The Dodd–Frank Act has created significant challenges for financial institutions, especially for smaller community banks. The legislation was designed to promote the safety and soundness of America’s financial institutions, but some small banks are finding it a struggle to meet DFA’s additional regulatory requirements.
Here is a sample of DFA components presenting challenges to smaller banks:
Dodd-Frank also established a $10 billion assets threshold that, once surpassed, designates a bank as a midsized institution. This requires them to comply with an additional set of regulations involving significant expenditures of time, effort, and money. Conversations with many banks, however, indicate that the pressure to comply with certain aspects of DFA starts well before reaching this threshold. Regulators are sending a message that banks under the threshold with moderate to aggressive plans for expansion through organic growth or acquisition need to demonstrate their ability to comply with enhanced compliance requirements well before taking such actions.
Many banks believe that the enhanced regulatory requirements associated with crossing the $10 billion threshold contain implicit penalties that discourage aggressive growth or acquisition.
The requirements of being categorized as a midsized institution are extensive. They include investments in new systems, hiring new compliance specialists, enhancements to existing risk management processes, and diverting current employees’ time and resources from traditional revenue-producing activities towards compliance.
Enhanced Dodd-Frank requirements add significant expenses to a bank’s existing cost structure. That only compounds the challenges banks face in an environment where low rates and uncertain economic conditions have already compressed margins and earnings.
These requirements include:
A Rock and a Hard Place
The costs of meeting new compliance requirements is straining small banks’ expense structures, compressing the margins of traditional banking activities, and making it more difficult to compete. As a result, banks are making their products more vanilla since they are discouraged from developing innovative products and services. They are hiding in the safety zone to avoid attracting regulatory attention, further reducing the value of their franchise.
And franchise value is exactly what banks need in this environment. As increased regulatory burdens lead small banks to reconsider their product line and service offerings, some are considering exiting tradition banking activities. Others are contemplating exiting banking altogether by putting their institutions up for sale. Dodd-Frank is fueling bank consolidation as some smaller institutions grasp for ways to extract value from their franchises.
Unfortunately, the very regulations that are driving banks to consolidate are also diminishing their core value as they become less profitable. There simply aren’t many exit strategies when earnings are constrained in a time of higher capital requirements. Community banks are stuck between a rock and a hard place.
Dodd-Frank will continue to be a speed bump for small banks looking to expand their business and grow beyond the $10 billion threshold. If community banks want to grow and be successful, they’ll need to take a step back and form a strategic plan to navigate and satisfy the regulatory burdens that come about when approaching this mark. Small banks must evaluate a variety of alternatives that could help them continue to remain competitive in this environment and ensure a successful path to preserving the franchise’s value.
Rob McDonough is a senior consulting manager for Angel Oak Consulting Group, a risk management consultancy to depository financial institutions, investment firms, and regulators. He previously spent 12 years as an economic analyst and capital markets examiner with the Federal Reserve System.