During the last several years, concern has increased that changes in the financial system have made it harder for rural banks to attract enough deposits to meet local credit demands. While urban banks may face some of the same problems, it is widely believed that funding pressures have increased more for rural banks than for urban banks. In response, bank trade groups and rural development officials have proposed new measures to expand rural banks' access to loanable funds.
Three factors have led to the increased concern about the ability of rural banks to fund their loans. First, loan-deposit ratios have risen sharply, reaching record highs in the last two years. In the past, such high loan-deposit ratios have beer taken as a sign that liquidity has been reduced to the bare minimum and that banks will be reluctant to make additional loans without receiving additional deposits. Second, rural deposit growth has been sluggish. Rural bankers attribute this sluggishness to the increased popularity of mutual funds and the death of older depositors with heirs in distant cities, and claim it has kept them from meeting local credit demands. Third, increasing numbers of rural banks have been taken over by urban banks and converted to branches. According to some critics, these branches take in deposits but make few loans to local borrowers, forcing remaining rural banks to meet a bigger share of the community's credit needs with an unchanged supply of funds.
This article examines recent loan and deposit trends in Tenth District states to see what evidence exists for each of the three sources of concern about rural funding pressures and to see if the concerns are more justified for rural banks than urban banks. Overall, the evidence indicates that sluggish deposit growth has increased funding pressures at rural banks but not any more than at urban banks of the same size. In short, increased funding pressures appear to be a small-bank problem rather than just a rural problem. This finding is tempered, however, by two important caveats. First, funding pressures could become more severe at rural banks than urban banks if rural investors begin investing as much of their wealth in mutual funds as urban investors do. Second, smallbank funding pressures are likely to have a bigger impact on rural borrowers because small businesses in rural areas are more dependent on small banks for loans than small businesses in urban areas.
The first section of the article focuses on the concern about rising loan-deposit ratios, the second section on the concern about sluggish deposit growth, and the third section on the concern about takeovers of rural banks. The last section summarizes the evidence and briefly discusses the policy implications.
I. THE RISE IN LOAN-DEPOSIT RATIOS AT RURAL BANKS
The first concern about rural funding pressures is that the loan-deposit ratios of rural banks have been rising sharply the last several years. Some analysts argue that a high loan-deposit ratio significantly increases the risk to a bank of suffering a liquidity crisis. Thus, as the loandeposit rises, rural banks may become increasingly reluctant to make additional loans, leaving some local credit needs unsatisfied. Other analysts dispute that the increase in loan-deposit ratios is a sign of severe funding pressures, arguing that the risk of illiquidity is too small to discourage rural banks from making additional loans.
What are the issues?
The concern about the rising loan-deposit ratio of rural banks is based on the idea that rural banks must worry about the risk of illiquidity because their small size makes it difficult for them to borrow on the open market. Most bank loans cannot be liquidated quickly. Thus, if a bank's depositors make unanticipated deposit withdrawals or if its loan customers unexpectedly draw down their lines of credit, the bank will either have to sell some of its security holdings or borrow on the open market. …