Why a Central Banking System Doesn’t Work for Everyone

Green America’s Take Charge Program urges consumers to support smaller, local financial institutions in lieu of megabanks. Here are a few reasons why local banks and credit unions benefit smaller communities across the country. 

Since the early 20th Century, The United States has relied heavily on its centralized banking system. Represented by the Federal Reserve and top-tier financial institutions, (such as Citi and Bank of America), a centralized system is one in which a single entity regulates a state’s currency, money supply, and interest rates. The Federal Reserve has many responsibilities, including regulating and supervising private banks, protecting the credit rights of consumers, and issuing the nation’s currency.

The role of large, wealthy private banks is important in understanding how the central banking system works. The Fed is not controlled by the government, but rather by a group of governing board members who are often employees of private megabanks. Private banks give the board information related to their particular economic situation, and Federal Reserve policy is based on their suggestions. In turn, Federal Reserve policy largely influences to whom, and by how much banks should lend their money.

www.freefoto.com, Ian Britton

The centralization of banking benefits wealth concentration and increases risks

Research suggests that “high-ability entrepreneurs” tend to gravitate towards a central banking system. Essentially, wealthy individuals and institutions enjoy the connectedness that a centralized system offers. Pooling together the resources of powerful entrepreneurs, however, increases the risk of losing all of that money by making poor lending decisions. Large, wealthy banks are able to spend more on screening potential borrowers so that they have the lowest chance of losing a large amount of money. Even so, due to their sheer volume of lending, a megabank’s ability to evaluate the underlying credit-worthiness of their borrowers is compromised at such a large scale. Despite their best efforts, risk is always present.

On the other hand, as a part of a decentralized system, banks face lower screening costs. Community investment banks and credit unions focus primarily on the specific regions they serve. Local banks spend less on the evaluation of potential small-scale borrowers, in part because of the modest needs of their customers and in part because they have less to lose by lending in the first place. As such, local banks can consider factors other than the bottom line, like a project’s potential benefit to or impact on the surrounding community or environment.

The difference in risk management costs leads to what researchers call a spatial bias. Think of New York City, where some of the largest banks in the nation are headquartered. Communities surrounding the central banks benefit from their proximity to the hub. After all, it’s much riskier to lend money to someone across the country than it is to lend to a neighbor. But what about the communities that are nowhere near a banking center? Credit-worthy businesses and consumers in these areas often have a hard time obtaining financing from megabanks, which prevents smaller communities from growing.

The higher risk faced by lending megabanks also steers their preference toward larger borrowers. It is less costly to screen one large entity seeking a loan than many small individual requests for risk. The problem is, large borrowers often need financing for some of the most damaging activities, like dirty energy and sub-prime mortgages (which helped trigger the economic malaise of the past 5 years). In addition to making those involved quite wealthy, these activities can have serious societal consequences – consequences that small, regional, low-impact borrowers would not likely cause.

Local Banks support what Megabanks Don’t

Areas with limited access to capital are best served by community investment banks and credit unions to finance homes and build infrastructure. These communities have relatively little to offer towards the megabanks’ record-breaking profits, and they frequently emerge as losers against investment opportunities considered to be “safe bets” by large banks.

What is particularly troubling about the influence megabanks have on our central system is that there is ample room for abuse – we have seen countless examples of megabank misconduct, and we know that the forces at play can be damaging to both the environment and communities.  For example, many large banks were recently fined billions of dollars for their role in the mortgage fraud that precipitated the Great Recession and are currently being sued by the FDIC for their role in manipulating LIBOR (an international interest rate).

Given this misconduct, we, as everyday consumers of financial services like modest lines of credit and checking/savings accounts, should support community investment banks and credit unions outside of the centralized sphere. Instead of supporting coal mining or questionable mortgage-lending practices, the fees paid for your bank’s services could go directly back into your own world, supporting community development and environmental protection projects. Unless your megabank can offer you something your local financial institution cannot, the decision to Take Charge should be a no-brainer.



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