Two years after President Obama signed the Dodd-Frank Wall Street Reform Act, it is impossible to ignore the fact that the new regulatory regime primarily helps the big banks while placing its heaviest burdens on community banks and other small financial institutions.
The proof is in the pudding. As the Wall Street Journal reported earlier this year, since the 2008 financial crisis, “too-big-to-fail banks got even bigger in terms of both assets and deposits. They also seem to be reaping the lion’s share of what business-lending growth there is in the U.S.,” particularly in the second half of 2011. That trend points in a dangerous direction: “Less lending among smaller banks signals continued tough times for small businesses, typically an important contributor to economic growth,” the Journal’s David Reilly explained.
And big banks aren’t just outpacing small banks — they’re outpacing the economy at large. According to Bloomberg News, the five biggest banks’ $8.5 trillion in assets at the end of 2011 equaled 56 percent of the entire U.S. economy — an enormous jump from the big banks’ 43 percent share of the economy just five years earlier.
How did Dodd-Frank allow — even encourage — this dangerous trend? The answer should be obvious to anyone outside the Beltway. As Jim Purcell, chairman of State National Bank of Big Spring in West Texas (which is a plaintiff in the constitutional challenge to Dodd-Frank that I am involved with), explained in a congressional hearing last month, big banks can much more easily handle the law’s massive compliance costs. “Big banks have armies of lobbyists, lawyers, consultants, and compliance staffers, without denting the banks’ profitability. Community banks, by contrast, lack those resources, and every extra dollar of compliance costs is one less dollar to spend on customer service, one more dollar of cost that ultimately must be passed through to customers.”
Mr. Purcell is not alone. The Wall Street Journal reported that a July 19 conference call with the Office of the Comptroller of the Currency became a “sparring match” between federal regulators and the small bankers facing increasingly heavy-handed treatment of community banks. “We’re paying for the sins of others,” said the president of a western New York bank.
This disproportionate regulatory burden is not the only advantage that Dodd-Frank offers to big banks at the expense of small ones. Economic studies have thoroughly demonstrated that big banks enjoying implicit “too big to fail” status can attract investment capital much more cheaply than can smaller banks. The reason is straightforward: Investors see those banks as less risky, because the government implicitly stands behind those banks.
Dodd-Frank did not end this advantage for “too big to fail” banks — quite the opposite. Dodd-Frank empowers regulators to officially deem big banks and other financial institutions as systemically important. This will take what was an implicit “too big to fail” designation, and make it official — and not just for big banks, but for other large financial institutions.
We’ve seen this movie before, a hundred times. As Nobel laureate George Stigler famously summarized in his “Theory of Economic Regulation,” “every industry or occupation that has enough political power to utilize the state will seek to control entry” by newer, smaller competitors.
Finally, we must keep in mind not just Dodd-Frank’s regulatory burdens, but also the imminent application of international “Basel III” capital requirements to small banks. Basel III was originally intended to rein in only the biggest banks, but regulators are now poised to impose these new standards against even small community banks.
Suffering those regulatory disadvantages, many small banks will have no choice but to put themselves up for sale. “[W]e can expect the pace of banking mergers and acquisitions to pick up near the end of the year and escalate throughout 2013,” warns Compliance Week, citing the chief of Deloitte Corporate Finance’s financial institutions chief.
In short, Dodd-Frank and other regulations will make big banks bigger, while crippling the community banking culture that brought wide prosperity to the American middle class — community banks that, unlike the big banks, had nothing to do with the financial crisis that Dodd-Frank was purported to rectify.
• C. Boyden Gray served as White House counsel in administration of President George H.W. Bush.