Community Banking is Alive, Well: The Three Myths about Dodd-Frank and Community Banks

June 8, 2017

This post is based off remarks given at a House of Representatives briefing on the 2007-08 Financial Crisis and the current state of financial reform.

There is ample media coverage and anecdotal claims from the banking industry that Dodd-Frank is bad for community banks. It’s politically challenging to counter this narrative because nearly every county in the U.S. has a community bank, and, in turn, every member of Congress has at least one community bank as a constituent. But, if you look at the best available data on the state of community banking, it becomes difficult to buy the story that Dodd-Frank hurts community banks. The data doesn’t support the claim.

To begin, let’s set the record straight on the facts.

Community bank profitability is up. The FDIC’s most recent report showed community banks’ net income rose 10.4 percent from last year. Its 2016 quarterly profile on FDIC-insured banks found community bank revenue and loan growth outpaced the industry at large. Since Dodd-Frank was passed in 2010, aggregate profit of FDIC-insured banks, including community banks, has followed an upward trajectory.

Bank lending is up. The same FDIC report found the annual loan growth rate at community banks outpaces that of non-community banks. Loan balances for community banks rose by 7.7 percent over the past 12 months. This is more than twice the loan growth in large banks, which was 3.3 percent. Over 75 percent of community banks increased their loan balances from a year ago.

Despite this evidence, a concerted narrative pushed by the banking industry and its lobbyists has successfully convinced policymakers that regulatory relief is needed for community banks. This narrative can be boiled down to three unfounded claims: 1) Dodd-Frank is an unfair one-sized-fits-all reform that treats large and small banks the same; 2) this has prohibitively increased compliance costs for community banks, making them unprofitable and unable to lend; and 3) this has resulted in the rapid disappearance of small community banks as they are forced to merge with one another or be acquired by large banks. All three are myths and here’s why.

Myth #1: Dodd-Frank is a one-size-fits-all approach. Dodd-Frank is a tiered regulatory reform. There are explicit exemptions in the statute for community banks, and when there aren’t, regulators have accommodated for the needs of community banks.

Some examples of the special treatment for community banks include the mortgage lending rules promulgated by the CFPB, which gives small creditors greater underwriting flexibility when issuing mortgages, thereby making it easier for community banks to benefit from the Qualified Mortgage safe harbor. Community banks are also exempt from enhanced macroprudential regulations that are designed to ensure the safety, soundness and sustainability of banking activities, including more stringent capital rules, liquidity coverage ratio, and mandatory stress testing.

To put small and large banks on equal footing, Dodd-Frank requires big banks to pay more for FDIC insurance coverage to account for their size and the level of risk they pose to the financial system and the economy. Furthermore, regulatory agencies, including the Federal Reserve and CFPB, set up community bank-specific councils to assess the particular needs of community banks and how to better adapt regulations to small bank operations.

Myth #2: Burdensome and high compliance costs make community banks unprofitable. Community banks are thriving and more profitable than ever. Their revenue and loan growth continue to outpace the industry. The complaint that community bank compliance costs are high because of Dodd-Frank is hard to justify given all banks, including community banks, have always had to bear compliance costs, as regulatory oversight is needed to ensure the sound functioning of their operations which are critical to the economy.

It is true that small banks use a relatively greater share of resources than large banks for regulatory compliance, but the data show community banking is healthy and continues to gain economic strength despite these costs. The Wall Street Journal noted that “community banks are the picture of health,” though the trend is not uniform across the varying forms and sizes of community banks. Midsize and larger community banks have seen stronger growth than the smaller banks, and there are other factors at play, such as geography, technological change, low interest rates, among others, that can hurt community bank profitability.

Myth #3: Rapid disappearance of community banks through M&As. Dodd-Frank is not the cause for mergers and acquisitions in banking. The total number of banks in the U.S. has been dropping for decades because of deregulation of interstate banking. If you want to blame a law for market concentration in banking, the Riegle-Neal Act of 1994 is a more deserving culprit. This law was the final step in a long trend of branching deregulation by allowing banks to set up new branches across state borders without the need to acquire a subsidiary bank.

The 2007-2008 Financial Crisis also led to an increase in community bank failures and market concentration, especially among community banks that engaged in riskier, and often predatory, mortgage lending. Despite these factors, the FDIC found that most community banks remained resilient amid long-term industry consolidation, and the trend of consolidation has largely been confined to banks with under $100 million in assets from 1985 to 2013. During this period, the number of institutions with assets under $100 million declined by 85 percent, while the number and total asset size of banks with $100 million–$10 billion in assets increased by over 5 percent.

This is not to say that community banks do not face real challenges. Their risks are locally concentrated, and they tend to serve the least populated, rural areas that typically suffer from economic divestment and underemployment. They face competition not only from big banks, but also from unregulated online lenders, and they struggle to keep up with rapid changes in technology. But these are not reasons to let community banks off the hook from important regulations that keep consumers protected from predatory, discriminatory, and fraudulent practices. Community banks don’t have halos over their heads. For example, the Home Mortgage Disclosure Act data shows small banks struggle the most to lend to people of color, with only 11.8 percent of small bank home purchase loans going to people of color. Small banks also make by far the largest share of high cost loans across all types of lenders, at 11 percent of their loans.

Regulators have identified and made necessary exemptions for community banks when and where they were justified. It is critical not to weaken consumer protections or endanger the safety and soundness of the U.S. banking sector in the name of preserving community banking, which all the leading evidence shows are doing just fine.

It is equally important for policymakers to resist feeding the false narrative that Dodd-Frank is bad for community banks. It is simply not true. The law and regulators have given community banks ample and adequate relief. Despite these exemptions, the banking industry, using community banks as a Trojan horse, continues to push for more, demonstrating its insatiable appetite for deregulatory measures. It is important to take a step back to assess Dodd-Frank’s impact on banking and the economy at large. But the question policymakers should be asking is not what is good or suits community banks, but what best safeguards the future of the U.S. economy and interest of American taxpayers.

This is one of many myths industry and conservatives make about Dodd-Frank. Our recent report “Doomed to Repeat: Debunking the Conservative Story About the Financial Crisis and Dodd-Frank” directly dispels the leading misconceptions promoted by the conservative and industry worldview about key and critical components of Dodd-Fran