The troubles facing the largest banks have trickled on down to the smaller banks, and it could get worse. There are an estimated 600 more banks that could fail if conditions don’t change, and some say as many as 1,000 banks could go under. The difference with these banks is that they’re not getting a helping hand from the government.

The Economist points out the host of issues that regional and community banks are facing right now:

• They are too small to pose a threat to the entire system and thus too small to require saving
• They are heavily exposed to commercial property, an asset class that continues to struggle
• The total of failures also disguises the size of individual collapses; banks accounting for more than 3% of the system’s total assets have fallen in the current cycle (compare that with 4.4% of assets in the entire ’80s Savings & Loan crisis)
• According to CreditSights, a research firm, when the current cycle is over, the rate of bank failures may be double what it was during the Savings & Loan crisis

There are 416 institutions on the problem list of the Federal Deposit Insurance Corporation (FDIC). (Other reasons regional banks are struggling).

Although the demise of small banks does not threaten the system the same way that the large institutions does, taxpayers bear the brunt of further loose strings. (How financial ETFs are grappling with the aftermath of the initial financial crisis.) This could force the FDIC  to borrow from a $500 billion credit line with the Treasury. It will also affect small business owners who rely on local lenders, with credit becoming harder to come by. (How will this affect related shares and ETFs?)

As Wall Street’s outlook begins to patch it self up, Main Street may see harder times ahead. (Will the latest community banks ETF go down with the news?)

• SPDR KBW Regional Bank ETF (NYSEArca: KRE): down 25.8% year-to-date

• First Trust NASDAQ ABA Community Bank Fund (NYSEArca: QABA): up 8.4% since inception on July 1

For more stories about banks, visit our community or regional banks categories.

July was also interesting as the Federal Reserve made huge efforts toward saving the banking industry by rescuing Fannie Mae and Freddie Mac, along with legislation to ease the credit crunch inspired by the subprime meltdown, reports Richard Widows for TheStreet. Some, if little, confidence was restored within the financial sector.

July’s top-performing financial ETF was HOLDRs Regional Bank (RKH), which gained 16.7% for July, but is down 17.2% year-to-date. KBW Bank ETF (KBE) was up 13.8% for July, yet remains 23.40% off for the year-to-date.

It all goes to show that one should consider carefully before believing a good month is a solid turnaround. Instead, we think it’s wisest to get in only when they cross the 200 day-moving-average. Financials will be in a position to perform once the turnaround begins, so sit tight.

Listen in as Tom Lydon discusses the economy on Fox Business.