Is there an advantage to banks in diversifying loan portfolios by geography? As we learned during the last downturn, geography can have a significant negative impact on banks.
As community banks, we aim to fulfill our namesake by being a part of, and representing, our communities. Sometimes, however, it is difficult to see that there may be a gap between our banks and the communities that we serve. The NFL had a similar issue before 2003 when they realized the disparity of the demographic between their players and head coaches. There were only two African-American head coaches at the time, out of the NFL’s 32 teams. “The Rooney Rule” changed that.
If you are a large bank, the share of commercial real estate (CRE) as a percentage of your balance sheet is likely slightly less than 5%. However, if you are a community bank, the share is likely over 20%, and growing. Even when viewed as a percentage of Tier-1 capital, larger banks hold about four times for commercial real estate exposure. That is a pretty big difference and CEOs (plus risk managers) should at least be asking the question as to why.
There is a classic debate in banking of whether it is better to diversify your loan portfolio or to “stick to what you know.” The logic of the stick-to-what-you-know camp is that since you understand X (insert your specialty – real estate, doctors, residential, etc.) your return will offset any gains in diversification.