The financial reform battle has been framed as a fight between big banks and Congress. Considering that the one of the ugliest aspects of the financial crisis was taxpayers being forced to bailout out giant financial institutions after discovering that they were so large that they couldn't fail without taking down the rest of the economy, this interpretation would seem logical. So in order for Congress to address the problem of too big to fail, shouldn't it be bullying the big banks, to the benefit of the smaller ones? You might think so, but there are a number of provisions in the Senate bill that worry community bankers. They fear that some aspects of financial reform will benefit the big banks and put the smaller ones out of business.
A Common Problem with Regulation
Most of the worries of community bankers boil down to a general problem with regulation: compliance with new rules requires that additional expenses are incurred. For a large company, these new costs aren't as harmful. They benefit from economies of scale -- an advantage where new fixed costs can be more easily absorbed by a larger company's higher profits.
For example, imagine two widget factories: one big one that employs 5,000 people and a small one that employs just five. If a new regulation requires all widget-makers to hire one person in charge of monitoring quality control, the big company's labor costs increase by 0.02%, while the smaller firm's labor costs increase by 20%. Smaller companies take a much bigger hit to their proportionally smaller earnings when additional regulation is imposed.
Applying This to Financial Reform
The Senate's financial reform is not an exception to this rule. There are a number of provisions that would hurt community banks due to their costs increasing disproportionally to those at larger institutions. Steve Wilson, Chairman and CEO of LCNB National Bank in Lebanon, Ohio, explains:
It's amazing how they've called this the Wall Street rein in act, and yet the overall bill is more targeted towards additional regulatory burdens -- additional regulations on the Main Street banks. We have identified, within the bill proposed in the Senate now, we have identified 27 new regulatory burdens that come to us.
One such new regulation that concerns Wilson would require additional reporting requirements for its depositors, which would include "geo-coding" to track residential or business locations. Wilson asserts that this won't be easy for some small community banks. They also must follow rules that forbid underwriters from discriminating based on a borrower's race or ethnicity. As a result, the new regulation will force small banks to hire additional employees in order to remain compliant with the existing rules. He points out the problem:
So how does a small bank that has one or two underwriters gather this information but not look at it? Not only do you have the burden of doing this job with a limited number of people, but you have an increased cost because you're going to have to go out and hire another person to do that.
Broader Competition Issues
Beyond additional costs imposed by regulation, some community bankers also fear that certain provisions in the Senate bill will provide big financial institutions with a competitive advantage. One aspect includes the $50 billion resolution fund that only big banks would have access to when being wound down due to their bankruptcy. David Bochnowski, Chairman and CEO of Peoples Bank in Munster Indiana, thinks this fund is a major problem for small banks. He believes it may continue to make big financial institutions appear to be too big to fail, and consequently safer, to consumers and businesses. He also thinks creditors will sell big banks cheaper debt if they can be assured to get more back through the fund in a failure event.
Some aspects of the proposed Consumer Financial Protection Bureau also concern Bochnowski. In particular, its broad discretion over determining whether an act or practice is "unfair, deceptive, or abusive" will make business much harder for community banks. Often, they serve a small niche of customers, so one-size-fits-all underwriting requirements may not allow for the flexibility they need. He was also concerned with a provision that would invalidate an entire transaction if a single of the Bureau's rules are broken.
Community Banks Not the Problem
A major cause of the financial crisis was the rise of subprime mortgages. But community banks -- which are already forced to follow strict rules -- weren't to blame, according to Steve Wilson. He blames non-bank mortgage brokers, noting that 76% of the bad loans were originated by the unregulated sector:
That's where the problem was created. That's where you were overextending people. We tell people "no," because we want them to be successful.
This bill does not go near far enough, nor does it even scratch the surface of regulating the unregulated. It's about more regulations on the regulated sector that didn't case the problem. You're gonna drive a certain number of them out of business.
Bochnowski also expresses frustration on this point, saying that community banks were not part of the subprime problem. Still, he is upbeat on the bill, calling it a "great start." He just believes that it needs to be honed to better protect livelihood of small banks.
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