In Small-Business Lending, Technology Hasn’t Replaced Face-to-Face Contact

Technological advances in information processing have dramatically transformed consumer banking. Americans today can apply for home mortgages, credit cards and bank accounts without ever stepping foot in a bank branch. Indeed, these advances have rendered the local bank branch obsolete for many, with in-branch visits accounting for only a small fraction of bank transactions. This suggests that branch closures should have minimal or short-lived effects on the availability of credit in the vicinities they serve.

In a recent paper, however, economist Hoai-Luu Nguyen suggests otherwise. Nguyen analyzed data at the census tract level, comparing small-business credit availability before and after bank branch closings that resulted from bank mergers. That is, she studied credit availability before and after the merger of two major banks—both with branches in a local market—forced one of those branches to close. These circumstances allowed Nguyen to isolate the economic effect of a branch closure. By contrast, simply comparing credit availability in localities where branches closed to localities where branches did not close would have produced biased results, as branch closings are often correlated with low profitability in the local market. For similar reasons, Nguyen ensured that both banks held at least $10 billion in pre-merger assets. This allowed her to parse out the specific impact of the branch closure from the aggregate market-level effects of the merger.

Nguyen found that branch closings “led to a sharp and persistent decline in credit supply to local small businesses.” Indeed, after a branch closing, annual tract-level small business loan originations fell by an average of $453,000, from $4.7 million. Loan originations remained depressed for up to six years, leading to a cumulative loss of $2.7 million in loans that those branches might have made if not for their closings. Nguyen found that these effects were hyper-local, not felt beyond six miles of the tract where a branch closed.

These marked declines in loan origination were not explained by higher costs of borrowing due to decreased competition in the local market (with one fewer bank), nor by the imposition of the buying bank’s possibly more stringent lending standards. In addition, the decline could not be explained by increases in business owners’ use of home equity lines of credit or credit cards. Nguyen found, however, that tracts where only the target of a merger had a branch did not experience a significant decline in loan originations.

Nguyen’s research suggests that the decline in credit availability is attributable to the disruption of branch-specific relationships utilized in small-business lending. Small-business lending relies heavily on “soft information and relationships,” and post-merger consolidation of branches often means bank personnel changes. Nguyen found that while branch closings led to a prolonged decline in small-business lending, “there was virtually no effect on local mortgage lending.” Nguyen hypothesized that this was because mortgage loans typically rely on credit history and income verification instead of the personal relationships and soft information common to small-business lending. Personal relationships take time to build, and simple forms cannot transmit that soft information—that is, “opinions, ideas, rumors, economic projections, statements of management’s future plans, and market commentary“—because it is “private and not verifiable, as it involves a personal assessment and depends upon its context.”

Although more research is needed, these findings may prove useful to policymakers, especially those considering bank mergers. Regulators today already evaluate bank mergers at the branch level, but they focus on accessibility. Given the importance of credit availability to small businesses, and of small businesses to the American economy both local and national, Nguyen’s work suggests that such evaluations should be more nuanced. More broadly, policy makers should take heed of these findings wherever it seems technology could replace human interaction.

Article source: Nguyen, Hoai-Luu. “Are Credit Markets Still Local? Evidence from Bank Branch Closings.” American Economic Journal: Applied Economics 11(1). (2019): 1-32.

Featured photo: cc/(ablokhin, photo ID: 910105798, from iStock by Getty Images)