Introduction

Square-Off: Are Financial Institutions Overregulated?

We ask this question because it matters, not just to banks but to the entire U.S. economy. We need a healthy banking system for the economy to thrive. But banks are in a bind. On the one hand, we have the "fintech" upstarts who are making inroads into consumer lending and wealth management, to name two areas. They are disrupting traditional business models. On the other hand, we have banking regulators, who, in the wake of the financial crisis, have really clamped down on banks. What has that ..

Unfortunately, not all of the rules and regulations designed to protect consumers have the desired impact. Often following a crisis, such as the one endured by financial institutions in the late-2000s, regulators will respond with a one-size-fits-all strategy that does not consider the implications to large segments of the economy.

Ash Patel (2)

Ash Patel

Take community banks for instance. Six years after the enactment of Dodd-Frank, small lenders that have served as the backbone of local growth in America are still being held to the same elevated levels of compliance as systemically important big banks. These institutions are expected to apply excessive scrutiny to every applicant even if the loan amounts being sought are nowhere near the multi-million (or billion) dollar sums routinely processed by the J.P. Morgans and Citigroups of the world.

While Bank of America might be able to absorb additional compliance costs without much impact, the additional rounds of paperwork and auditing associated with reactionary regulations such as 1975’s Home Mortgage Disclosure Act are far beyond what community banks can afford. As a result, thousands of smaller banks are either not lending or they’re passing the costs onto customers with higher interest rates — even while U.S. Federal Reserve Board has been keeping rates near all-time lows. It is putting community banks at an unfair disadvantage to the bigger conglomerates, and it’s giving consumers fewer options. That is not a good combination for our economy.

It is actually riskier now because the larger financial institutions have become so much more concentrated than before the latest financial crisis.

Twenty years ago, there were approximately 12,000 banks in the nation, and now there are about 6,000. Meanwhile, the overall American economy has grown by trillions of dollars and has recently been producing an annual GDP growth of about 1%. With all of that money trading hands through fewer financial institutions at faster speeds than ever, consumers need to be protected. To do that, we need strong community banks.

The sad irony of it all is that regulators were trying to do the opposite. They wanted to protect consumers and take risk out of our banking system. The steps they took in 2010 did stop the bleeding at the time, and the markets have largely recovered since then. However, these regulations will not be sustainable for community banks over the longer-term.

Community bankers need to be able to competitively lend to consumers who need capital if their communities are going to thrive. This can only be achieved and sustained through balanced regulation — not emergency measures forged out of crisis. It has to be the appropriate regulation for the appropriate risk. A run on Commercial Bank of California would be nowhere near as dangerous as a run on Wells Fargo, so why regulate them the same?

Even though community banks are overregulated in this regard, the need for easy capital is still alive and well among the small business community. This void is being filled by underregulated fintech startups and crowdfunding platforms, entrepreneurs who are providing a solution but also a whole new set of risks. The best way to truly strengthen the financial system is to balance it with an appropriately regulated community banking sector.

Ash Patel is president and CEO of Commercial Bank of California.

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