Last week, the House passed a major bill that would roll back a number of financial regulations put in place by the 2010 Dodd-Frank Act. While pundits say the bill, the Financial CHOICE Act, will be dead on arrival in the Senate, lawmakers owe it to community banks to consider at least those portions of the bill that offer smaller banks relief from the regulatory crush. For these banks, a reprieve from the Dodd-Frank Wall Street Reform and Consumer Protection Act can’t come soon enough.
The original reason for Dodd-Frank was well-intended, as is the case with many government initiatives. The law’s overall goal was to help avoid future financial-institution crises. Like the Glass-Steagall Act in 1933, Dodd-Frank was prompted by significant negative events in the economy during 2009 and 2010.
However, the law has accelerated a long-term and unabated trend that is very dangerous to America: the decline of the number of smaller banks in the United States.
Do we want to continue down the road toward becoming a place like England, where five or six banks control 99 percent of assets? My answer would be no. Already in the United States, the four biggest retail banks collectively hold 45 percent of all customer bank deposits.
Some might argue correctly that fewer banks are easier to regulate (and therefore, society is better protected). Others might argue that fewer banks are better able to pass along savings to consumers through lower operating costs.
However, even if the above benefits of fewer banks were true, history has shown us that the overall advantage of competition in markets is so overwhelming and strong that it clearly outweighs the value of having few and very powerful financial institutions. More competition has in almost every instance resulted in better choices for consumers. This is simply born of more supply driving down prices and increasing services. If you ever doubt the assumption, try getting quick service from your cable company or, worse, negotiating with it.
Thirty years ago, there were more than 14,000 banks in the United States. Today, there are approximately 5,000. A reason for the decline in community banks (not the only reason) is that the regulatory costs, both direct and indirect, from laws like Dodd-Frank create an overwhelming burden on smaller institutions. New home mortgage lending rules and risk-based capital requirements, as well as upcoming requirements to gather more data related to business lending are among the increased burdens being imposed by Dodd-Frank. Fixed costs of regulation (such as hiring administration to ensure compliance) hit institutions with lower revenues harder than they hit larger banks that may already have intensive infrastructure. People often think that bankers all wear the same white shirt, but they do not. Most banks are small businesses, with 40 percent of U.S. banks having fewer than 30 employees. For about one in five banks with less than $50 million in assets, hiring just one additional person could push the institution below a minimum return that investors require of a small bank, according to Fed research.
In addition, the financial crisis of 2007-09 was not remotely caused by community banks; rather, it was caused by the rote and unthinking securitization of real estate products — something no good community banker would ever do.
By default, as institutions get larger, the people running them get further and further from not only strategic decisions, but from tactical product decisions that can ruin an organization. If there are only a few organizations, this dynamic will be negatively amplified in the United States. One large bank default tends to affect other larger organizations and even the entire economy. This played out as a fact in the financial crisis. If Community Bank A decides to invest 10 percent of its assets in a portfolio of real estate that does not have adequate collateral as evidenced by simple loan-to-value ratios with good appraisals, who would care? Few people, for the simple reason that Community Bank A makes up a very small part of the American economy. I realize this begets the adage that big is bad, but in the case of community banks in the financial-institution market, it is clear.
This is not an argument that small banks don’t need to be regulated. They do. Banks hold people’s money and the government has to protect the people, so it only makes sense that they’re regulated. Rather, there has been a misapplication of what is needed for large banks as compared with small banks, which has created an undue burden on smaller institutions. Dodd-Frank is the prototype of a misguided regulation in this regard.
The bottom line is that community banks — like other small businesses in the United States — are massively overregulated, and their existence is threatened, as is evident by the decline in the number of them. Over the long run, this not only gives consumers fewer options but also creates more risk in our economy. Lawmakers should sort through the rhetoric and ensure that community banks get relief. We should encourage more competition in the banking industry, not less.
Brian Hamilton is the founder and chairman of Sageworks, a financial information company, and founder of Inmates to Entrepreneurs. @Sageworks
Mary Ellen Biery is a research specialist at Sageworks. @MELloyd