At Thanksgiving dinner last week, talk turned quickly from turkey to regulation. One of the dinner guests, along with a couple other computer whizzes, has designed software for which they think there is a real market. There is just one problem-regulation. The company can't even pilot test its product without first getting the blessing of state and federal regulators. The company's three employees know their way around computer codes, but regulatory codes are a different matter. The consequences of getting it wrong can be stiff penalties or, as my guest pointed out, "people get thrown in jail for this kind of stuff." The reality is that well-intentioned regulations may kill his company before its product goes live. If it does see the light of day, another set of regulations may make banks less likely to lend to the company.
My dinner guest's story is just one of thousands of similar ones. A great product and a willingness to pour hours into perfecting it are not enough. You also need regulatory expertise. Usually when two guys start a business in one of their garages, neither one of them is, aspires to be, or even knows a regulatory geek. Hourly rates driven by ever-increasing regulatory complexity make hiring an expert out of the question. You might set out to redesign your product so that the regulations don't cover it, but even that requires a deep understanding of government rules. So your only hope is to get bought out by a bigger company with a whole staff of regulatory experts.
Start-ups that do manage to figure their way through the regulatory maze may find themselves confronted by another problem-funding. The small banks that small companies often turn to for funding are themselves overwhelmed by regulation. Adding an extra compliance person to deal with the regulatory burdens emanating from Dodd-Frank, for example, may be the difference between a small bank staying in business and closing its doors or merging with another bank to spread out the regulatory costs.
A community banker may have sufficient familiarity with a local small business and the area in which it operates to know that a loan to the company will get repaid. But worries about justifying it to a regulator without the same local knowledge may keep him from making the loan. A banker that went into banking because she enjoyed working with growing small businesses in her community might leave banking because she does not enjoy working through an increasingly complex regulatory environment that steers time and resources away from customer service.
Regulators can create exemptions for small banks, but even figuring out whether an exemption applies and what its conditions are can be difficult work. For example, the staff of the Commodity Futures Trading Commission issued regulatory relief for small banks earlier this year in the form of a "no-action" letter. The letter allowed the banks an extra month to comply with a requirement that makes them eligible for an exemption from certain onerous CFTC rules, but not without reminding them that the requirement at issue "was expressly noted in the Federal Register" when the agency adopted the exemption. Expecting small bankers to have searched through thousands of pages of technical CFTC documents in order to find buried within them a brief mention of something pertinent to them seems impractical. Small banks are too busy absorbing regulations issued by their banking regulators to closely monitor the rulemaking activities of an agency that doesn't usually regulate them.
Even the people who devise complicated banking regulations are starting to ask whether they have gone a bit too far. Earlier this fall, the Bank for International Settlements-the institution that developed the international bank capital standards that are the basis for our domestic capital standards-issued a discussion paper about regulatory complexity. Rather timidly it suggests that "[t]here is some evidence that some parts of the capital framework have become unduly complex and that the marginal benefits from incremental complexity may be small, or even negative." While U.S. regulators have taken some steps to reduce the complexity of capital standards as they apply to small banks, they have a lot of regulatory simplification work yet to do.
Regulatory complexity should not be the stuff of Thanksgiving dinner conversations. But until we find effective ways to get rid of excess regulations and simplify the remaining ones, the people who run small banks and small businesses are going to be worrying about regulations, even during holiday dinners.