Community Banks Struggle under Dodd-Frank Regulations

The harms caused by the Dodd-Frank Act keep adding up for American banks, especially smaller community banks which struggle to bear the costs of new regulations. A new report from Marshall Lux and Robert Greene, fellows at the Mossavar-Rahmani Center for Business and Government at Harvard Business School, details how the financial law is taking a toll on community banks.

While the federal entities which regulate banking each have a different definition of what constitutes a community bank, in general community banks are relatively small and have a regional focus, close ties to customers and lending policies that allow borrowers who may struggle to get loans from large banks to take out loans from community banks.

According to Lux and Greene, community banks’ share of the bank lending market and banking assets has fallen by 50 percent over the last 20 years. However, they’re still key players in certain sectors.

Unfortunately, these banks have struggled in recent years, losing asset share as the banking market has consolidated. While the financial crisis played a role in their market share losses (community banks’ share of banking assets fell 6 percent from the second quarter of 2006 to 2010), the passage of the Dodd-Frank Act resulted in even larger losses, with community banks’ asset shares falling more than 12 percent since the second quarter of 2010.

According to Lux and Greene, Dodd-Frank has led to banking consolidation and hurt community banks by imposing hefty regulations that impose large costs on smaller institutions:

– Large banks can better bear the regulations imposed by federal regulators due to economies of scale. For community banks, the average costs of regulations are higher.
– According to a 2014 Mercatus Center survey, more than 25 percent of community banks planned to hire compliance or legal personnel within the following year. The same survey found one-third of banks had already hired additional staff members in order to comply with new regulations from the Consumer Financial Protection Bureau.
– According to a 2014 study from the Minneapolis Federal Reserve, regulatory-driven hiring at the smallest community banks has a real impact on profitability, causing one-third of such banks to become unprofitable.
– In 2012, William Grant, former chairman of the Community Bankers Council of the American Bankers Association, estimated that industry compliance costs after Dodd-Frank were $50 billion per year (12 percent of operating costs). Grant also said regulatory compliance as a share of operating expenses was 2.5 times greater for small banks than for large banks.

For small business owners and farmers, this is a troubling trend, because large banks have less knowledge of local conditions than do community banks. Lux and Green write, “Community banks had little role in the financial crisis, yet play a major role in critical U.S. lending markets.” Unfortunately, “[O]ne of the most significant problems community banks face is the sheer volume of banking regulations…The legal costs for community banks associated with more regulations are inherently a larger portion of overall revenue than for larger institutions, making any form of compliance more difficult.”

The solution? Lux and Greene urge lawmakers to create a better, more reasonable regulatory system that imposes fewer burdens on community banks, suggesting that federal financial regulators be required to conduct cost-benefit analysis for significant rulemakings and submit their proposed regulations to the Office of Information and Regulatory Affairs for review. Not only would such reforms result in higher-quality analysis, but Lux and Greene say the standards “would help ensure that regulations achieve their intended outcomes without resulting in unnecessary harm for community banks.”

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