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Over the last several decades, consolidation in the banking industry has created larger banks, according to new research by ������˾��Cox Finance Professor Erik Mayer, leading to some negative effects for low-income households. Mayer’s work provides the first evidence of a link between the structure of the banking industry and intergenerational economic mobility. “Once I saw the pattern in the data that low-income households were impacted by the structure of local banks, it naturally led to the question of inequality,” he says.

Mayer points out that for the typical American household, the median size of banks within 10 miles of where they live is over 7 times larger in 2015 than it was in 1995. His research shows that big banks’ increased market share has resulted in reduced access to credit and less upward economic mobility for low-income households.

Softer side of banking

“A difference between small and large banks is that small banks may be more equipped to use soft information,” Mayer says. The idea is that you grant a loan officer the discretion to use “soft information,” like their assessment of an individual’s character, in the lending process. Of course, both small and large banks use hard information like credit scoring tools, but loan officers in small banks typically have more discretion.

Small banks are not making bad loans to lower-income borrowers, the research shows. Instead, they are able to originate more loans to low-income borrowers because of their greater use of soft information — loans a larger bank may not be able to make by relying on credit scores alone.

Mayer’s research shows that soft information is more important when lending to a person with a lower income or credit score. Often, these borrowers have less developed credit histories, reducing the quality and depth of the hard information available to lenders. This creates a potentially important role for soft information and the lenders who use it. According to Mayer, “If soft information is valuable when lending to lower-income households, and small banks have an advantage, then small banks can be important providers of credit for low-income households.” Indeed, the research finds that borrowers of low-economic status—for example, low income, subprime credit score, and/or limited credit history— experience lower credit approval rates when local banks are large. In contrast, the size of banks has little or no effect on borrowers of high-economic status.

Access matters

Access to credit is important for lower-income households. Being able to access an auto loan, a short-term installment loan, or a home equity line of credit can assist low-to-moderate income families in smoothing their consumption over time. This helps with making the needed investments in their children’s human capital. Parents’ financial investments can take many forms such as in educational supplies, participation in extra-curricular activities, college prep tutoring, and private school tuition, to name a few

The idea is pretty simple, Mayer says: “Better access to credit for lower-income households should benefit the children raised in those households and lead to better outcomes later in life.” More equal outcomes for children from low-income families, i.e. upward intergenerational mobility, is a prominent measure of “equality of opportunity.” Mayer’s research is the first to highlight the role of financial institutions like banks in intergenerational mobility.

A lack of quality data has hindered prior efforts to study intergenerational mobility, Mayer notes. “We didn’t have any granular data on intergenerational mobility until some recent groundbreaking research by Raj Chetty and his co-authors, who used IRS data under careful restrictions,” he offers. The research utilizes the newly-available measures of mobility, which are available at the county level for the U.S. The primary measure of upward mobility Mayer uses is the probability that a child from a low-income family (parents in the bottom 40% of the income distribution) moves out of the bottom 40% of the income distribution as an adult. On average, this happens 51% of the time. For context, he offers, “In a world of perfect equality of opportunity, this number could approach 60%."

A key finding, Mayer’s research indicates that as large banks significantly increase their market share in an area (by a standard deviation), upward mobility levels fall by nearly 5 percentage points. Compared to the average of 51%, this represents a 10% decline in mobility levels.

Connecting the dots

Mayer’s research shows that small banks are important providers of credit for lower-income households, and that by alleviating these households’ credit constraints, small banks promote intergenerational economic mobility. This novel link between local financial institutions and mobility is particularly relevant in light of the continued consolidation in banking.

As Mayer points out, there are differing schools of thought on topics like income inequality and wealth inequality. However, promoting equality of opportunity—that an individual’s success depends primarily on their abilities and work ethic rather than family circumstance—is likely to garner broad support. He notes that equality of opportunity receives less attention than income or wealth inequality. “In the modern era, what we really want to offer first and foremost is equality of opportunity,” Mayer surmises. “Most people can get on board with that regardless of their political ideology.”

The paper, “Big Banks, Household Credit Access, and Economic Mobility,” is authored by Erik Mayer of the Cox School of Business, ������˾��.

Written by Jennifer Warren.