Why Small Community Banks and Credit Unions Have Been Immune to the Credit Crisis

In the last 6 months, the US economy has seen perhaps the largest shake-up since the great depression. The real estate market severely receded after hitting new all time highs, unemployment is now over seven percent, the financials industry has seen a number of emergency mergers and acquisitions, it’s much more difficult to get certain types of loans, and government debt is piling high as the eye can see.

We’ve seen a number of banks either fail or nearly fail and be saved by the last minute by a fed-engineered buyout by another bank. The first to go was Indymac back in September. Other banks such as Wachovia and AIG soon followed suit. There are still a number of banks, such as Citigroup, that are still teetering on the edge, despite large cash injections from the federal government.

What is it that all of the banks that have failed or have come close to failure have in common? They were lending people that simply couldn’t afford to repay their loans. There was simply a massive amount of available credit, so instead of letting that investment money sit idly by, they relaxed lending standards so that more people could get loans, even if there was no reasonable expectation that they could afford them.

These banks started offering sub-prime mortgages to consumers with histories of bankruptcy, large amounts of outstanding debt, relatively little income and generally bad credit. The banks justified these loans using advanced calculations which took into the factor that some of the customers would fail to repay, but on balance the investments were still sound. Unfortunately, the banks severely underestimated the percentage of people that would fail to repay their loans and the value that these banks had in those mortgages fell dramatically.

However, there were a group of banks, mostly small community banks and credit unions, that were largely unaffected by the major problems faced by the financials-industry. These banks and credit unions were much more careful about who they lended money to, taking a much closer look at the person and their ability to repay before offering them a loan.  They offered fewer sub-prime mortgage options to customers, so they have had much fewer of the ‘toxic’ assets on their balance sheets which might otherwise cause a bank to go insolvent.

Ultimately we can learn that the answer to the nation’s major bank problems is not injections of capital or new regulation, but rather a new commitment to only loan money to people that can actually afford to repay the loan. It’s time to move away from only looking at a number to determine someone’s credit-worthiness and look at the person as a whole.