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Kimberly Hirai | Sep 29, 2011 09:40 AM

Early this August, 12 branches of a bank serving rural Washington state -- the Colfax-based Bank of Whitman -- shuttered their doors for good. The closure is just one more in a long series of bank failures stemming from the financial crisis.

MoneyWhile news coverage of the Great Recession highlighted the collapse of colossal financial giants like Lehman Brothers, the impact on small banks that lend to small businesses and farmers in rural communities was also significant. The recent closures in Washington show the recession's effects still rippling through small towns in the West, although there are also some signs of recovery.

The vast majority of banks are community banks, making up 98 percent of the total, or nearly 7,000 across the nation. They are often the lifeblood of local economies, lending to small businesses through custom assessments and face-to-face relationships.

Yet many of these local economic mainstays are struggling. In July, Arizona ranked first for the "highest concentration of capital-starved local banks among states," according to Invictus Consulting Group, a bank research firm in New York. This lack of capital means that banks might not have enough funds to cover future risks or deposits. The study reported that 19 of the state's 36 local and regional banks were at risk.

And last year, National Public Radio reported smaller banks, still struggling from bad real estate loans made during the housing bubble in the early 2000s, were slower to pay back bailout money from the Troubled Asset Relief program.

There are signs of recovery, even as some banks continue to close their doors. Bank failures are actually down this year. Compared with 2010's 157 bank failures, 2011 has just 73 so far.

Paul Merski, executive vice president and chief economist for the Independent Community Bankers of America says community banks are stable now, about three years after the financial meltdown. Slow growth and new regulations are worrisome, though.

"Community banks' bread and butter is small business lending and we need much faster economic growth and job growth to get that credit going again," Merski says.

And new requirements from the 2010 Dodd-Frank banking law can hinder community banks as they struggle to comply. Risk retention rules, which require banks to hold onto a portion of loans rather than sell them, could disproportionately impact small banks, which won't be able to do as much lending. And just figuring out the new regulatory environment is more costly for smaller institutions, says Chris Cole, senior regulatory counsel and senior vice president of the Independent Community Bankers of America. Merski agrees: "Bank regulators are in essence tying the hands of banks from being able to lend more because they are requiring banks to hold higher levels of capital," he says. The additional time, money and personnel used to keep up with regulations also creates greater expense for the community bank.

While many community banks seem stable, the fact that they have had to tighten their standards may mean they'll be lending less -- a sort of Catch-22, as more difficult access to credit means fewer small businesses get off the ground. In High Country News' home hub of Paonia, one local bank branch manager said they've had to tighten lending standards, requiring 20 to 30 percent down payment on a loan when they used to look for 10 to 15 percent. They've also shortened the repayment period from five to three years. Possibly as a result, but possibly because of the slow economy, they've also seen few small business loan requests.

Local bankers in Paonia believe they will outlast the hard times, though some economists thought economic growth would be moving more quickly by now, Merski says.

Kimberly Hirai is an intern at High Country News.

Image courtesy Flickr user Surat Lozowick.

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