Dodd-Frankly speaking, this act is wearing thin

In making Dodd-Frank’s provisions applicable to banks of all sizes, federal regulators trapped community bank dolphins in a Wall Street tuna net.

From the pages of In Business magazine.

The five-year anniversary of the Dodd-Frank Wall Street Reform and Consumer Protection Act has come and gone, but not without an avalanche of criticism. The law that was enacted to head off another financial crisis by reducing systemic financial risk and put an end to “too-big-to-fail” institutions on Wall Street is becoming a thorn in the side of community banks and credit unions.

While there is disagreement among bank executives about the severity of the impacts, particularly among banks of different sizes, community bankers and credit union executives say the law’s subsequent rule making and regulatory interpretations are doing real economic harm to banks, small businesses, and consumers. What’s more, the laborious rule-making process is nowhere near complete, so in their view, more harm is likely to come.

Jim Tubbs, president and CEO of State Bank of Cross Plains, acknowledges the noble intent behind the law, but notes that almost 400 new regulations will come out of the law, and his research indicates that federal bureaucrats are not even halfway through the rule-writing process. “So that, in itself, is already pretty daunting to know — that with everything that has transpired in the first five years of the Act, we’re still a long ways away from really swallowing everything as an industry,” he states.

The 2,300-page law, named for chief sponsors who are no longer in Congress — former U.S. Senator Christopher Dodd of Connecticut and former U.S. Rep. Barney Frank of Massachusetts — is considered the most sweeping rewrite of the nation’s financial laws since the Great Depression-era banking reforms. However, critics contend that none of the law’s promises have come to pass, noting that too-big-to-fail institutions are still with us, big banks are even bigger, smaller banks are fewer in number and pondering mergers with larger institutions, and bank fees have increased while the number of financial products available to consumers have decreased.

Some critics pin the nation’s stubbornly modest economic recovery on Dodd-Frank because even as the Federal Reserve’s quantitative easing has built up bank reserves, overall lending hasn’t increased that much. In Wisconsin, however, the overall picture is brighter, as the state’s 185 chartered banks reported an 8.7% increase in net income and a 6.3% increase in total lending during in the first half of 2015 compared to the same period of 2014, according to data released by the Federal Deposit Insurance Corp. The first half includes a lower past-due loan ratio of 1.71%, and a 6% rise in commercial and industrial lending, which topped $5.5 billion, according to the Wisconsin Department of Financial Institutions.

Even with those encouraging numbers, one of Dodd-Frank’s most vocal critics is Rose Oswald Poels, president and CEO of the Wisconsin Bankers Association. She states that banks of all sizes continue to struggle with what she called the law’s overwhelming regulatory burden, which affects small community banks to a disproportionate degree. “The regulatory burden is almost like a snowball that keeps growing into an avalanche because it’s just not over yet,” she states.

Sense of community

Community banks, which make the bulk of small business loans, are reportedly overwhelmed not so much by Dodd-Frank, but by the complexity of the rules handed down by federal bureaucrats. They are hiring more compliance officers to deal with the complexity of emerging Dodd-Frank regulations, but they aren’t hiring as many people to process business, consumer, and other types of loans. To build the necessary scale, they are also giving strong consideration to merging with larger banks.

John Patti, a mortgage loan officer with State Bank of Cross Plains, works with a young couple on their mortgage loan. Other community banks are thinking about getting out of the mortgage lending business because of the cost impacts of the Dodd-Frank Act. (Photo: Adam Crowson)

For many, lumping community banks in with the Wall Street “perps” that helped cause the housing and financial collapse was akin to catching dolphins in a tuna net. “With regard to the concept of the Act, it was done in good faith,” Tubbs states. “We certainly had a financial collapse, and the Act was to prevent another collapse from happening. Hence, more transparency within the so-called Wall Street banks, as well as a complexity of being able to monitor the too-big-to-fail banks — once again, on Wall Street.

“Last but not least, as the long title states, we needed more protection for consumers. So without question, the concept behind the Act was established in good faith, but unfortunately the consequences have been quite a burden on community banks.”

That burden, he adds, involves researching, interpreting, understanding, and then enacting the regulations that have been passed down. In the past, these regulations would have been just four or five pages long, but now they could be as long as 100 pages for one rule. As a result, the bank’s compliance expenses, including personnel and software upgrades with new forms, applications, and disclosures that are aligned with new rules, have increased 40%.

“So we will have to research and interpret, and then make sure that our systems, policies, and procedures are in compliance with that regulation,” Tubbs says. “To say the least, the increase in cost has skyrocketed for community banks to be able to monitor and measure how we’re doing in relation to all these regulations that are being passed down to us.”

Since banks have to maintain profitability to provide a good return to the shareholders who have invested in them, banks pass those costs to their customers to the extent that they legally can. In that environment, Tubbs notes that there are fewer free services unless certain conditions are met — free checking through a rewards program or another incentive — and consumers see different kinds of service charges. So while banks invest in compliance and in conveniences like mobile banking services, “the industry has to find new ways to pass on these expenses, these costs to the consumers in order to maintain an appropriate level of profitability for return to our shareholders,” Tubbs asserts.

One area where banks are likely to engender little public sympathy is with their complaints about the Durbin Amendment, named for U.S. Senator Richard Durbin, D-Illinois. That part of the Dodd-Frank law placed a cap on the fees banks can charge to retailers to process debit card transactions, which cuts into a bank’s revenue for common transactions. Tubbs cited one statistic that says the cap pulls $14 billion in revenue out of the financial industry, but however large the impact, it means finding other ways to increase revenue.

“If that isn’t being passed on to the consumer, and the bank’s profitability has now been impacted, you’re going to have shareholders who are more disgruntled with their return, and you’re not going to be able to fund your benefit program, whether it be 401(k)s or other things, as much as you hoped you could,” he explains. “So you could end up then with more turnover.”

Tubbs suggested that disgruntled shareholders and disappointed employees contribute to an environment for increased mergers and acquisition activity. He notes the overall number of banks has decreased in number from over 8,000 a few years ago to about 6,800 today. Some of this decline is due to bank failures stemming from poor operational decisions, but some is also attributable to costly regulation.



Betting the mortgage

Another goal of Dodd-Frank was to protect consumers, particularly people who are in the market for a mortgage loan. In the years leading up to the financial crisis, the law’s backers believe that many consumers fell pray to predatory lenders in the subprime market. In many cases, these were people who weren’t financially qualified to own a home but were encouraged to get into an unmanageable level of indebtedness and within a short period of time, found themselves overextended and facing foreclosure and bankruptcy.

To avoid a recurrence of this scenario, the law established the Consumer Financial Protection Bureau, which was charged with preventing predatory mortgage lending and with improving the clarity of mortgage paperwork (disclosures) for consumers. However, local credit union executive Kim Sponem, president and CEO of Summit Credit Union in Madison, says consumers are more confused by the increasing amounts of paperwork.

Sponem notes that a year ago, there were 3,000 pages of new regulations with regard to mortgages coming out of the CFPB, and that all institutions — banks and credit unions — needed to comply with them. This year, regulators followed up with more rules under the Real Estate Settlement Procedures Act, or RESPA, which requires more disclosures, reprogramming of systems, testing, and “an enormous amount of time that is diverted away from our core mission,” Sponem says. “Some of the things that the law is trying to do is confusing to people. There is additional paperwork and you have to delay now the loan closings and that adds more time to the process, and consumers don’t like that. That was not the intent of the law, but that was the outcome.”

“The regulatory burden is almost like a snowball that keeps growing into an avalanche because it’s just not over yet.” — Rose Oswald Poels, president and CEO of the Wisconsin Bankers Association

Oswald Poels says banks also have been hurt in mortgage lending because in addition to more costly and confusing paperwork, the regulations that have come from Dodd-Frank restrict a bank’s ability to subjectively analyze a mortgage loan. In the past, when banks analyzed credit, they examined the financial aspects but also looked at the character of a prospective borrower. “They have really removed any ability to factor in who your customer is in terms of their background, their expertise, and whatever it might be,” she says. “They might be new to a job, but you know they are hard-working people and they are going to succeed, and so you’re just willing to take the risk there to provide that mortgage loan to help them get a house.”

Steve Hansen, vice president and senior residential sales manager for Associated Bank, suggests that different banks view Dodd-Frank differently. He says Associated Bank, a Midwest regional institution, has been able to support compliance with the assistance of its sales and regulatory teams, processing operations, and compliance department. While such capital and human resources have allowed Associated Bank to stay on track, Hansen notes the resources of a community bank are often more limited.

Hansen believes Dodd-Frank has helped clarify what the consumer’s closing costs are going to be. He says the law allows banks to do more for the consumer, including set expectations for them, establish better communication and rapport, and give them an interpersonal level of service throughout the process. The intent of the law is to have no surprises for the consumer, “so they make the best possible decision they can when they finance the purchase of a home,” he states. “To illustrate, when they come in the door for the first time and sit down and do that initial disclosure, what’s all involved with the transaction of buying the home? What is going to be needed for the home’s actual cost? Then it goes into the lending process and, timing-wise, when we need to deliver documentation to the customer and have their decision made on the loan. Then, when they get to the actual closing table and get that settlement to review, it’s going to be close to what was given to them on the initial estimate. There may be a few changes along the way, but those changes will be fully disclosed and they will receive the documentation.”

While community banks consider getting out of the mortgage lending business, Hansen does not envision this scenario for banks in general, especially with more millennials expressing an interest in home ownership. “It’s something that is still a very strong product in the bank’s arsenal of consumer products,” he says. “We see the mortgage sometimes as the door-opener for the bank.”

More regs or smart regs?

Dodd-Frank was based in part on the premise that the financial crisis was caused by deregulation, yet financial regulations on financial services were hardly shrinking when the financial crisis hit. They grew every year between 1999 and 2008, including regulations related to Sarbanes-Oxley, the 2002 law enacted in response to the accounting scandals of the 1990s. To critics, it wasn’t deregulation that caused the 2008–09 financial crisis, it was ill-considered regulation, particularly the loosening of underwriting standards in mortgage lending.

One solution to the regulatory burdens imposed by Dodd-Frank is a size limitation on the banks these regulations apply to. Tubbs notes this idea isn’t foolproof because some of the regulations already have size parameters, only to have bank regulators overrule the rule writers. “They (rule makers) state that this regulation would be for banks that are $50 billion in assets, and that of course would be a very, very large bank,” he notes. “The challenge that we have is even though that might be how the regulation is written, our bank regulators will say, ‘Even though you don’t fall within that, we want you to make sure that you can abide by that.’”

So a best practice meant for large banks becomes an expensive requirement for community banks. “Putting a size threshold would be wonderful,” Tubbs adds, “but then we need the regulators to also understand that it’s okay not to have that best practice here because maybe that’s not the best thing for our community bank and the community it serves.”

Noting that some large banks are very traditional in what they do and aren’t as aggressive as some smaller banks, Oswald Poels recommends peeling another layer from the onion and regulating accordingly. “I think the better formula we would prefer to see the regulators take is sort of a risk-weighted approach to regulation,” she recommends. “So they would tier it to the risk and complexity, not so much the size of a bank.”

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