How Dodd-Frank Hurts the Little Guy
Contrary to conventional Twitter wisdom, the Economic Growth, Regulatory Relief, and Consumer Protection Act is far better news for Main Street than Wall Street. Passed by the House yesterday, the law, derided by critics as the #BankLobbyistAct, would in fact reduce regulatory pressures on small banks, enhance economic mobility, and reduce inequality.
The Dodd-Frank Act was introduced after the financial crisis with the noble intention of protecting consumers and maintaining the stability of the financial system. Unfortunately, a side effect of Dodd-Frank is that the same regulatory stick used on “Too Big to Fail” banks has been punishing community banks, local banks with less than $10 billion in assets. Community banks did not engage in widespread subprime lending or securitization, nor did they engage in risky speculation with derivatives. Their reward? The onerous requirement of complying by the same standards as the big banks.
Community banks are important because they are a vital source of small business funding and are critical to the economic mobility of poorer and rural Americans. The FDIC reported that community banks serve more than 1,200 US counties, including 16.3 million people “who would have limited physical access to mainstream banking services without the presence of community banks.” Economic mobility in rural America is poor: Over 85 percent of persistent-poverty counties in the United States are rural. Facing a lack of access to the same services as urban Americans, many rural Americans find it difficult to escape the cycle of poverty. One key tool to beat this is better access to credit, a service provided by well-functioning community banks. That’s why it’s so worrying to see these banks in decline.
Big banks are increasingly serving only the wealthiest of customers, and are much less connected with local communities than community banks. One of the primary advantages of these localized institutions is their specialized knowledge of their communities. This allows them to make loans to small businesses and individuals who don’t fit neatly into the one-size-fits-all financial models of the big banks. Unfortunately, Dodd-Frank was constructed without regard for these relationships.
Regulatory costs are also disproportionate for smaller banks. Small banks cannot spread regulatory costs over a large portfolio of loans, and they lack the ability to hire armies of legal staff to interpret complex, changing requirements. This means community bank boards are forced to become more focused on regulation than serving their customers. For example, instead of hiring an employee to structure products for aspiring entrepreneurs, banks may be forced to hire a compliance officer. These extra costs also leave banks less capable of offering basic banking services to these communities.
Not only does this lead to poorer economic mobility, it also gives larger financial institutions a competitive advantage, contributing further to the concentration of the industry. Unsurprisingly, large financial institutions don’t want this to change.
The good news is that yesterday’s reforms can provide some positive regulatory relief for smaller banks.
Dodd-Frank originally set the size at which banks will be subject to more stringent regulations at $50 billion in assets. This is far too low. Even Democratic Senator Barney Frank, for whom half the bill is named, publicly supported a higher threshold, believing it would provide a more competitive environment, lessening the dominance of the “mega banks.” This reform raises the threshold to $250 billion (with an important caveat), and simply exempts smaller banks from unnecessary and overbearing oversight.
Another great concept is the “regulatory off-ramp.” It allows community banks, with assets below $10 billion, an exemption from complicated capital requirements if they satisfy an acceptable level of leverage. In other words, if they take steps to mitigate risk, they are rewarded by exemption from costly requirements.
The so-called #BankLobbyistAct provides modest reforms tailored to community banks. Far from a gift to Wall Street, the bill delivers much-needed relief to Main Street by allowing smaller, more community-focused banks to thrive.
John Webster is a freelance writer who focuses on finance, banking, and monetary policy issues. Follow him on Twitter @john_webster1.