Small Banks in the Eye of Dodd-Frank

Small banks didn't cause the financial crisis that led to the Dodd-Frank Wall Street Reform and Consumer Protection Act - and the act's framers said they didn't intend for the law's burdensome requirements to hit smaller institutions. But the results of our recent small-bank survey published through the Mercatus Center demonstrate the futility of these good intentions. Small banks are facing rising compliance costs and are finding it harder to serve their customers.

Our anonymous, online survey of approximately 200 banks with $10 billion or less in assets reveals tremendous frustration with the Dodd-Frank rollout and its implications for the future. The surveyed banks object to - in the words of one banker - "the maddening pace of illogical and unnecessary regulation (that would not) have done anything to prevent the 2008 collapse." Neither do surveyed banks discern a benefit for consumers, who are seeing personalized service replaced with cold regulatory checklists.

One category of concern is the pace and volume of the new regulations. Dodd-Frank regulations are simply the latest wave to wash over an already heavily regulated industry. We asked banks to compare Dodd-Frank's regulatory burden with the existing Bank Secrecy Act rules, which are widely perceived as very compliance-intensive. More than 95 percent expect Dodd-Frank to be at least as burdensome.

Survey respondents also identify specific parts of Dodd-Frank that keep bankers up at night. One of these is the new Bureau of Consumer Financial Protection. Even though Dodd-Frank's framers sought to shield small banks from the bureau's direct line of fire, the regulators are a source of substantial anxiety for the banks we surveyed. More than a third of them report hiring additional compliance or legal personnel in response to the bureau's regulatory initiatives.

Concerns about the bureau may stem from banks' experience with its mortgage rules. Of the surveyed banks, nearly 6 percent already discontinued residential mortgages and an additional 10 percent anticipate doing so. Although those numbers may seem small in the scope of the national mortgage market, discontinuations will ripple through the communities these small banks serve.

Although bank consolidation long predates Dodd-Frank, banks believe the act is paving the way for even more. Regulatory burdens are easier for big banks to absorb since they can spread them across more assets. As one might expect, the statistics show that big banks are solidifying their hold. The five largest banks by assets now hold more than 40 percent of assets and deposits, which is much higher than the approximately 20 percent held in 2000. Of the surveyed banks, 94 percent expect further consolidation. Over a quarter of respondents anticipate their own bank to participate in a merger or acquisition within the next five years.

If the past is any predictor of the future, small banks will adapt and innovatively respond to new regulatory requirements. Yet, the prevailing sentiment among the surveyed banks is that regulatory compliance burdens, in the short run, are a growing obstacle to their profitability - a necessary prerequisite for their survival.

Why should we care if small banks fade from the landscape? After all, many other countries lack a notable small-bank sector. The survival of American small banks is important because they meet the banking needs of populations that aren't particularly attractive to large banks. They serve small towns, rural communities, small businesses, and borrowers with unique needs and credit histories that don't fare well in unbending large-bank credit models. Small banks can make smart lending decisions based on information gleaned from their deep ties with their communities.

Regulators should solicit the input of small banks, use economic analysis, and take seriously statutory mandates to analyze regulations from a small-bank perspective. One way to ease the sting of new regulatory requirements could be simply giving small banks additional time to comply. More fundamentally, it is time to take a hard look at the rulebooks. Let's get rid of rules that aren't working so bankers can get back to serving their customers.