The Transformation of Banking and Its Impact on Consumers and Small Businesses

By William R. Keeton
Federal Reserve Bank of Kansas City

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The banking industry has undergone profound changes during the last decade. The most obvious change has been the large number of bank mergers, which have increased both the average size of banks and the area over which they operate. Other changes may also prove dramatic but are at this point just getting under way-the growth of Internet banking and the combination of banking with other financial services, such as insurance and securities underwriting.

The implications of these changes for the profitability and safety of banks have been widely discussed, but what do they mean for local economies? Some analysts argue that the changes will benefit most communities by increasing the public's access to financial services and making it easier for banks to continue lending during regional economic downturns. Others argue that the changes will end up hurting many communities, especially smaller ones, because the large organizations created by mergers will be uninterested in serving small customers and will siphon off funds from smaller markets to lend in big cities.

To shed light on the debate, this article focuses on the two groups that are most likely to be affected by the transformation of banking-consumers and small businesses. Before the recent changes, surveys consistently found that these two groups relied heavily on local banks for their credit and payments needs. It stands to reason, therefore, that they would also be the groups most affected by any changes in local banking practices resulting from consolidation, Internet banking, or financial integration. A further reason for focusing on small businesses is that these enterprises play an especially important role in the economic performance of smaller communities-the communities where there has been the greatest concern about the possible adverse effects of the transformation in banking.

The article concludes that the recent changes in banking are likely to benefit consumers and small businesses in most communities, as long as they remain free to choose between small and large banks for their banking services. The first section of the article reviews the three major changes in the banking system-consolidation, Internet banking, and financial integration. The next two sections argue that these changes are likely to benefit both consumers and small businesses, provided small banks are available to fill any gaps in service or credit to smaller customers. The last section concludes that small banks face a major but not insurmountable obstacle in continuing to fill this role-the increased difficulty of obtaining funds.

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