Buying Local: Better for Banks, Too

Locavores argue that shopping in neighborhood stores boosts the local economy, and buying veggies from the farm just out of town reduces your carbon footprint. Now research suggests local is also better when it comes to banking.

When failing banks in the United States are purchased by far-flung entities without similar services, the purchasing banks often don’t value the assets the way a local buyer would, according to research by João Granja of MIT’s Sloan School of Management and Chicago Booth’s Gregor Matvos and Amit Seru. This means the buyers pay less for the assets, and the government gets stuck picking up the slack.

Selling failed banks is a way to ensure the banking system continues working after negative shocks. The approach keeps a failed bank in place, potentially preserving the value of its assets and the relationships between bank employees and clients, which may not be easily or quickly replaced.

But when there is no local buyer financially capable of stepping in to make the purchase, the Federal Deposit Insurance Corporation (FDIC)—the US-government entity that protects depositors’ bank accounts—is forced to seek out distant buyers. In the Great Recession, local or regional entities bought many of the failed banks in the US—only 15 percent of acquirers did not have branches within the state, the research finds. However, some of those local institutions were distressed as well, and the acquired bank was eventually swallowed up by the highest well-capitalized bidder, regardless of geography.

The FDIC often sells these distressed banks at auction, at fire-sale prices. The Great Recession and its aftermath saw an unprecedented number of banks being taken into receivership by the FDIC and then sold at auction. The average bank that failed between 2007 and 2013 was sold at roughly 28 percent of what its assets were worth. In the end, the FDIC lost $90 billion in these sales.

Technology has made it possible for distant buyers to take over these failing banks relatively easily. And the prevailing view in the industry is that borrowers do so much business online now that they place less importance than they used to on relationships formed with bank managers and bank officers.

But the research suggests that the FDIC and acquirers are undervaluing purchases, in large part because they underestimate the continued importance of the borrower-banker relationship. “Those relationships are not so easily replaced,” says Seru. “While all these technological advances make it easy to liquidate a bank’s assets in an efficient manner to banks located anywhere, it may not be the best way to sell a failed bank, for either the bank’s assets or for the FDIC.”