Do Bank Branches Matter? Why The Fed Is Wrong

In a recent Economic Commentary titled Do Bank Branches Matter Anymore?, the Federal Reserve Bank of Cleveland wrote that bank branches matter because a local presence in a market — i.e., bank branches — enables a bank to gather better data about local conditions and make better lending decisions. The authors wrote:

“Bank-customer relationships can overcome [adverse selection in lending decisions]. For banks, interactions with customers allow them to gather information on a customer, so-called soft information, which is not easily captured in a credit score. Banks operating in a local market are also more likely to have information on the local economy, giving them a context from which they can evaluate the future prospects of a borrower that is not readily available to an out-of-market lender. 

Because the gathering of soft information is difficult to do without a physical presence in a local market, the closing of a bank branch is different from the closing of a grocery store. One can still buy oranges, perhaps at a higher cost, by traveling farther to a different grocery store. But one cannot always get a loan by traveling to a distant lender.

We find that low-income homebuyers who obtain their mortgages from banks with branches in their neighborhoods are less likely to default than homebuyers who use banks without a branch in the area or mortgage brokers. These findings suggest that a physical presence gives banks the opportunity to get to know distressed areas better and channel resources to people who can manage them best.”

My take: The Fed is wrong about:

1) Knowing a market. “Knowing” a market doesn’t come from having physical offices (or branches) in a particular market. “Knowing” a market comes from developing a systemic business capability that captures data about a market, and on the impact and results of business decisions made in that market over a period of time.

The “soft” information that the authors refer to — information about spending habits of individual borrowers — is no more accessible to a bank with a physical presence in a market than to a bank without a physical presence.

In fact, I would argue that an Internet-only bank whose customers are heavy users of debit cards actually have better “soft” data regarding their customers financial lives than a branch-oriented bank who customers still rely heavily on cash and checks. Why? Banks’ ability to categorize debit card transactions is more advanced than their ability to analyze check transactions.

2. Correlation and causation. The Fed is confusing correlation with causation. Iit might be true that “low-income homebuyers who obtain mortgages from banks with branches in their neighborhoods are less likely to default than homebuyers who use banks without a branch in the area or mortgage brokers.”

But the only way that the absence of bank branches would be the cause of the default is if applicants applied to both brick-and-mortar and Internet-only banks, and were turned down by the b&m banks and accepted by the branchless ones. This doesn’t seem very likely. 

It’s hard for me to tell from the article, but it appears that the authors looked at data from a selected number of counties in Ohio, comparing 2002 to 2010. Had they looked at California, Florida, or Texas, my bet is that they would have found very different results. In addition, as the authors note, bank branches “have been disappearing in some major metropolitan areas.”

With the economic conditions that existed between 2008 and 2010, it’s hard to conclude that the increase in loan defaults is caused by branch disappearances.

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If the purpose of the article is to convince banks that in order to improve their lending business they need to expand their branch presence, I have to disagree. 

Looking ahead, the opportunity for banks to gather “soft” information about customers and markets will not come from a branch presence. Instead, it will come from the growth in the use of mobile technology — specifically for mobile banking and mobile payments will give the banks much greater insight into spending habits and trends in the markets they do business in. 

So do — or should I say — will bank branches matter? If banks use branches to distribute smartphones to their customers, then the answer is yes. 

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2 thoughts on “Do Bank Branches Matter? Why The Fed Is Wrong

  1. I agree, bank branches don’t matter, and if anything, will be a drag on profitability on branch banks for years to come. If there’s an effect, it’s perhaps that an in-person lending decision is able to take into account verbal and non-verbal cues that an automated online process can’t / won’t take into account. Also, there may be a higher sense of long-term accountability by an in-person decision maker.

    If all of this is true, the leap to “a bank need branches” is still a logical non-sequitur. At most, a bank might need “mobile” lending decision makers, just like the fleet mobile adjusters used by Progressive. Not coincidentally, Progressive doesn’t have branches (or agents).

  2. Making local decisions, via local branches, does make an impact on the profitability of the branch. First, you are likely to make more loans (if you have the latitude to make your own decisions) by meeting with people face-to-face. Automated decisions via web or mobile, or even human decisioning at a remote location, tends to lead the decision maker to a black and white conclusion. And, typically, it is all just credit score driven (unless you have the wherewithal to give everyone the same rate). So more loans leads to less losses as a percentage because… you are making more loans. The second side of this is if you are making local decisions, hopefully you are collecting locally as well. If you live and work in the community you serve, you want people to stay in the house and car. You are going to work face-to-face, hopefully, and not bow to a GSE….Given what we have been through (2008 to present), seems a local presence builds trust—woven into the fabric of all that you do—for your community, that you serve. Aren’t you doing everything to invest in each community you serve? Mobile, web, etc. is all about access via all delivery channels. Branches are the face of your organization—-or at least the organizations I would prefer to work with.

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