Research on whether community banks still play a major role in small business lending is debated in recent studies. The lending and the deposit taking of community banks is declining, according to recent studies. This study, which uses FDIC Statistics on Depository Institutions (SDI) data for the period of 2019 to 2020, re-examines the role community banks play in providing funding to small businesses by using the FDIC's definition of a community bank. During the COVID crisis, our empirical findings show that community banks disbursed and lent more money through the Payment Protection Program than non-community banks. Community banks continue to provide valuable services to small firms across the country and, therefore, they are significant from a public policy point of view. This study helps to expand the understanding of community banks' overall performance and also during times of crisis.

Community banks, Payment Protection Program, Relationships lending, Small business

Banks play a major role in the distribution of funding to small firms. In particular,small banks are constructed to provide local support to small businesses since larger bankshave a history of not supporting small firms due to less profit making (Lux & Greene,2015). Community banks are examples of smaller banks with a business model generallybased on taking deposits from the community in which the bank is located and lendingthose funds to support the bank’s local economy (Hanauer et al., 2021). (Hanauer et al.,2021) explains that in spite of the lack of universal definitions, community banks are oftendescribed by two key characteristics: their small size and their commitment to serving theirlocal communities. Despite the benefits of community banks to the survivability of smallfirms, particularly those with non-White owners, limited assets, and education in the smallbusiness financing and the enact of various policies to support small business financing,community banks are in a decline (Carlson, 2021). In this paper, we examine community banking, the changes in the marketplace that have put more pressure on communitybanking, and community banks effectiveness with distribution small business financing, particularly during times of economic shock.

Researchers have examined the role of the decline of community banks. Researchexists showing a downtrend in the number of deposits taking in community banks. Another contribution to the decline expressed in the research is the explosion of non-traditional alternative lenders like fintechs (Carlson, 2021; Lux & Greene, 2015). The advancement of cheaper and optimized computing, the boom of Big Data, and the performance of sophisticated algorithms have benefited fintechs and contributed to this decline. All have allowed alternative lenders to provide financing using hard information (Hanauer et al.,2021). Also, the convenience that traditional bigger banks and alternative financiers provide with modern technology features which small businesses like due to convenience and speed. Research explains that community banking is still critical to sustain the health of small businesses since they have traditionally used established longer-term relationships with customers to obtain information not readily available through more standardized means. This has provided community banks with an advantage in lending to small or newly formed businesses that may lack extensive credit history. This difference incommunity banking importance raises the question on whether or not community banks are still relevant to small businesses, particularly during times of distress. The aim of thisresearch is to analyze if community banks played a significant role in the distribution ofPayment Protection Program (PPP) funds.

A community bank is typically a relationship bank with assets of less than $10billion. Relationship banks’ primary advantage is their understanding of local economicsand knowledge and understanding of their customers and a willingness to accommodate their customers. In contrast to bigger banks, community banks typically have fewertechnologies, returns, and earning streams. They are more vulnerable to economic downturns.

As opposed to loan officers at larger banks, who make lending decisions based oncredit scores and statistical models, loan officers at community banks examine factors suchas the borrower’s credit history, the bank’s relationship with the borrower, and the localeconomy. Furthermore, since community banks are more connected to the local economy,they can oversee the loan in a way that larger institutions cannot. Since most community banks offer personalized lending decisions, they are called "relationship banks," as opposed to the larger financial institutions they compete with as "transaction banks." Community banks thus provide small businesses, locals, and farmers with capital because they provide personalized service and loans that credit-centered larger financial institutions cannot. Among the main reasons for this flexibility is that community banks are closely held, which connects them to local markets, economies, and communities, while larger institutions have more ties to capital markets.

Due to their focus on local control and decentralization, community banks haved played a crucial role in America’s financial system. Locally owned, these small banks specialize in providing financial services to small local businesses that are often overlooked by other financial institutions. A change in policy allowing for bank consolidation hasdecreased community bank visibility (Hanauer et al., 2021). The 2008 financial crisis hasalso affected community banks.

Community banks profitability have been in decline. (G. & C., 2020) investigated the profitability of community banks relative to that of large banks. These researchers found the average return on equity for community banks as a whole was 7.10 percent over the period 2001-2017. (M. et al., 2021) explains over the past several decades, the numberof community banks in the United States has steadily declined. At the same time,community banks’ share of U.S. banking assets has fallen considerably as the country’s largest banks have increased their dominance, aided by wide geographic coverage andeconomies of scale. As (Lux & Greene, 2015) explains, community banks were able to weather the 2008-2009 financial crisis but had losses amounting to 6 percent of U.S. banking assets. In addition, the passage of the Dodd-Frank Wall Street Reform andConsumer Protection Act has led to a shrinking in community banks assets over 12 percent.

Community banks play a vital role in the US economy, contributing 50 percent ofall loans to the small business sector, which comprises 99.9% of all US firms and nearly halfof private-sector employment (Bowman, 2019). Due to advances in technology, changes inbanking regulations, and increased competition, the number of community banks and thenumber of bank branches, deposits, and assets held by community banks in the USA haveall declined substantially over the past three decades (Perkins, 2021). Over the past three decades, the number of community banks with less than $1 billion in assets has decreasedby almost two-thirds - from 17,514 in 1986 to 4704 in 2018 (Perkins, 2021).

The poor performance of community banks has not only raised major concernsamong policy-makers about the long-run viability of community banks (Bowman, 2019;Perkins, 2021), but also stimulated an increasing amount of research attempting to identify reasons behind the weak performance of community banks. For example, (Emmons &Yeager, 2004) examined the effects of local economic shocks on the performance ofcommunity banks. (DeYoung, 2007) investigated the weak performance of communitybanks from the viewpoint of Internet adoption.

Congress authorized the Payment Protection Program (PPP) as part of the CARESAct (Fairlie, 2020b). To assist small businesses and their employees to deal with theadverse financial effects of the COVID19 pandemic, PPP was enacted. The Small BusinessAdministration (SBA) administered PPP by providing forgivable loans to firms that metcertain criteria. More than 5,000 lending institutions participated in PPPs two draws. PPPbegan on April 3rd, 2020 and ended later in the same year. Due to the ongoing effects ofthe COVID-19 pandemic, the Paycheck Protection Program was reopened on January 11,2021. Over 5.2 million loans were disbursed totaling over $950 billion dollars in funding.

CARES Act, Section 102, explicitly stated that PPP should prioritize “smallbusiness concerns owned and controlled by socially and economically disadvantaged individuals.” Unfortunately, due to the lack of specificity on how private financialinstitutions should administer the loans, numerous media reports expressed ofminority-owned businesses facing challenges securing the loans (Beer, 2020; Zhou, 2020).There was not the same level of media attention given to the struggles ofnon-minority-owned businesses with securing the loans.

COVID-19 media attention and recent academic studies on the subject (Jung et al.,2021) has illuminated existing economic inequalities for minority firms. (Costa, 2020)explains that PPP has not benefited Black firms. (ColorofChange, 2020; Fairlie, 2020a) report that Black owners faced a disproportionate share of COVID-19 failures. Forinstance from February to April of 2020, there was a 41% decline in Black-ownedbusinesses (Dua et al., 2020). White entrepreneurs experienced only a 17% decline. Amongthose Black firms that applied for PPP support, only 12% received the assistance they hadrequested. Forty-one percent received none. According to (O’Connell et al., 2020), data shows more than half of the $522 billion PPP money went to bigger businesses, and only 28percent of the PPP money was distributed in amounts less than $150,000 to small businesses. (Fairlie, 2020a) examined the first three months of the pandemic anddetermined that economic losses were experienced in May and June 2020, and partialrebounds from April 2020 were felt across all demographic groups and most industries. Thenegative economic implications of firm closures, particularly minority-owned, during thepandemic can not be overlooked. Minority-owned entrepreneurship is the economic engineof the communities, typically low to moderate income, that these firms operate in.

Research does exist that evaluates PPP lending to small businesses. (Richardson et al., 2020) provided a statistical analysis on the distribution of PPP loan volume acrossneighborhoods differentiated by percent minority population. They analysis shows thatmore PPP loans were distributed to neighborhoods of color and that the major lendinginstitutions helped ensure this flow into these minority communities. (Howell et al., 2021)research analysis differs as they show small- and medium-sized banks are consistently leastlikely to lend to Black-owned businesses, with large banks close behind. (Wang & Zhang,2021) showed that there was a large disparity in both the presence and density of PPPenrolled lenders by racial composition of the neighborhood. They explained that moreheavily Black neighborhoods have significantly lower take-up of PPP loans, particularly inlower population (more rural) areas where this disparity is most salient.

Only a handful of studies assessed community banking performance during times ofeconomic crisis such as the Great Financial Crisis and COVID-19 pandemic. (Nguyen &Barth, 2020) found evidence indicating community banks provide more, in terms of bothnumber and dollar amount, small business loans, particularly in non-metropolitan areas.Importantly, the researchers found that community banks provided significantly more small business funding in areas where such firms typically experience difficulty in obtaining funding from non-community banks. However, the burst of the housing bubble in2007-2008 significantly crippled banks across the nation as banks at all levels were left withmany nonperforming loans (Cole & Damm, 2020). (Howell et al., 2021) explored how PPP lenders differed in the share of their loans that went to minority-owned and especially toBlack-owned businesses. They found that fintech lenders appear to have played an important role in extending PPP loans to Black- and Hispanic-owned businesses. Their study did not have community banks defined.((Hassan & Karim, 2021) examined the immediate impacts of COVID-19 on FDIC chartered banks’ performance. They concluded that relationship banking is paying off for community banks versus non-community banks.(Gunther & Klemme, 2012) found that during the 2007-2008, midst of the Great Financial Crisis, that the benefits of the community banking model allowed community banks to lend high-quality loans and have significantly lower failure rates than large banks.

It is not clear whether community banks that rely on relationship banking outperform non-community banks. As a result, the question of whether community banksplay a larger role in small business funding than non-community banks remains unanswered in the literature, especially due to the consolidation that has been occurring inthe industry. In this paper, we examine whether community banks provide more funding to small businesses than non-community banks at the county level across the nation. In only a few studies, small business loans made to community firms were compared with thosemade to non-community firms (Cole & Damm, 2020).

In this paper, the examination relies heavily on the FDIC Statistics on DepositoryInstitutions (SDI) datasets. As a result of these datasets, we can examine the number andamount of PPP loans made to small businesses by community and non-community banks,which was not available over previous studies. By doing so, it is possible to compare before and during the COVID crisis the role of community banks in small business lending.

Taking this into account, little is known about the role that community banksplayed in making PPP loans available to the public. The purpose of this study is todetermine whether community banking is relevant to local businesses in times of economic shock, especially with the decline of community banks.

Pooled ordinary least squares (OLS) regression models were used to test hypotheses,with the error terms clustered by year. Two dependent variables,PPPLOANSOUTSTANDING and PPPLOANSBALANCE, were used in all the regressionsfor hypotheses testing. One of the independent variables is a dummy variable for whether abank is a community or non-community bank.The hypotheses and the relevant model to test the hypothesis is as follows.

Hypothesis 1 (H1): Community banks provide a greater number and amount of Payment Protection Program loans than do non-community banks.

To test this hypothesis, the following model was estimated

CB which is a dummy variable, measures whether the bank is a community bank or not, and is equal to 1 if it is. If H1 holds, B1 should be positive. We then split the sampleinto two subperiods: the year 2019 prior to the outbreak of COVID and the disbursementof PPP by banks, and the year 2020 during the epidemic and disbursement of the PPP bybanks.

To test whether a community bank provides more small business funding in eachcounty, equation (1) is re-estimated for these subperiods. B1 is not expected to besignificantly different from zero before the outbreak of COVID and the disbursement of PPP by banks, but will be significantly positive afterward, as previously discussed.

For the above model, the bank control variables (BankingControlsb,t) were included.For bank control variables, the natural logarithm of one plus total assets of the bank(Assets), equity capital to total assets (Equity), noncurrent loans and leases to total assets(NonCurrentLoans), return on assets (ROA), and cash balance to total assets (Liquid)were included. To control whether the bank is new, a dummy variable with one value if itis less than five years old, and zero otherwise, was created. Likewise, the ratio of commercial and industrial loans to total assets (Business loans) was controlled for.

Annual bank financial data used in this study were from the FDIC Statistics onDepository Institutions (SDI) and cover the period 2019 to 2020.

The final sample included 41,389 observations, with 37,818 community banks and 3571 noncommunity banks. A summary of the data is shown in Table 1, which comparesthe variables at a bank-year level for non-community banks compared to community banksfrom 2019-2020. In general, there were statistically significant differences in means betweennoncommunity banks and community banks. In particular, noncommunity banks, onaverage, had more assets (Assets), a higher equity to total assets ratio (Equity), a highernoncurrent loans and leases to total assets ratio (NonCurrentLoans), a higher profitability(ROA), a higher ratio of commercial and industrial loans to total assets (Business loans),and a higher cash balance to total assets ratio (Liquid).

Figure 1, in the Appendix Section, depicts the difference in assets, liabilities,deposits, and equity between community banks and noncommunity banks during theperiod of 2019 to 2020.

Table 2 presents the results for Hypothesis 1 for the period 2019 to 2020. Thedependent variables are the natural logarithm of one plus number of Payment ProtectionProgram loans originated by a bank in Columns (1) to (3) and the natural logarithm of oneplus dollar amount of Payment Protection Program loans originated by a bank in Columns(4) to (6). The results of the OLS regressions are shown in columns (1) and (4). The fixedentity effect regressions are shown in columns (2) and (5). The time effects of regressionsare shown in columns (3) and (6). All regressions include bank control variables and areclustered at the year level. Columns (1) to (6) show results in that community banks, onaverage, provided significantly more and a larger dollar amount of Payment Protection Program loans than non- community banks. This is represented by the CB variable. Theseresults indicate that community banks provide more small business loans thannon-community banks based on the number of PPP loans and the dollar amount during the crisis.

Based on the study, we can conclude that during the period 2019-2020, community banks provided small businesses with more PPP loans than noncommunity banks.According to the evidence, community banks provide more small business loans, both interms of volume and dollar amount.

Furthermore, this study shows that community banks are still using relationshiplending to fund small businesses when they have a presence in the communities where thesmall businesses are located. In terms of public policy, the results indicate that communitybanks remain important because they provide valuable support to small businesses in theUnited States.

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