A law passed in 2010, Dodd-Frank, designed to reduce corporate and Wall Street fraud, has certainly been making headway toward its intended goals. However, an unintended side effect of the law has been increasing difficulty for small businesses to obtain loans from their community banks and credit unions.
The main reasons? First, because of Dodd-Frank, there are significantly fewer community banks and credit unions in existence. Succumbing to the weight of the regulations, they have either gone out of business completely or been gobbled up by larger regional and national financial institutions. Second, the smaller community banks and credit unions that do remain have become so focused on devoting resources to complying with Dodd-Frank requirements that they have less time and resources to focus on lending to small businesses or are reducing the numbers and types of loans that they do make.
The legislative text of Dodd-Frank totaled approximately 850 pages, and its new rulemakings have created over 20,000 pages of regulatory text. When it was passed, it involved the creation of almost 400 new rules, about 250 of which had been passed by July of this year. As a result, Dodd-Frank is estimated to have created $24 billion in compliance costs and 61 million hours in paperwork burdens.
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A recent survey of 6,500 small lenders conducted by the Independent Community Bankers of America (ICBA) looked at the market share of U.S. banks with less than $10 billion in assets and found that their share has been shrinking at a significant rate since the passage of Dodd-Frank. The survey also found that 29 percent of respondents reported that the requirements of Dodd-Frank are restricting their ability to make commercial and farm loans.
A recent report, "How Are Small Banks Faring Under Dodd-Frank?" published by the Mercatus Center at George Mason University, also found that Dodd-Frank significantly affects small banks and their customers. "A large majority of respondents view Dodd-Frank as more burdensome than the Bank Secrecy Act, and the participating banks reported substantially increased compliance costs in the wake of new regulations," said the report. These costs include hiring new compliance personnel, increased reliance on outside compliance experts, additional resources allocated to compliance, and more time spent by noncompliance employees on compliance. "The increased regulatory burdens have led small banks to reconsider their product and service offerings…," said the report. "The prevailing sentiment among surveyed banks is that regulatory compliance burdens are becoming a growing obstacle to small banks' profitability and their ability to serve their communities."
Experts have been aware of the problem for some time. "As battle-scarred survivors of a financial crisis and deep recession, community bankers today confront a frustratingly slow recovery, stiff competition from larger banks and other financial institutions, and the responsibility of complying with new and existing regulations," said Ben Bernanke, chairman of the Federal Reserve, at a community banking conference in 2013. "Some observers have worried that these obstacles, particularly complying with regulations, may prove insurmountable."
The problem has come to a head recently, though. "Dodd-Frank is a failure that is crippling small lenders under the weight of its regulations," said Rep. Steve Chabot (R-OH), chairman of the House Small Business Committee, at a September 17 hearing of the committee's Subcommittee on Economic Growth, Tax and Capital Access.
"Small financial institutions – our community banks and credit unions – are traditionally the individuals that lend to small firms," said Tom Rice (R-SC), chairman of the subcommittee. "The burdens created by Dodd-Frank are causing many small financial institutions to merge with larger entities or shut their doors completely, resulting in far fewer options where already there were not many options to choose from."
"The exponential growth of regulation in recent years is suffocating community banks' ability to serve their small business customers," said B. Doyle Mitchell, Jr., president and CEO of Industrial Bank (Washington, D.C.), testifying at the hearing on behalf of the ICBA. "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."
"Capital access for small businesses remains a critical pillar of economic vitality," said Marshall Lux, a senior fellow in the Mossavar-Rahmani Center for Business and Government at Harvard University, and another person testifying at the hearing. As of 2012, banks were the primary financial institution for over 85 percent of small businesses, and 51 percent of small business loans were from community banks, according to Lux.
"Any regulatory requirement is likely to be disproportionately costly for community banks, since the fixed costs associated with compliance must be spread over a smaller base of assets," said Lux. "Regulatory pressures such as those brought about by Dodd-Frank are undermining the competitiveness of community banks, preventing new community banks from forming, and curbing their ability to lend."
Problems are similar for credit unions. According to Scott Eagerton, president and CEO of Dixies Federal Credit Union (Darlington, S.C.), testifying at the hearing on behalf of the National Association of Federal Credit Unions, "(T)he unprecedented new compliance burden placed on credit unions has been immense. The impact of the growing compliance burden is evident as the number of credit unions continues to decline, dropping by more than 17 percent (1,280 institutions) since the second quarter of 2010." Ninety-six percent of those institutions were those with under $100 million in assets.
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