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Do Small Banks Need a Bailout?

These small institutions cry foul over the Treasury’s bailout bias. Here are the pros and cons.

It’s a fight over $700 billion. Small banks are clamoring for a large share in the Troubled Asset Relief Program (TARP) that had appropriated majority of the funds to large banks like Citigroup, JPMorgan Chase and Washington Mutual. In an article by Christopher Rugaber of Businessweek, 1,000 small banks have already applied for support in order to generate more capital and thus provide more loans to borrowers. Small players have already noticed that the Treasury is favoring banks with large amounts of capital but the funds are reportedly used to acquire smaller institutions instead of reviving their credit programs. (Read our related post here.)

Support is necessary for ailing institutions when a massive bank run can create a drastic domino effect to other banks, thus affecting the finances of the communities that they cater to. If allowed to fail, small loans that are afforded by borrowers who cannot have access to a large bank’s credit will be retarded. For mortgage loans, small banks have played an important and significantly large role in the residential mortgage market by taking advantage of locations where larger banks have minimal coverage. Mortgage brokers also benefit from the thousands of volumes of mortgage loans sold in the secondary market, indicating the large contribution of their mortgages whether small or large, to the property sector.

On an opposite point, the crisis has not debilitated a lot of small banks in the country as compared to the downturn in Wall Street. Most banks were able to survive amidst the series of bankruptcies this year. This alone would contradict the purpose of the bailout which is supposed to rescue only failing institutions. Also, large banks have tapped online banking to reach to distant borrowers and corner small banks’ market share. The latter’s presence is threatened and the funds may not be effective for making loans. Finally, these banks are limited with services and the market has continuously favored mergers and acquisitions that will allow the acquiring bank to tap more customers and expand its client base. By injecting capital through the TARP, the funds may still end up with the large banks set to acquire small institutions.

Although there are disadvantages, we recommend that small banks get a slice of the bailout pie to avert further possible failures in the financial industry. They may be acquired by larger banks but for now, those of the verge of bankruptcy need more attention than insurers and car manufacturers.

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