While the nation’s biggest banks created highly complex and risky trading instruments that operated outside of regulatory oversight and ultimately drove many of them to the brink of insolvency, an entirely different category of banks carried on business pretty much as usual, receiving deposits and making loans to their communities, even when the economy started to contract.

Many of these small independent banks say they are now feeling the brunt of a crisis that they did not create, and are being left to fail while their much larger counterparts are bailed out.

“There was no credit crunch on Main Street,” Christopher Whalen, managing director of Institutional Risk Analysis, said during EPI’s June 10 forum, Community Banks in the Bailout. Whalen, whose consulting firm tracks bank performance, shared data showing that there was never a dramatic spike in complaints among the smaller banks’ customers. Credit on Main Street did get tighter as the economy got worse, but unlike the sudden near collapse on Wall Street, the shift was measured and large amounts of money continued to flow.

Although some sort of government response was clearly needed at the height of the credit crisis to prevent the economy from collapsing, the panel questioned why the big banks were propped up, while smaller insolvent banks were allowed to fail.

As smaller banks start to fail at an alarming rate, many complain they are being penalized for the mistakes of Wall Street, including excessive trading of derivatives, whose values had little connection to the actual economy. The trading of derivatives such as credit default swaps, has been widely described as a form of gambling that had no place in banking.

Some 37 independent banks have failed so far this year and more than 300 others are on the FDIC’s watch list. As more and more government funds go to the 800-pound gorillas of the banking sector, there is less remaining for the banks that are regarded as small enough to fail. Whalen and other panelists at the EPI forum described an emerging system that overtly favored the very largest banks, providing them with the resources to offer much better interest rates than their smaller competitors, while imposing onerous reserve requirements on the community banks.

For example, William Dunkelberg, chairman of Liberty Bell Bank, which operates four branches in southern New Jersey, said the FDIC increased Liberty Bell’s reserve requirements five-fold between 2007 and 2008, effectively imposing extremely tight lending limits at a time when banks are being urged to lend more. “This has been very, very damaging,” he said. “It is not appropriate that we have to put up money to pay for the bad behavior of others.”

To be clear, even the 37 banks that have failed this year represent a tiny portion of the 8,000 independent banks in the United States. Karen Thomas, executive vice president of government relations at Independent Community Bankers of America, stressed that the overwhelming majority of small banks would ride out the storm. But she said many of them would emerge somewhat weakened, being unable to provide the loans that are so critical to an economic recovery.

The examination of small banks in the bailout is part of EPI’s Bailout Analysis Project studying the government’s response to the bailout. Program director Nancy Cleeland said the treatment of small banks in the bailout was serving to make the playing field even more lopsided than it was prior to the recession and credit crunch.

“As this crisis plays out, the big banks are getting bigger,” she said.