Improving Diversification: As credit quality issues mount, astute loan pooling is key to survival.

The key to community bank survival is commercial loan sales, but unfortunately it is an expedient most bankers reject. Many argue that they won't sell small-business loans because they make so much from them. This is incorrect.

While community bank returns from small-business relationships are large, those from the loan portions of these relationships are not high, in part because of pricing and in part because of the requirements for capital.

The Limits of Diversification

Let's consider the capital question first.

Because small-business loans are both risky and illiquid, lenders should support them with unusually ample capital …