Dodd Bill's Hidden Target: Community Banks

Sen. Chris Dodd’s financial regulatory reform bill, on which the Senate is slated to take a cloture vote this afternoon, has been the subject of much criticism of late, primarily for what opponents say amounts to a de facto institutionalization of “too big to fail” with regard to the biggest power players in the financial sector.

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However, Capitol Confidential has learned that there is another, equally troubling aspect of the bill that observers say is going unnoticed in the debate surrounding Dodd’s proposals: Its hammering of community banks. Relatively small institutions compared to the names often cited in the news, community banks typically operate in small towns, urban neighborhoods or the suburbs. Their remit usually involves funding small businesses that require credit in order to operate payrolls and to expand, and lending to families financing home purchases or college. Many of those familiar with the banking industry, overall, say that community banks bore little to no responsibility, on balance, for the financial meltdown that occurred in 2008. Nonetheless, an analysis of the Dodd bill indicates that if it passes, community banks will be subject to a whopping 27 new regulations that one individual who has worked with banks professionally and is closely tracking the legislation says “could threaten to put many community bankers out of business, thus reducing competition in the banking sector overall, and diminishing consumer choices.”

That individual further asserts that while the bigger, Wall Street banks will likely be able to adapt to the bill (though their efficiency and ability to compete internationally could take a knock), the community banks will not–potentially making the system more risk-prone, also.

At some community banks, staff already work with what can be 1,000 pages or more of regulation with which they must comply daily. The Dodd bill would notably add to this, and observers say its 27 new regulations would, were the bill passed and signed into law, vastly increase administrative costs to banks, and diminish their ability to provide valuable customer service by focusing employees’ attention on compliance, rather than meeting customers’ needs. One example of such new, burdensome regulation might be the requirement that banks ascertain upfront whether small businesses seeking loans are women or minority owned, and then handle that information in ways that could potentially prove cumbersome in terms of internal administration. Another would be the requirement that banks itemize each loan according to 12 specific criteria, in addition to others that the Consumer Financial Protection Bureau (CFPB) may deem appropriate.

Community banks could also suffer from provisions making it tougher to move loans off their books, which those involved in the industry say could ultimately negatively impact their ability to make new loans to businesses and families in their communities. Backers of financial reform say that such restrictions are necessary, to ensure that lenders aren’t making credit available to people who will never repay it, without themselves retaining substantial risk for doing so. However, critics say this discounts a core reality of community banking: Community banks have a better track record of making quality loans than do the non-bank lenders whose actions experts say were responsible for the meltdown in 2008, and who critics charge were too disconnected from the people they purported to serve. Furthermore, some banks are concerned about lower lending limits that could be foisted upon them under the bill, and which they say could affect their ability to meet ongoing customer needs.

Still another difficulty presented by the Dodd bill is the prospect that community banks could find themselves regulated by multiple different entities, including (depending on their structure) the Federal Reserve, the Federal Deposit Insurance Corporation, and the new CFPB.

Experts who have reviewed the Dodd bill’s language say relatively simple changes could ensure a regulatory overhaul that will prevent the kind of situation that arose in 2008 from occurring again without hammering community banks. If these changes are not made, they warn that, were the bill to be passed and signed into law, we could end up with a more risk-prone system that is host to less competition and more consolidation of power and money in the hands of many of the actors whose behavior instigated the meltdown in the first place. However, a key question that remains is whether political leaders driving this legislation want a real solution, or what one critic called “a bright shiny object that looks like meaningful, effective financial reform to wave at the voters come November.”

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