The Dodd-Frank Disconnect – The Price of Regulations on Community Banks

The Dodd-Frank regulations—enacted in response to the collapse of Lehman Brothers and the other near failures of 2008 and 2009—have caused banks to be more cognizant of the risks and more careful in their lending practices, extending loans only to the most qualified customers. The largest institutions are now subject to “stress tests,” a simulation developed by the Federal Reserve to enable them to assess how a given financial institution’s portfolio would hold up if they were faced with their own “Lehman moment.” Furthermore, the Volcker Rule restriction prohibits federally insured institutions from trading for their own profit, while also limiting their ownership of risky investments.

“Compliance has become a major distraction for community bank managers. Any community banker will tell you that their job has fundamentally shifted from lending and serving customers to struggling to stay on top of ever-changing rules and guidance.” Marshall Lux, John F. Kennedy School of Government at Harvard University

According to the Federal Reserve, commercial bank loans have increased 77% since hitting a post-crisis low in October 2010, and total loans and leases by banks grew by almost 7% per year during the last three years. And, bank profits have been soaring. The Law of Unintended Consequences Despite the seemingly positive outlook, during a meeting with small business owners, President Trump proclaimed: “Dodd-Frank is a disaster. We’re going to be doing a big number on Dodd-Frank.” The rules aimed at large, multifaceted institutions have fallen hard on banks with less than $10 billion in assets—a group that accounts for about two-thirds of all small-business lending. Dodd-Frank was built primarily to address the excesses of large, global institutions, not small-town banks that take risks on people they know, and don’t pose the same risks to the financial system as large banks. It’s a disconnect that should be recognized—and repaired.

“Regulation is killing community banks, and if the process is not reversed, we could end up in a world where we have four big banks in this country.” —Steve Mnuchin, Secretary of the Treasury

The Financial CHOICE Act: Regulatory Relief for Community Banks and Credit Unions In 2016, House Financial Services Committee Chairman Jeb Hensarling (R-Texas) Introduced the Financial CHOICE Act (Creating Hope and Opportunity for Investors, Consumers, and Entrepreneurs) to replace the Dodd-Frank Act and promote economic growth. The CHOICE Act includes regulatory relief for community banks and credit unions and would repeal the Volcker Rule (limiting trading by financial institutions), and the Durbin Amendment (limiting debit card transactions fees). The CHOICE Act includes reforms to ease the strain on consumers finding it increasingly difficult to access affordable credit, as well as that of community financial institutions unable to offer the products and services that those consumers demand.

“The regulatory pendulum had likely swung too far in the aftermath of the 2007 to 2009 financial crisis. Community and regional banks in particular should be treated with a lighter touch based on each institution’s risk profile rather than one-size-fits-all rules.” —Dennis Lockhart, Former Federal Reserve Bank of Atlanta President and CEO

Among other reforms, the law would require financial regulatory agencies to appropriately tailor regulations to fit an institution’s business model and risk profile, thereby reducing pointless compliance costs and allowing banks to devote more of their operating budgets to meeting customer needs. A significant provision provides “Relief from Regulatory Burden for Community Financial Institutions.” The proposed law has been subject to extensive hearings, and the outcome of this legislation and the overall fate of Dodd-Frank remain uncertain. However, some or all of the provisions of the Financial CHOICE Act could eventually become law. Chairman Hensarling plans to introduce an updated version of the Dodd-Frank — gutting Financial CHOICE Act by the end of the month. A modified version could be made agreeable to both parties in the Senate and, despite Democratic opposition, it would be far easier to pass this law than either a tax-reform bill or ACA reform.

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