Some Banks Are Too Small to Succeed

At a time when there’s much focus on what divides us, it’s easy to forget that most people agree on some things. Chief among these is our hope for a strong economy that produces opportunity. And while those on the left and right have different ideas about how to get there, virtually everyone agrees that a vibrant pipeline of new businesses creating new jobs and innovation is at the core of it.

But what’s at the core of new business creation? Entrepreneurs. You know, those stubborn dreamers who can’t help but imagine how the world should be and then try to build businesses that move in that direction. Yet even though entrepreneurs can be found throughout the U.S., the capital they need for new businesses has become increasingly concentrated in a few large geographic markets. A 2017 study by the Economic Innovation Group found that the “extreme concentration of these vital sources of capital into a few hubs means much of the country’s entrepreneurial potential remains latent in underserved and overlooked regional ecosystems.”

Historically, community banks—those with less than $10 billion in assets—have been the primary source of lending to new businesses in rural communities. In bankrolling rural entrepreneurs, community banks possessed a key advantage: They knew the character of their borrowers. This personal relationship permitted budding entrepreneurs in areas largely outside the venture-capital ecosystem to gain access to the capital they needed to open a beauty salon, a restaurant or a plumbing business.

Unfortunately, the crush of regulations that followed the 2008 financial crisis has required community banks to pull back from character-based loans. A 2015 Harvard working paper found that since 2010, when regulations increased on these institutions, community-bank lending to small businesses has rapidly declined. Rather than hire loan officers, community banks have been forced to hire compliance officers charged with applying regulatory rules, originally developed for money-center banks, to small institutions. As one small lender told The Wall Street Journal, “When they created ‘too big to fail,’ they also created ‘too small to succeed.’ ”

The reduction in character-based lending by community banks doesn’t just mean fewer Waffle House franchises and beauty salons employing people in small-town America. Because of the internet, business location is less important than ever. In other words, an entrepreneur in rural Georgia who might have previously opened a new retail store, today might start the next Amazon.com . But she could only start that disruptive business with access to capital.

Solving this problem will require a combination of approaches, including legislative initiatives like the Investing in Opportunity Act’s plan to promote investment in distressed communities through tax incentives. But cleaning up the regulatory mess is an obvious place to start. Community banks should be governed by different regulations, enforced by different regulators, than those at money-center financial institutions, ones who understand the unique risks small institutions face.

With less regulation, community banks could devote a portion of their capital to small-business lending that generates jobs, innovation and growth. There’s an entire group of potential entrepreneurs whose ideas have yet to be unlocked. Who knows how far-reaching their innovation might be, if given the chance?

Mr. Ricketts is the founder of TD Ameritrade and now pursues various entrepreneurial and philanthropic projects, including Entrepreneurs Create Jobs.

(Read the full Op-ed by Joe Ricketts in THE WALL STREET JOURNAL)