Updated May 9, 2023 at 12:39 PM ET
Silicon Valley Bank, Signature Bank, and now, First Republic Bank.
The failure of three smaller lenders in less than two months has shaken the entire global banking sector — with potentially major economic ramifications. And the banking turmoil continues, with shares of regional lenders such as PacWest sliding this week.
That has left many people asking: Why does the U.S. have so many banks and do they pose a risk for the economy?
The U.S. has more than 4,000 small banks. That's more than any other country in the world and more than all of the small banks in the entire European Union combined.
Here's why the country ended up with so many lenders and what that means for the U.S. economy.
Why does the U.S. have so many small banks?
It all started more than a century ago. Before the days of big, sprawling national banks like Bank of America and JPMorgan Chase, Americans just did not trust big banks.
"When America was in its earlier days, we had kind of a populist suspicion about big banks, especially big city banks," explains Richard Squire, a professor of law at Fordham University who specializes in financial and banking law. "Were they completely trustworthy? Were they gonna prey on farmers and small businesses, who might not be as sophisticated?"
To address these concerns and protect small banks, many states put in place so-called branch banking laws.
"Those made it illegal to operate a bank out of more than one building," Squire says. "So every little town in America had its own local bank.
At one point, in the 1920s, there were nearly 30,000 banks in the U.S.
The big problem with small banks
But all of those little banks posed a big problem for the U.S. economy: They would go bust all the time and people would lose everything.
Bank runs would spread like contagions, leaving whole communities devastated.
But then something happened in 1934 that changed the game for small banks entirely: the federal deposit insurance system.
That was a guarantee from the federal government that it would back up any deposit in any bank for up to $2,500 back in 1934 ($250,000 today).
It was a Depression-era measure to stabilize the then-cratering banking system, but it ended up becoming a game changer for small banks.
"This really helps the smaller banks compete with the bigger banks in terms of their perceived safety," Squire says.
Branch banking laws that limited the growth of lenders have mostly faded away. Still, the number of banks in the U.S. remains far higher than the number in any other country.
How small banks have shaped the economy
The large number of small banks in the U.S. has shaped the economy in many ways. For one thing, Squire says, the banking sector is far bigger than it would otherwise be.
And that means a lot more loans given that loans are a critical way banks make money. Squire says there are probably far more mortgage loans, small-business loans and other loans in the U.S. than there would be if there weren't so many banks.
This can be a great strength. The plentiful availability of credit has been credited with the robust startup culture in the U.S.
But it can also be a great weakness. Overly aggressive loan practices were a main cause of the 2008 financial crisis, a crisis that also centered around banks most people hadn't heard of.
The case for small banks
But some see small banks as the U.S. economy's superpower. Small banks enable lending to be tailored to particular communities — they know the risks and opportunities in an area and their community far better than some giant multinational institution.
Case in point: The Bank of Bird-in-Hand. It opened its doors in Bird-in-Hand, Pa., in 2013.
It was the first bank to open after the global financial crisis and it got national attention. After years of bailouts, crises and economic struggle, people thought it was insane to open a bank.
Bank CEO Lori Maley wasn't worried. She knew the community and she felt confident the bank would succeed.
Bird-in-Hand is located in the heart of Amish country. Maley says Amish customers have very specific banking needs that most banks can't accommodate.
"For one thing, Amish customers would not be able to go to a regular bank and get a mortgage loan," she explains. "Their property is nonconforming: It doesn't have electricity."
The Bank of Bird-in-Hand offers special loans for Amish homes and farms. Also some special accommodations like a drive-through that caters to horse-drawn buggies.
"We actually have an awesome picture of a horse looking in the drive-through window," Maley says, laughing.
Also, because horse travel takes a long time, the Bank of Bird-in-Hand has several mobile branches that it takes out to some more remote areas. It's called the Gelt Bus. (Gelt is the old German word for money.)
The Gelt Bus is built in an RV. It has an ATM and a teller window and runs on a circuit through some more remote areas of Pennsylvania.
The strategies have worked. Bird-in-Hand now has six locations, four Gelt Buses and a billion dollars in capital. Demand has been consistently high. At one point, it had lines out the door of customers waiting to open accounts.
"We had Amish sitting on the floor, sitting everywhere," Maley recalls. "It was really amazing."
But smaller banks can still get in trouble
Still, smaller banks can pose risks — and that was made clear by the failures of the three lenders over the past two months.
Smaller lenders can be more vulnerable to shocks, like the sudden bank run that led to the demise of Silicon Valley Bank. And bank runs can happen much faster now that people can communicate and move their money almost instantly.
And the failure of a small bank is not necessarily an isolated event. The demise of Silicon Valley Bank and Signature sparked fears that other smaller lenders could also find themselves facing a bank run.
Fordham's Squire thinks the events of the last couple of months will likely mean a lot fewer small banks in the near future, as smaller lenders find themselves under increased scrutiny, possibly dealing with stricter regulation and a shrinking number of depositors.
Americans have already pulled nearly $200 billion out of small banks in the past couple of months. Most of them put that money in a handful of very big banks that felt safer.
And, in fact, when First Republic Bank shares were cratering, it was a big bank that came to the rescue: JPMorgan Chase, the country's biggest lender, just got a lot bigger.
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