Historically, local and national banks have served separate borrower types. Despite deregulation and financial innovations, local banks persistently hold an advantage in using soft, relationship-based information to screen and monitor borrowers. If local banks still matter, they should be able to identify good, local investment opportunities that a national bank might overlook.
Service companies are likely to rely on local banks
Service companies tend to have more soft information, e.g. local demand for a particular service that is essential to their survival. They also tend to have low levels of collateral which limits a bank’s ability to recoup loan losses. Without collateral, borrowers rely on relationship lending from local banks that have an advantage in using soft information to grant loans. Service-oriented companies are typically more soft information-intensive because they often invest more in human capital relative to collateralizable assets.
Local banks and service job growth correlation
At the national level, there is a correlation between local banks and service job growth. Specifically, over the past 35 years, labor markets with more local banks have seen a higher shift into service jobs across the U.S. Over this same period, local banks did not appear to influence job creation in other, collateral-intensive industries, such as construction.
case study
A case study using county-level alcohol legalization sheds a more nuanced light on the relationship between local banks and service job creation. It reveals whether and why local banks were important. When counties legalize alcohol sales, new investment opportunities at restaurants and newly-established bars increase demand for service employees.
In this setting, all counties experienced higher demand for service jobs. However, the actual growth in service jobs may be limited by the financing that companies can get from local or national banks. In other words, if the appropriate sources of finance are not available, companies may not be able to create new service jobs.
Counties with more local finance experience more service job creation. Service job creation is catalyzed by local banks. This relationship is unique to the service industry. Counties with more local banks increase employment growth in the food services and alcohol industry by 13 percentage points more than those with less local banks. On average, this amounts to an additional 29 new jobs per year for two years following alcohol legalization, representing about 10% of average employment in bars and restaurants.
unique relationship
The next question is why local finance is necessary for employment growth in service companies.
Service-oriented companies in this setting are likely small or young with low collateral and high information asymmetry. These characteristics generate soft information and, in part, drive the unique relationship between service companies and local banks. The role of soft information is keenest among newer companies. Young service companies (two to three years old) account for about 50% of service job creation after alcohol legalization.
In contrast, local finance is not associated with employment growth in alternative, collateral-intensive industries. A finding suggests that collateral removes the need for soft information, and therefore, for local banks.
service-oriented U.S. economy
The link between local finance and employment growth comes through the lending channel. Small business loan volumes increase at local, not national, banks. Moreover, the supply of individual loans increases at local, not national, banks.
The introduction of new service jobs spurs industry employment substitution that resembles the labor market substitution in the broader economy. Over the past 35 years, the highest productivity gains and job growth in the U.S. has come from service occupations. Results from the case study reveal why and how local banks have played a pivotal role in the transition to a service-oriented U.S. economy.
Overall, the findings suggest that finance may not be “one-size-fits-all” in the evolving service sector in the U.S. economy. These results are timely due to the rise of service jobs as a primary driver of economic growth and the contemporaneous decline in local banks.
Dr. Elizabeth Berger is an assistant professor at the University of Houston in the Bauer College of Business. Most recently, she was an assistant professor of finance at the Samuel Curtis Johnson Graduate School of Management, Cornell University. Professor Berger currently studies the effects of financial institutions on labor market outcomes, stock price efficiency and company profitability and competition.