The financial services industry, particularly banking, was one of the most stagnant industries in the country just over a generation ago. Bank product offerings and locations were legislatively determined. Price competition was so limited that banks sought to attract new customers by giving away toasters, while the financial services and products available to customers were few. Consequently, banks often behaved more like a regulated utility than a competitive business. Meanwhile, small-business owner complaints about bank services, especially credit availability, were pervasive. Over the years, a bi-partisan political coalition deregulated the financial services industry. The goal of deregulation was to stimulate competition and provide better service to all customer segments at better prices. Today, mail boxes full of solicitations from financial services companies are evidence that the banking industry is vastly more competitive than it once was. But did that competition, resulting from a generation of deregulation, benefit small businesses? This issue of the National Small Business Poll, Bank Competition, addresses the question.
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The Competitive Environment
A slight majority of small-business owners (51%) report using more than one financial institution to conduct their firm’s banking business (Q#5b). While 47 percent use one institution exclusively, 32 percent use two, 13 percent three, and 6 percent four or more. The size of a business appears unrelated to the number of financial institutions used by its owner(s).
The term “financial institution” includes more types of financial service providers than commercial banks; credit unions are an example. However, for most small-business owners, “financial institution” means a bank. Ninety-four (94) percent report their primary financial institution is a bank compared to just 6 percent who use a credit union (Q#5c). A handful of owners list other types of institutions (finance companies, cooperatives, investment banks).
Small-business owners have a wide choice of banks. They typically find six to 10 banks (not branches, but banks with different names) operating in the area where they do business. Forty-three (43) percent estimate the number between six and 10, while 37 percent estimate a lower number, and 16 percent a greater number (Q#5). Just 7 percent of owners have just one or two choices. These firms are likely to be found in rural areas.
Small-business owners also report that the number of bank offices in their local market, in contrast to the number of branches, has grown over the last three years. Fifty-eight (58) percent observe increases compared to 30 percent who perceive no change (Q#5a). One in 10 (10%) report a decline. This reported increase likely means that larger banks are moving into new markets (most likely through branching), considering that the number of bank charters has been declining in the United States for the past 15 years.
Mergers and acquisitions within the banking industry are largely responsible for the decline in the total number of bank charters in the country. Since 2002, effectively post 9-11, one in four (26%) small-business owners has experienced a merger or acquisition of their principal bank (Q#6). Most owners have not greeted this change with enthusiasm. For example, 42 percent of those affected say that it caused minor transition problems while another 27 percent say that it affected them negatively (Q#6a). However, bank mergers and acquisitions motivated only 8 percent of those experiencing them (or 2% of the entire population) to change banks. Twenty-three (23) percent think mergers and acquisitions involving their primary bank have either had no effect or had a positive effect on their business.
A plurality of small employers (38%) use the largest banks in the country (assets exceeding $10 billion) as their principal financial institution (Q#7). Of the four bank size categories examined, none had fewer than 16 percent of small-business owners using a bank in the size group as their principal bank. With the consolidation of the banking industry during the past 15 years (especially in terms of share of deposits), small-business owners might be expected to shift their patronage toward larger banks. Still, a substantial share of them, including owners of larger, small enterprises, remains a customer of small financial institutions. Perhaps the availability of technology to small banks has enabled them to provide a wide range of services and to focus on customer service. As a result, smaller banks can effectively serve larger, small businesses.
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Competition for Small Business’ Banking Business
Small employers believe that banks are competing more for their business today than they were just three years ago. While 45 percent notice no change in competition for their banking business, 43 percent report an increase (Q#1). Eighteen (18) percent believe there is much more competition. In contrast, 9 percent indicate that there is less; fewer than 4 percent say much less. The bottom line is that a net 34 percent think that competition for their banking business is on the rise.
Small-businessmen and women cite many reasons for their perspective on bank competition. It starts, but does not end, with banks’ direct marketing efforts. Of the 43 percent who notice greater competition today than three years ago, three in four (74%) report that they have received more mail solicitations and advertising over the period (Q#2D). Owners of the smallest businesses, those with fewer than 10 employees, are most likely to have observed increased mail solicitations. Sixty-five (65) percent say that they recognize more competition exists, at least in part, because they have received more phone calls asking for their banking business (Q#2F). Owners of larger businesses, those with over 20 employees were more likely to receive a phone contact. Fifty-seven (57) percent mention that they have received more in-person solicitations at events or at their firm’s office (Q#2A) with owners of larger, small firms again more likely to report this type of contact. Only 42 percent notice more radio and TV advertising focused on smaller enterprises (Q#2B) with no difference in the frequency by firm size.
These figures understate bank marketing efforts to reach potential small-business customers because they are only drawn from owners noticing more competition for their banking business. Owners who sense no change in competition may also have been positively affected by these marketing activities. Nevertheless, the banking industry’s marketing efforts have attracted small-business owner attention and helped to stimulate a sense of greater competition.
Banks can generate competitive appeal to small employers in ways beyond direct advertising and solicitation. One of the most important is the array of products and services they offer. Sixty-five (65) percent of small-business owners who report greater competition agree that there are more financial products and services targeted to small business today than three years ago (Q#2E). Another way to generate interest among small firms is location: 69 percent mention additional banking locations in their area (Q#2G). Finally, 54 percent find evidence of increased competition in their ability to get interest rate quotes from lenders all over the country, an indicator most frequently reported by owners of the smallest businesses (Q#2C). Overall, small-business owners point to no single reason that supports their reports of more competition for their business, but rather point to a series of bank actions that lead them to the conclusion.
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Shopping for a New Bank
A behavioral indicator of the state of bank competition is small-business owners’ willingness to shop for an alternative provider. If owners are dissatisfied with their current bank or they seek a more attractive package of products and services, a competitive environment encourages them to shop for a meaningful alternative. The results of this Poll show that they do shop and frequently do change banks as a result of shopping.
Twenty-one (21) percent of small-business owners report that within the last three years they or someone on their behalf shopped for a new principal financial institution (Q#3). Owners of the largest small firms were almost twice as likely to shop as owners of the smallest, perhaps because their service requirements are greater. The remaining 78 percent did not shop.
Reasons for shopping could be stimulated either by banks reaching out to attract small-business customers (“pulling”) or by banks offering poor services and pushing them out the door. Differing from the past, it now appears that the primary motivation for shopping is better deals offered elsewhere. Forty-two (42) percent report that their primary reason for shopping was to test the waters and see what was “out there” in terms of service and/or product opportunities (Q#3a). Another 18 percent say they knew that they could get a better situation elsewhere and went to find it. In contrast, 38 percent were not happy with their financial institution at the time, motivating their search.
No single reason spurred small-business owners to look for a new principal bank. Dissatisfaction was tied to a variety of issues with an average of three reasons given. The two most frequent reasons were poor quality of service (62%) (Q#3bF) and being treated like a stranger (57%) (Q#3bE). But there were other reasons as well. Forty (40) percent attributed their dissatisfaction to bank fees getting out of hand (Q#3bI); 37 percent say that the reason for shopping was that they wanted better loan terms or interest rates (Q#3bD); 33 percent needed more or different services (Q#3bC); 32 percent cite turnover in account managers (Q#3bA); the same number mention that their credit needs were not satisfied (Q#3bB). The two reasons least often cited for dissatisfaction with their bank (and hence the motivation to look for a new one) were a merger or acquisition (21%) (Q#3bH) and an inconvenient location (20%) (Q#3bG).
The sample size for this series of questions is small (N = 67). As a result, the two most frequently cited reasons are not statistically different from one another, as are the middle five and the bottom two. It is best to think of the individual reasons in terms of the most common, the least common reasons, and those in the middle.
Seventy-eight (78) percent of small employers did not shop for a new bank in the last three years (Q#3). The primary reason for inaction, cited by 70 percent of those who did not shop, was dissatisfaction with their current bank (Q#3c). That means over half (55%) of all small-business owners did not shop because they were happy where they were. The second most important reason for not shopping was the hassle and inconvenience of changing (18%). These owners apparently believed that any marginal benefit they could obtain by switching would be more than offset by the transaction costs of changing banks. Only 5 percent report that there were no real alternatives with owners of the largest firms reporting this reason twice as often as owners of the smallest firms.
Not all shoppers change banks. Only one-third of those who shopped changed; two-thirds did not. And many who changed banks did so without shopping for a new one. About three of four who changed banks shopped; one in four did not.
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Only one in 10 small-business owners changed their principal financial institution during the last three years (Q#4). Owners of the largest were twice as likely to have changed as were owners of the smallest. Bank changes were spread almost evenly over the last three 12-month periods (22% in 2004, for example) (Q#4a), suggesting no intervening event influenced switches to alternative banks. It also suggests that the number of owners who change is not very large during a relatively stable and healthy economic period. Since the survey was conducted in the early part of the year, 2006 has fewer cases than the years 2005, 2004, or 2003.
The distribution of reasons for making a change likely differs from the reasons for shopping or the reasons for dissatisfaction. For example, not all people who are dissatisfied will switch banks; they might not find anything better. Or, generally well-satisfied people may change because another bank has something even more attractive to offer or because they have been actively solicited.
The two categories of reasons that small-business owners most often cite for switching their principal financial institution are service and credit issues. Sixty-four (64) percent report that a reason for changing was that the new bank had a better quality of service (Q#4bF). A similar reason involves more and different services than offered by the old bank. Of those switching, 47 percent changed to get more and different services (Q#4bC).
Credit needs/terms is also a reason for a high proportion of switches. Half (50%) say that a reason for their change was the expectation that they could more easily satisfy their credit needs at the new institution (Q#4bB). Fifty-three (53) percent also believe that the new institution would provide them better loan terms or interest rates (Q#4bD).
Other issues were less frequently cited as the primary reason for changing principal banks. However, all reasons listed on the survey drew more than marginal interest. Thirty-eight (38) percent note that the new bank charged more reasonable bank fees (Q#4bH). Thirty-six (36) percent say that the new bank had a better location (Q#4bG). Two other reasons - it actively solicited your business and you were treated like a stranger at the old bank – draw positive responses from 35 percent (Q#4bJ) and 34 percent (Q#4bE) of switching owners respectively. As described above, small-business owners were frequently solicited, but relatively few switched and not all of those attribute the change, even in part, to solicitation. That means bankers must call on many owners (probably many times) before enticing one to change their principal bank.
Stability of account managers has been a small-business owner complaint for some time. Yet, it does not appear to have had a major influence on bank switches. Just 28 percent say that a reason for change was that the owners wanted more stability in account managers (Q#4bA). Similarly, considerable merger and acquisition activity has been occurring in the financial services industry. Yet, only 22 percent of those switching mention merger or acquisition as a reason (Q#4bI).
The sample size in this series of questions is also small (N = 70). The results, therefore, have a high margin of error and only can suggest relative frequencies. Still, some classes of reasons are clearly more important than others.
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The evidence presented shows that banks vigorously compete for the business of smaller enterprises. Moreover, small-businessmen and women believe that competition is more vigorous than in the past, despite the dramatic consolidation in the banking industry. New charters as well as branching by larger banks into new markets has increased direct marketing and personal solicitations in the battle for market share of small firm financial business.
About one in five small-business owners shopped for a different principal bank within the last three years. The substantial number who shopped implies that a very large proportion of the population believes enough difference exists among institutions to make shopping worthwhile. Their efforts suggest that they perceive a potentially large return from changing banks, especially considering that change is a time consuming process for time-pressed owners. Yet, small-business owners could be shopping because they are unhappy with their current institution or because someone else offered them a better deal. The reasons owners give for shopping suggest a combination of the two, with more being pulled from their current institution than pushed. Moreover, 25 percent of those switching changed principal banks without shopping - an indication that they were enticed from their old bank by a better offer.
The primary reason that over three-quarters did not shop is that they are satisfied with their bank. For the remainder, only a few (5%) cite a reason that is related to a lack of competition. Overall, the relatively low frequency of shopping on the part of owners should be viewed as a positive, not a negative. The consolidation of the banking industry through merger and acquisition continues and small-business owners typically find such changes disruptive. However, only two percent of the population changed banks in the last three years for that reason. More common reasons for change by the one in 10 changing are tied to loan availability and terms as well as availability of services.
Half of small businesses patronize more than one bank or financial institution. The motives for these divided loyalties are not clear. Perhaps, some owners are just hedging their bets. For others, one institution performs better on one aspect of the relationship and another performs better on a different aspect. But the fact that small-business owners can (and do) play one bank off against another suggests that a highly competitive market of great value to owners of small enterprises currently exists in the American economy.