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Mom-And-Pop Banks Apparently Too Small To Matter For Dodd-Frank

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A study out of Harvard University claims that the Dodd-Frank Act has done more harm to community banks than the financial crisis it was ostensibly designed to prevent.

The study “focuses on the plight of community banks in the United States,” whose share of U.S. banking assets and lending markets “has fallen from over 40 percent in 1994 to around 20 percent today.” (RELATED: Warren Accused of Clinging to Dodd-Frank at Expense of Middle Class)

According to the study’s authors, Marshall Lux and Robert Greene, a senior fellow and a research assistant respectively at Harvard’s Kennedy School of Government and Robert Greene, the community bank “is a financial structure shaped by the tendencies of U.S. politics toward decentralization and local control,” providing an alternative to larger banks and helping to offset their out-sized influence on the financial sector.

The gradual decline of community banks has been periodically accelerated by disruptions such as the savings and loan crisis of the 1980’s or the 2008 financial crisis, but their rate of decline has continued to increase in recent years despite the absence of any significant market fluctuations.

Lux and Greene claim that, “community banks withstood the financial crisis of 2008-09 with sizeable but not major losses in market share”—shedding 6 percent of their market share between the second quarter of 2006 and mid-2010.”

However, since the second quarter of 2010, “around the time of the Dodd-Frank Act’s passage, [they] found community banks’ share of assets has shrunk drastically – over 12 percent.” (RELATED: Dodd-Frank a Total Failure, Bipartisan Panel Agrees)

Dodd-Frank, which many critics considered to be at best a gut-level reaction by Congress to the financial crisis, was billed as a way of ending the “too-big-to-fail” status of large banks, so from both a political and an economic perspective it is worth examining the law’s practical effects.

Lux and Greene note that, “[Government Accountability Office] reports, regulators, industry participants, and Fed studies all find that consolidation is likely driven by regulatory economies of scale,” but contend that those studies “fail to assess the impact that regulatory burdens have had on consolidation of the community bank sector.”

“In 2012 congressional testimony,” the authors recount, William Grant, then-chairman of the Community Bankers Council of the American Bankers Association, “made a ‘very conservative’ post-Dodd-Frank estimate of total industry compliance costs at $50 billion annually, or 12 percent of operating cost.”

In addition, Grant told Congress that, “The cost of regulatory compliance as a share of operating expenses is two-and-a-half times greater for small banks than for large banks,” suggesting that any large-scale regulatory reform would tend to increase consolidation in the industry.

To get a better idea of the impact regulations have on small banks, the authors contacted a firm that handles regulatory compliance concerns from community banks to ask which compliance-related complaints they hear most frequently from customers.

Rules put in place by the Dodd-Frank Act not only topped that list of most-burdensome regulations, but took the second and fifth spots, as well.

Due to the increased compliance costs associated with Dodd-Frank, the authors claim, “regulation—as opposed to market forces—appears to be an increasingly powerful force driving the growth of bank mergers.” (RELATED: Dodd-Frank Makes Future Taxpayer Bailouts More Likely)

Although “consolidation is not inherently a bad trend,” they say, “policymakers should be concerned that a critical component of the U.S. banking sector may be withering for the wrong reasons.”

Lux and Greene stop short of calling for the repeal of Dodd-Frank, but do say that, “Congress should act to improve existing regulatory processes,” and encourage policymakers to “examine simpler capital rules and various rule exemptions for community banks.”

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