There are now two Americas: a growing, dynamic and prosperous urban America (including suburbs) that votes almost exclusively Democratic, and a shrinking, poor, rural America that votes Republican. This divide carries significant consequences, from increased polarization to the opioid epidemic, and defies traditional economic logic. Unless something is done soon to turn around the economic fortunes of rural America, the political and cultural cleavage between rural and urban areas will become complete, and Americans will consider their fellow citizens in other parts of the country as foreign as, well, foreigners.
As rural America’s economic fortunes declined, so too did the number of banks willing to serve them. In December 2017, The Wall Street Journal reported that of America’s 1,980 rural counties, 625 don’t have a locally owned community bank (twice as many as 1994), and that at least 35 counties have no bank at all, with about 115 served by just one branch.
Postal banking and tax-advantaged “opportunity zones” are two recent policy proposals designed to increase the flow of capital to poor rural and urban communities. While these proposals are well-intentioned, they suffer from several design flaws and do not target the unique needs of rural America. Thankfully, solving the rural-banking problem may be as simple as expanding the authority of an existing network of credit institutions that Congress established over 100 years ago to serve the financing needs of America’s agricultural producers.
Few outside of banking have heard of the Farm Credit System, but FCS institutions have been serving the credit needs of farmers, ranchers and other agribusinesses since passage of the Federal Farm Loan Act in 1916. The FCS was originally set up as a system of 12 borrower-owned district banks across the country that would provide long-term funds to local Federal Land Bank Associations, which in turn would provide mortgage loans to agricultural producers. While the FCS has changed significantly over the last 100 years, the original mission, and basic structure, remains in place. Today, the FCS consists of four banks that provide funding to 69 associations scattered throughout the country. These associations make loans to farmers, ranchers and other eligible borrowers who are also owners of their local association through a required purchase of stock that is tied to the size of their loans.
If you drive through any rural area, chances are you won’t have to go very far before you run across a Farm Credit association. In my state of North Carolina, for instance, Farm Credit Carolina maintains 32 branches that serve 54 counties throughout the state. Much like the community banks of yesteryear, these branches are mainstays of the local community, with branch employees often living in the same small towns as the borrowers they serve.
Rather than reinvent the wheel, it makes sense to tap into the existing FCS infrastructure to serve the broader banking needs of rural America. Therefore, I propose that Congress amend the Farm Credit Act to allow FCS institutions to provide a greater variety of financial products to a broader base of customers. Specifically, associations should be allowed to offer checking and savings accounts, as well as secured and unsecured loans, to individuals and all businesses (not just agricultural) located in the rural communities they already operate in (I call this idea “FCS banking”).
The main advantage FCS banking has over postal banking is that FCS institutions already have a long and successful history of performing banking’s most fundamental task — measuring and managing credit risk. In addition, because the FCS enjoys status as a government-sponsored enterprise and the associated funding advantages, associations should be able to issue loans at interest rates below what a commercial bank would offer. Congress may also want to consider granting existing rural community banks the option of joining the FCS, which would provide these institutions with an additional, low-cost, source of funding.
FCS banking has the added benefit of coming with a built-in regulatory structure that can easily adjust to oversee the expansion in FCS activity: the Farm Credit Administration. Similar to the mandate of federal banking agencies, the FCA ensures that FCS institutions operate in a safe and sound manner and has supervisory and enforcement authorities over these institutions. The FCA does not receive federal appropriations; instead, it funds its operations through assessments on regulated institutions and through interest earned on investments with the U.S. Treasury.
An expansion in the FCS’s product offerings and customer base would necessitate an expansion in the FCA’s supervisory responsibilities. New staff would be hired and existing staff would need training on how to supervise the risks associated with deposit-taking and nonagricultural loans. These costs would be covered by additional assessments on regulated institutions.
If associations are to attract deposits, these deposits must be insured, similar to how commercial bank deposits are insured by the Federal Deposit Insurance Corp. Thankfully, the Farm Credit System Insurance Corp. already serves as the government insurer for FCS debt obligations. FCSIC administers the Farm Credit Insurance Fund and collects annual insurance premiums from FCS banks. Under FCS banking, the FCSIC would also serve as the insurer of deposits held at associations (subject to threshold limits). FCSIC’s deposit insurance fund would be funded through annual premiums on deposit taking associations.
Expanding the FCS’s lending authority and granting associations deposit-taking authority would be a significant change for a system that is not exactly known for its willingness to innovate. Associations would have to renovate branches and upgrade IT systems, current staff would require additional training and new staff would need to be hired. All of this comes with increased costs, but the FCS would recoup these costs in short order as they reap the benefits of the low-cost funding that insured deposits provide. Additional regulatory accommodations — and perhaps statutory changes — would need to be made to grant deposit-taking associations access to the Federal Reserve’s Automated Clearing House system so that association depositors would be free to make and receive payments from their accounts.
Beyond the technical challenges, politics is the biggest hurdle to implementing FCS banking. The FCS has long been a thorn in the side of commercial banks. The source of this displeasure lies in the FCS’s tax status. Income earned from real estate lending is exempt by law from all corporate income taxes and FCS profits on non-real-estate lending are exempt from state and local taxes. In addition, bonds, debentures and other obligations issued by the FCS banks are exempt from all taxes other than federal income tax, thereby making them attractive investments and providing the FCS with a lower cost of funding.
Commercial banks also complain that the FCS has strayed too far from its original mission of lending to small farmers, and in so doing they’ve encroached on the banks’ territory. As an example, they cite one FCS bank’s (CoBank) $725 million loan to Verizon Wireless to complete its purchase of the European cellular company Vodafone in 2013. This loan prompted the Independent Community Bankers of America to write a letter to the FCA to ask why a multinational telecommunications company qualified for “tax-advantaged financing from a government-sponsored enterprise that provides credit and other services to agricultural producers and farmer-owned cooperatives.” CoBank defended the loan by noting that they have the authority to support companies that seek to provide modern communication services to rural communities.
Banks complain that the FCS lends to nonagricultural businesses — in violation of its original mission — but it is exactly this type of lending that is needed to jump-start rural communities. To assuage the banks’ concerns, FCS banks would be restricted to serving customers that operate exclusively in rural communities (as defined by some objective standard, such as census tracts).
Banks also complain that in many areas, they can’t compete with the FCS due to the latter’s tax treatment and funding advantages (derived from its GSE status). These advantages amount to a government subsidy, and should the FCS ever get into trouble, it will require a taxpayer bailout. In fact, the FCS has been bailed out once before, in 1987, in the midst of the farm crisis. A combination of high interest rates and oil prices, a strong dollar, and collapsing commodity prices — due in part to an export embargo against the Soviet Union — led to a wave of farmer defaults that led Congress to pass a $4 billion bailout of FCS.
But while the potential for an FCS bailout remains — with or without FCS banking — some perspective is in order. One $4 billion bailout over a 100-year period is a pretty good track record when compared with the history of commercial banks in this country. In 2008 alone, Congress bailed out the largest banks to the tune of $700 billion — more than twice the amount of current FCS assets.
Allowing the FCS to diversify its lending portfolio and accept deposits will make the system less reliant on the agricultural sector and the booms and busts that come with it. When you combine diversification with effective supervisory oversight by the FCA, the risk of a bailout is low. And if government support is ever required, the amount will surely pale in comparison to the extraordinary support too-big-to-fail banks received in 2008.
Of course, expanding the Farm Credit System’s authority will not cure all of rural America’s ills. The FCS faces the same competitive pressures as commercial banks, and like banks, has experienced a wave of consolidations that calls into question the system’s willingness to serve small farmers. Allowing Farm Credit associations to serve more customers with more services can stem this tide and strengthen the overall health of the system. More important, it can provide affordable banking services to rural communities that desperately need it. Rather than rely on a government agency with no banking experience, or the potential trickle-down benefits of tax breaks for the wealthy, why not lean on a system that has functioned well for over 100 years?
If Congress is willing to stand up to the bank lobby, they will see the benefits clearly outweigh the risks.