to determine
whether lenders without offices in local market areas should be
considered important competitors in making small business loans.
We find that such loans to small businesses often turn out to be
credit card loans (Cyrnak, 1998). Credit card loans and the loans
made by community banks to their small business customers must be
priced differently, since the percentage of loans that banks charge
off as losses is so much higher for credit card loans than for the
loans by community banks to their small business customers. In the
last 10 years the charge-off rate on credit card loans was 3.4 percentage
points above the charge-off rate by small banks on their commercial
and industrial loans. Because of these differences in charge-off
rates, credit card loans will not undermine the role of community
banks in making loans to small businesses that they know well, monitoring
closely the activities of these borrowers, and working out problems
with these borrowers rather than simply charging off their past-due
My fourth and final comment involves the participation of relatively
small banks in the delivery of banking service over the Internet.
If the Internet threatened the existence of small banks, we would
expect to find few if any small banks capable to providing Internet
banking services. Table 2 presents information on the banks with
Internet sites through which their customers can conduct transactions.
As of June 1998, about 75 percent of these Internet banks had assets
below $1 billion. Small banks can offer these Internet banking services
because Internet service providers have reduced their prices substantially
in recent years. The initial cost to community banks of establishing
Internet sites has fallen to between $25,000 and $50,000 (Marenzi,
During his luncheon talk in May 1999, John McCoy mentioned a particular
form of Internet banking in which small banks will not be able to
compete: bill presentment and payment. Banks and nonbank vendors
are developing systems for delivering bills from companies to their
customers over the Internet. Bank customers will go to the home
pages of their banks to view bills sent to them by businesses. The
bank customers will send instructions to their banks over the Internet
to pay the bills. This service is not in operation on a large scale
at this time, but developers of bill presentment systems think this
arrangement for receiving and paying bills will become an important
I do not understand why small banks would be unable to provide
their customers with bill presentment and payment services. A bill
presentment service that would be the most useful for businesses
and their customers would link as many businesses and banks as possible.
The banks and nonbank service providers that are developing these
systems have incentives to include small banks.
Developers of bill presentment services might face legal problems
if they attempted to exclude some potential participants. Because
of the economies of scale in the operation of bill presentment services,
one system is likely to become dominant. A dominant provider of
bill presentment and payment services would assume social responsibilities
that it did not have when developing its system. It is important
that those who control the service not be permitted to set terms
for access and pricing that will give some billers or some banks
advantages over others in providing services to their customers.
State governments have dealt with this type of issue in the operation
of the payments system, in regulating the operations of ATM networks.
Several states require ATM networks to share their networks with
all banks. ATM networks became essential facilities for banks, and
those who developed these essential facilities were limited in their
discretion to restrict the participation by banks.(1) To me the
same logic would apply to a dominant provider of bill presentment
and payment services that becomes an essential facility for participating
in the banking business. I am not a lawyer, however, and this is
as far as I will go in playing the role of lawyer.
In sum, then, I do not think the evidence supports the argument
that the Internet has undermined the viability of community banks.
* Mr. Gilbert is Vice President and Banking Advisor of the Federal
Reserve Bank of St. Louis <email@example.com>.
The thoughts Mr. Gilbert expresses here are his own, and not necessarily
those of the Federal Reserve Bank of St. Louis or the Federal Reserve
- See Baker (1995 and Balto (1995) for their
analysis of these issues involving the operation of ATM networks.
- Baker, Donald I. "Shared ATM Networks
The Antitrust Dimension," Federal Reserve Bank of
St. Louis Review (November/December 1995), pp. 5-17.
- Balto, David A. "Payments Systems and
Antitrust: Can the Opportunities for Network Competition be Recognized?"
Federal Reserve Bank of St. Louis Review (November/December 1995),
- Bostic, Raphael W. and Glenn B. Canner. "New
Information on Lending to Small Businesses and Small Farms: The
1996 CRA Data," Federal Reserve Bulletin (January 1998),
- Cyrnak, Anthony W. "Bank Merger Policy
and the New CRA Data," Federal Reserve Bulletin (September
1998), pp. 703-15.
- Egland, Kori L., Karen Furst, Daniel E. Nolle,
and Douglas Roberstson. "Banking over the Internet,"
Quarterly Journal, Office of the Comptroller of the Currency (December
1998), pp. 25-32.
- McCoy, John B., President and CEO, Bank One
Corporation, luncheon address, the 35th Annual Conference on Bank
Structure and Competition, sponsored by the Federal Reserve Bank
of Chicago, May 7, 1999,
- Marenzi, Octavio. "The Home Banking Outsource
Dilemma," Financial Service ONLINE (July/August 1998), pp.