The Dodd-Frank Act includes a requirement for the regulators and government agencies to promulgate 390 rules to implement its provisions. As of the end of the third quarter of 2015, 307 rules have been finalized or proposed, leaving 83 as yet undrafted. In recognition of the burden this massive regulatory expansion would impose on business and the public, Congress included in the Dodd-Frank Act a provision for the Government Accountability Office (“GAO”) to study this regulatory burden each year and report to Congress on its findings. In a document dated December 31, 2015, the GAO issued a report entitled “DODD-FRANK REGULATIONS, Impacts on Community Banks, Credit Unions and Systemically Important Institutions.” Among other matters, the report purports to examine “…the possible impact of selected Dodd-Frank Act provisions and related rules on community banks and credit unions.”
Not surprisingly, the report found that community bankers and regulators differed in their assessment of the costs and other impacts associated with the Dodd-Frank Act. As the report says, “… community banks, credit unions, and industry associations GAO interviewed cited an increase in compliance burden associated with these rules. Some of these industry officials also reported a decline in specific business activities, such as loans that are not qualified mortgages, due to fear of litigation or not being able to sell those loans to secondary markets.”
Regulators, on the other-hand, “… told us that it is still too early to assess the full impact of Dodd Frank Act rulemakings on community banks and credit unions, and while they have heard concerns about the increase in compliance burden, they have not been able to quantify compliance costs.”
Even though the Dodd-Frank Act purports to exempt community banks from many of its provisions, anyone with regular contact with the managers of small banking institutions will be well aware that they believe they have been subjected to dramatically increased compliance costs and significantly restricted investment opportunities. That cost/earnings squeeze is particularly galling to bankers who universally believe their segment of the industry contributed virtually nothing to the financial collapse that gave rise to the Dodd-Frank Act.
Many observers believe that one of the groups most responsible for the financial crisis in 2008 was the credit rating industry which issued indefensible ratings long after it became apparent the underlying mortgages did not support the credit worthiness of the securities into which they had been accumulated. One of the most paradoxical effects of Dodd-Frank is that the altogether ineffectual provisions intended to address the short-comings of the clearly culpable credit rating agencies is wreaking serious collateral damage on the completely blameless community banks.
Dodd-Frank required that credit ratings be eliminated as a standard to determine whether an investment is “investment grade.” Federal agencies were tasked with reviewing their regulations
and replacing reliance on credit ratings with standards of credit worthiness the agency deems appropriate. Those revised regulations now provide that for any investment, an insured depository institution must determine that the probability of default by the issuer is low and the full and timely payment of principal and interest is expected. The rules governing that determination are complex, detailed and include analyses of the institution’s risk profile.
Every banker knows that reasonable, prudent due diligence is necessary for any investment and a comparison of the financial crisis losses suffered by community banks as a group versus larger institutions shows clearly the smaller banks were far more careful and aware of their duty to perform that function than the largest institutions. Community bankers have long operated under the requirements summarized as the three Cs of credit – Character, Capital and Capacity. They didn’t need the Dodd-Frank Act to tell them they must to be certain they will get their depositors money back on time when they make an investment. The problem for small banks is that the way they evaluate an investment is vastly different from the process decreed by regulatory bureaucrats.
The new rules require a process that is far beyond the capability of most community banks. There were approximately 6,200 FDIC-insured institutions with less than $10 billion in assets in 2015. Of those, nearly 3,800 had assets of less than $250 million. Those 3,800 simply do not have the staff and expertise to comply with the new standards being promulgated, at least not with confidence they will not be subject to examiner over-reach or investor law suits. These smaller banks have more employees per $1 million in assets than the larger institutions. Allocating already tight budget dollars for sophisticated investment advice exacerbates that disparity and is a totally unwarranted burden.
At a time when the small manufacturer borrower base is shrinking, the qualified mortgage rules make housing loans more difficult and CFPB auto lending restrictions eat into that market, community banks will be faced with an ever narrowing operating margin between escalating compliance costs and fewer places to deploy their depositors money. Finding investment vehicles that will provide a reasonable return and meet the new standards of credit worthiness without costly and burdensome vetting will be a continuing challenge for community bankers.