It can be argued that the ongoing financialization of local economies challenges the need for physical presence of credit intermediators, local bank branches in particular. The recent COVID-19 pandemic has only sped up the process of ‘bank de-branching’ of economies. Hypothetically, reduction in local bank networks, if compensated by new online distributional channels, should have a neutral impact on local business activities as well as overall regional economic performance. However, the recent evidence from major economies has so far painted a more nuanced picture.
Global Trends in Bank Branch Network Re-design
A recent publication illustrated that bank branch closings in the United States are still associated with a substantive adverse effect on lending activity to small-and-medium enterprises (SMEs). In Sweden, new firm formation in a region was negatively affected in case of bank branch closing as it usually increases the distance to the nearest operating bank branch. In Italy, while expansion of local banks may have indeed increased credit availability, thus boosting local economy, it also generated adverse effects when associated with decrease in bank cost efficiency. On the other side of a spectrum, firms in London, the global hub of financial services, faced a higher probability of being credit-constrained if they were located nearer to a brick-and-mortar bank branch.
Geographical proximity tends to play an irreplaceable role. Not only is spatial distribution of branch closures crucial to understanding financial inclusion, the greater operational distance between bank branches and credit providers increases credit constraints faced by local SMEs.
Slovak bank system has experienced a significant reduction in number of bank branches over the last six years. At the end of 2021, Slovakia has seen a total closure of 25% of all bank branches compared to the peak year 2016. Concentration of remaining bank branches can be traced to major regional hubs, often at the expenses of more distant and less economically active regions. What could the potential long-term impact of this profound structural change be? This blog aims to provide some tentative preliminary evidence discussing the effects of this transformative change. It draws on research, funded by the Regional Studies Association ‘Membership Research Grant Scheme’, which has investigated changes in labour productivity of small and medium enterprises in Slovakia in a response to the ongoing bank branch network redesign.
Bank Branch Closings as a Treatment
As part of our research we were able to collect historical data from all the major bank brands actively operating in Slovakia with regards to their bank branch localization decisions. After geo-coding all bank branches we then linked this database to a list of quantitative information gathered from unique micro-level accounting data for all SMEs in Slovakia.
The decision of bank managers to close a selected bank branch is usually driven by considerations related to its perceived economic potential of a region. The bank branch closure is then imposed as a treatment on a firm located in close vicinity, with its effect to be dealt with over a medium to longer term. It can be hypothesised that while more creditworthy firms are able to move to a new credit loan provider at a much quicker speed and at lower costs, firms already marginally credit-constrained are to suffer to a higher extent in presence of such an adverse shock. Thanks to the information about the quasi credit scoring calculated externally for all firms in our sample, we aimed to analyse whether the treatment in form of bank branch closing will have the highest impact among the less creditworthy SMEs.
Bank Branch Closings as an Incentive
Findings from the several empirical models estimated as part of the project deliver several intriguing information. Over one third of small and medium enterprises included in our database experienced bank branch closing within radius of 5 km around their headquarters. By expanding the radius to 20 kilometres, which roughly coincides with urban areas of most of the cities in Slovakia, over 4/5 of firms were exposed to such a negative treatment.
As expected, firm’s labour productivity, measured by total value of sales per employee, has responded negatively to bank branch closing, with less creditworthy firms being affected to a higher extent than highly ranked SMEs. On the contrary, labour productivity based on value-added concept reports a positive growth three to four years after a firm has been exposed to a bank branch closing. This, seemingly counter-intuitive outcome, deserves particular attention.
While a negative effect on sales may simply reflect temporary loss of access to short-term operations financing, any changes in firm’s value added production require a more profound adjustment to firm’s production processes often possible only through long-term bank funding. Closing of a bank branch should therefore motivate firms to search for a new source of credit among remaining competitors. In an attempt to prove creditworthy to a new bank, a firm may even need to figure out new, possibly unexpected, growth opportunities. Additionally, the dissolution of an established client-bank relationship (i.e. disruption of the lock-in effect) may sometimes be associated with better credit conditions.
Redesigned concentration tendencies in bank networks along with closings of smaller bank branches have been observed across Europe as well as in the United States. Slovak banking environments have not been an exception to this trend. Data from this project indicates that a significant portion of small and medium enterprises in our sample have experienced impacts from bank branch closings in their wider vicinity.
This experience has impacted predominantly firms with lower creditworthiness and resulted in medium-term decrease in labour productivity, when measured by total reported sales. However, a positive increase in value added following an adverse shock among these firms may point out to one possible benefit; a new incentive to rethink their longer-term growth potential.
Maria Siranova is Senior Researcher and Head of the Macro-Financial Analysis at the Institute of Economic Research, Slovak Academy of Sciences. Her research focuses on international finance, banking and regional development issues. She is currently focusing of research in area of bank and capital networks redesign, from both, macro and microeconomic perspective.
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