Introduction
The Dodd-Frank Act in the banking sector has come out to be the biggest re-write of regulations in the area. This legislation has detailed some provisions aimed at preventing an occurrence of a financial crisis like the one of 1998. The industry provisions have, however, led to the emergence of the factors which forced the systemically important institutions to wind down. The Act created the Systemic Risk Council whose primary task is to oversight the situations containing a potential contagion well in advance before it happens. Some of the small banks desired to serve the local community to which they offer innovative products but the Act came up with so many regulations that have made it costly for community banking institutions to implement and maintain them. This paper analyses the impact of the Dodd-Frank regulations on community financial institutions and consumers.
Discussion
According to Marsh and Norman (2013), the Act purposes to protect consumers by putting in place measures leading to stable financial operations. Some of the provisions here may overburden community banks making them abandon more expensive lines of service or consider merging, consolidating, or going out of business. Any of the above outcomes will deprive Americans of the services they are currently enjoying from their community institutions.
The Dodd-Frank as it is currently structured will lead to the creation of “too-big-to-fail” financial institutions because it is compelling by the use of the law the concentration of assets in a few large institutions. The provision of minimum asset requirements to provide certain products may drive community banks to rethink their operations framework if they want to survive. The example is the closure of Shelter Financial Bank in 2012, which was a community bank in Columbia, Missouri. The proprietors analyzed and found that adhering to the Dodd-Frank regulations will cost them slightly over USD 1 million per year and these expenses are more than their annual profits.
The number of mergers and acquisitions is on the increase as many community banks have realized that they stand to lose market with their smaller sizes. For example, Western Reserve Bank of Medina was acquired by Westfield Bank. The owner said that adhering to the regulations appeared cumbersome and remaining profitable was a challenge. The clients these institutions were serving were affected and had to seek services in new organizations.
This Act also requires all financial products to be standardized and this undermines the flexibility community banks enjoyed as they could model products as per the requirements of that particular community. This aspect reduces the diversity and creativity of products consumers enjoy, and in the end, it will lead to fewer people accessing and having the ability to use these standardized products.
The community banks had a perfect knowledge of their operating area and offered products based on non-standard soft data like the character of the customer. Usually, the community bank understands challenges these people face and which the larger bank may not want to take into account. After some time, most of these clients will be cut off from receiving credits and their businesses will suffer in return.
Additionally, it is important to points out an overall increase in compliance burdens arising from the enactment of these rules. The challenges the institutions will go through include the requirement to hire more staff, conduct regular trainings of employees, and more importantly, the lack opportunities to allocate more time to address compliance systems and the periodic updates pertaining to them (United States Government Accountability Office, 2015).
The Act requires financial institutions to coordinate their adherence to the regulations. The organizations had to establish compliance departments and employ more staff to oversee this exercise, and this led to an incremental cost of USD 100 million to the economy. These measures will adversely affect the competitive power of these institutions, their investment and expansion abilities, their productivity, innovation capabilities and in the long run, some of them will find it challenging to compete in the domestic and export markets.
Maintaining these regulations is a burden to the small entities because of the additional structures they should maintain (United States Government Accountability Office, 2015). The organizations find it hard to pass the expenses to their clients because their services may end up expensive to the clients. Therefore, these companies absorb the costs associated with the regulations, create the required departments, and employ experts to control such activities.
The Act introduced reforms that strengthened the oversight of financial services. The deposit insurance reforms were expected to benefit the community banks and credit unions by putting in place slow but healthy changes. That in fact had positive results as it led to the emergence of well-structured organizations. Nevertheless, the surveys done point out that some companies had to increase their fees to cushion against the effects of the regulations (United States Government Accountability Office, 2015). As a result, many small institutions in the category of community banks, credit unions, and industry associations saw moderate-to-minimal rise in numbers of clients seeking their expensive products.
The mortgage regulations will impose an additional burden on many community banks and credit unions, and as a result some institutions will reduce the lending products they offer, and in the extreme cases many small organizations will end up dropping the mortgage lending business altogether (United States Government Accountability Office, 2015). Therefore, this will call for a need in the regulators to conduct the exercise in a manner likely to pass benefits to organizations in rural or underserved communities. The relief will exempt these organizations from implementing all the regulations and they will offer affordable services to their clients.
Disalvo and Johnston (2016) also affirms that the supervisory regulations and policies have higher cost implications to smaller community institutions given that some have fewer staff who will undertake the regulations. Besides, some may not have the necessary structures including departments that shall conduct the regulations.
Community institutions and small banks have argued that these strict regulations are making it hard for them to carry out their normal businesses of offering cheap services to their consumers (Disalvo and Johnston, 2016). They have made presentations to the relevant agencies and politicians to repeal parts of the Dodd-Frank regulations and exempt them or introduce a section that shall have different requirements for small institutions and another set for the well-established ones.
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The analysis of institutions with an asset base of less than USD 10 billion, which falls under the classification of small banks, shows that the new home mortgage lending rules significantly affect their service offering abilities. The institutions face many challenges even with the broad range of exemptions directed towards them (Disalvo and Johnston, 2016). The regulations include a new risk-based capital requirement that will be an extreme given that these institutions have to approach financiers to meet the requirement. The cost of this additional capital will increase the adherence burden. However, large institutions only needed to create a reserve for this element. Some bankers complained about the incremental costs resulting from the regulations on debit card transaction fees. They pointed out that these costs are passed on to clients, and it is a disadvantage to them since they put the whole transaction charge on clients’ shoulders, unlike the large corporations that may pass a small portion of the charge as a way of attracting clients with cheaper services due to their abilities of negotiating cheaper services with various merchants (Disalvo and Johnston, 2016).
The new capital requirements demand 150% risk weight on risky CRE loans which are referred to as high volatility commercial real estate. Small institutions invest heavily in this product because they consider it stable. CRE is composed of majorly these community banks because they hold more than 50% small bank loan portfolios in comparison to about 25% for big institutions. Therefore, requiring higher costs on these loans will negatively impact the competitiveness of these small institutions as they have a detailed knowledge of the local real estate markets and that is a basic area they rely on to grow (Disalvo and Johnston, 2016).
The Dodd-Frank Act introduces the changes likely to make United States institutions rank at bar with the international capital standards as detailed by the Basel III. The American Banking Association expects comprehensive revisions especially on the risk-based and leverage capital frameworks leading to the creation of a solid financial system (American Banking Association, 2012).
The Act subjects certain types of bank assets to more capital requirements. Some of these assets, including the securitizations, trading assets, derivatives, and adherence will have an impact on all banks, but small institutions may find the burden of compliance more difficult. The regulators are undertaken thorough examinations and the effects have included raising the minimum capital requirements. ABA projects that the regulators will continue imposing higher requirements within the sector, some of which may make the operations of community banks not profitable.
Community banks face a double jeopardy given that they have to follow Consumer Financial Protection Bureau (CFPB) rules, while adhering to the prudential regulators in some areas like debit card overdraft measures, giving direct debit advances, and also on matters regarding rewards checking (American Banking Association, 2012). This Act gives the State Attorney Generals powers to enforce federal consumer protection laws on all community banks. Therefore, institutions will have to be creative for them to remain profitable as the AG will impose sanctions or curb rates that his office feels are expensive to consumers.
In addition to the aforementioned facts, the Act has made record keeping and reporting costly, making community banks at a disadvantage due to implementing the required structures. The bureau has the rights to demand “other information” from any community bank at any time. Moreover, the bureau requires these institutions always to compile and report all additional HMDA data in addition to HMDA-like small business loan data (American Banking Association, 2012). The regulations include a provision that banks should give their clients an expanded access to their bank accounts, transactions, and information regarding fees they charge per service or transaction. The compliance with all these provisions will require the banks to acquire specialized banking reporting systems to accommodate the changes as the bureau keeps changing the laws from time to time. Buying such software system is expensive to the community banks and making modification from time to time will strain their resources even more.
According to Lux and Greene (2015), the overregulation of the American community banks by the Dodd-Frank Act has hastened the concentration of assets in several megabanks. Some of the unintended consequences that have arisen caused the elimination of businesses that could have helped young entrepreneurs to grow.
Community banks have a local presence and have the capacity to understand the needs of their immediate clients and they have the ability to assist the community to reach its potential. The hundreds of regulations the Act puts into place have burdened community banks and many are collapsing at a faster rate due to the higher regulatory costs and limited capital available to these institutions and their clients (Lux and Greene, 2015). Therefore, the Act is increasing the operating costs while hindering the access to capital. It has also cut the revenue streams these businesses relied on, which will evidently weaken the economy.
The Act should exempt community banks from certain regulations as they did not participate in subprime loans hence they did not play any role in fueling the economic crisis. Most of them have not sold any securitized mortgages because of their small size. Moreover, they do not have a lot of money to engage in opaque and risky derivative transactions. Therefore, it is evident that imposing unnecessary regulations on banks with less than USD 1 billion assets will ideally award a competitive advantage to the bigger banks with assets in excess of USD 10 billion (Lux and Greene, 2015). Meeting the regulations will be expensive to the larger banks too, but because of the impact the regulations have on the smaller ones, compelling them to wind up, the larger institutions will end up absorbing the extra clients. This will eventually lead to a higher market value to them.
Community banks rely a lot on creating good interpersonal relationships instead of the normal criteria, like using financial statements among other models, in providing services to their clients. Therefore, they are in a better position to serve small businesses which they can audit from time to time based on their operations. Studies performed on interpersonal relations show that the companies relying on them have significantly lower default rates compared to the urban banks that use complex lending models (Lux and Greene, 2015).
Marsh (2015) articulates that the Act is imposing unnecessary costs on community banks without giving consumers or the economy as a whole, satisfactory benefits to justify the expenses. Enforcing the Act will encourage financial institutions to standardize their products, leaving many meaningful borrowers without any protections or access to crediting.
The Act relies on the premise that many banks had created innovative products especially subprime lending that led to the banking crises. However, the Act fails to recognize that relying on innovative products has helped some community banks to grow because they understand and trust their clients and can come up with appropriate products to suit the needs of the latter. Some of the clients for the community banks are regarded as informationally opaque in that they may not have the ability to keep proper records as the large banks require (Marsh, 2015). These people will lose out or will have to create the required accounting records for them to access facilities large banks, which is stressful to many of them.
The Act should consider narrowing down the banking activities instead of the heavy regulations it has imposed. Narrowing down will require banks of all sizes to shorten the range of their activities and choose one or two main areas to offer services, like taking deposits or lending among many others. Large banks can segregate their departments and in the process, they will be able to cater for their various clienteles. Based on this approach, the law will manage to reduce the size of the “too-big-to-fails” so that in case of a crisis, the economy will not suffer a lot (Marsh, 2015).
The Act should consider the side effects of limiting standardization because it deprives many clients of the chance to access credit facilities. Community banks in the past were able to offer suitable products to different clients. This created a lasting relationship and the clients never failed on their obligations as the products were tailored towards their needs (Marsh, 2015). Coming up with standardized products will give an advantage to the large institutions that can approach clients from many parts of the country and lockout community banks that could be operating from areas with a handful of businesses with proper accounting records.
Wallison (2015) points out that the Act is responsible for the heavy regulatory costs and the resulting new restrictive lending standards that have made it impossible for community banks to finance small businesses like they did before. Large institutions on their part have access to many channels of revenue hence they have not been affected by the law as such.
The Act is responsible for the slow growth in the banking sector after the effects of the recession. For instance, in 2014, JP Morgan Chase noted that it would employ exactly 3000 new staff who will cater for the new compliance procedures. The result has been that these additional staff could not be hired despite of the regulations (Wallison, 2015). They would eat into the earnings of the company and this is the cause for slow growth in almost all banks. Small banks will also suffer because they have to hire more personnel and offer them adequate tools to start working. Some of these incremental costs were in some instances equal to or even more than the annual revenue, a factor that compelled some of these institutions to close down or merge with others (Wallison, 2015).
Community banks have a smaller asset base and cannot afford compliance costs which are minimum USD 1 Million. Therefore, spreading these costs over a small asset base will force these institutions to divert resources from some of their core activities if they want to survive. For instance, some community banks had to lay off non-compliance staff to create room for compliance ones. Therefore, the remaining staff will have to take on more duties for the institution to perform its normal operations. As researchers have pointed out, the cost of regulatory compliance, when factored to be a share of normal operating expenses, will be 2.5 times higher for community banks compared to the larger ones. This reason has led to the small banks suffering more from the effects of these reforms while the large institutions continue to grow (Wallison, 2015).
Conclusion
The Dodd-Frank Act aimed to create a stable banking industry, but it has ended up alienating some clients from the mainstream banking services. This law has played its negative role in collapsing, merging or buy-outs of community banks that were assisting the middle- and low-income clients. This law is responsible for the creation of a few big institutions that will spell economic disaster if they collapse. This law should adopt measures to encourage the growth of the small community banks instead of driving them out of business. This is the only way the economy will benefit and the people will access cheap and rewarding banking services.
