Dodd-Frank Helps Wall Street But Harms Small Banks

While small banks weren’t responsible for the financial crisis, they still have to deal with a disproportionate regulatory burden. To address this, Rep. Jeb Hensarling (R-TX), chair of the House Financial Services Committee, introduced the Financial Choice Act to revamp our financial regulatory system in 2016. The bill’s prospects would have been dim under a Hillary Clinton presidency, but the election of Donald Trump has changed the political landscape. 

Assuming it follows the blueprint of the original, the bill would set a new tone for how America pursues financial regulations. Not only does it recognize the fundamental need for change, more importantly, the proposed legislation also draws the right conclusions about the type of change that’s needed. Hensarling recognizes that the Dodd-Frank Wall Street Reform and Consumer Protection Act has failed us and must be replaced.

There are many well-documented problems with Dodd-Frank. Among the most pernicious is its restructuring of the financial sector. The big banks are bigger than they were before the 2008 crisis, while community banks feel most of the burden of excessive regulation. This shouldn't come as a surprise. While it’s a pain for big banks to have to hire a bunch of new lawyers, they can absorb the increased compliance costs of new regulations. For small banks, it’s much harder.

CEOs of large banks have even voiced opposition to a full repeal of the law. The Washington Post quotes JPMorgan Chase CEO Jamie Dimon as saying: “We’re not asking for the wholesale throwing out of Dodd-Frank.” Given all the money they’ve sunk into compliance lawyers, it’s hard to blame him. As Goldman Sachs CEO Lloyd Blankfein puts it:  

“More intense regulatory and technology requirements have raised the barriers to entry higher than at any other time in modern history. This is an expensive business to be in, if you don’t have the market share in scale. Consider the numerous business exits that have been announced by our peers as they reassessed their competitive positioning and relative returns.”

The data seem to confirm this. According to research by leading industry analyst SNL Financial, five banks hold over 44 percent of the industry’s assets. While an upward trend already existed prior to Dodd-Frank, Forbes noted that between the second quarter of 2010, when Dodd-Frank passed, and the second quarter of 2014, “community banks…lost market share at rate double what they did between Q2 2006 and Q2 2010.”

In a 2016 article for Politico, American Bankers Association President and CEO Rob Nichols noted that, “more than one in five U.S. banks have disappeared — 1,708, or more than one every business day — since Dodd-Frank was enacted.” While it’s certainly possible in principle for big and small banks to coexist happily and grow together, that doesn’t appear to be happening.

A Federal Reserve report noted that between 2009 and 2013, only seven new banks formed. Many factors, including a weak recovery, have contributed this slow growth. But the increased regulatory burden has undoubtedly played a key role in shrinking number of community banks. A 2013 survey by Hester Pierce, Ian Robinson, and Thomas Stratmann of the Mercatus Center found that community banks were worried about new regulations and greater compliance costs, and were increasingly contemplating mergers as a result.

The median number of compliance officers employed by surveyed small banks rose from one to two. This may not seem like a huge number. However, it’s important to consider the nature of these community banks. It’s a big deal to have to hire a new employee who serves no other purpose than to sort through the law. Forcing banks to divert resources from serving customers to deciphering federal bureaucracy is hardly beneficial to a bank’s bottom line — or their customers. Even when new financial regulations don’t apply to them, small banks still have to expend resources reviewing these regulations in order to make that determination.

Despite Congress’s intention to increase caution and stability in the banking system, Dodd-Frank has instead served to bolster big banks and squash small ones. This trend needs to be reversed. Any proposed regulations that apply to community banks must be subject to intense scrutiny. Cost and benefits must be more heavily considered by the agencies churning out new rules.

Lawmakers could start giving community banks relief by replacing burdensome federal regulations with simple rules, such as increased capital requirements. This would serve to cut down on compliance costs while also ensuring that banks are equipped to handle downturns in the market. 

Instead of giving markets the impression that some banks are still “Too Big to Fail,” the financial sector — and economy as a whole — would be better served by cleaner and simpler regulations that provide true stability without smothering community banks. 

Brett Linley is an Economics and Political Science graduate from Hofstra University.