Dodd-Frank Act spells trouble for small banks

With the onset of the Dodd-Frank Act in July, community banks are bracing for an onerous wave of new regulations that will tax their resources and could ultimately force them to merge with larger banks.

The American Bankers Association predicts the Dodd-Frank Act will help drive more than 1,000 banks out of business by the end of the decade.

On the compliance side, Dodd-Frank has serious implications for community banks, as more than 5,000 pages of new rules are expected to be issued by the Consumer Financial Protection Bureau, said Rose Oswald Poels, president and chief executive officer Wisconsin Bankers Association.

“We are expecting compliance costs to increase dramatically,” Oswald Poels said. “This will force all banks to have a dedicated compliance officer, or officers, in order to stay on top of the changing regulations. There is no question it will add to the cost of running a bank.”

At the community bank level, there is typically someone who wears the compliance officer hat, but it might be one of several responsibilities, and that person is not dedicated solely to compliance, she said. With Dodd-Frank set to take effect on July 21, that part-time role will no longer be enough to help banks meet the new set of regulatory standards.

“We are going to have to invest a lot more money into people and resources to manage the heavier compliance load,” said Brad Quade, regional president for the Milwaukee division of Johnson Bank. “Right now it’s requiring a great deal of additional resources to get our arms around what the expense will be going forward.”

“Obviously, the smaller you are, the larger the burden that places on you,” said Steve Steiner, a senior vice president with North Shore Bank in Brookfield.

Under Dodd-Frank, the Consumer Protection Financial Board (CPFB) has total rulemaking authority and is expected to create rules that will protect consumers at the expense of the banks. Because the new rules written by CPFB won’t require the approval of customary bank regulators, it creates potential for a conflict between consumer protection and financial soundness, Steiner said.

“We are not happy about that, most regulatory agencies have a board, this is putting all of the power in the hands of one director,” Oswald Poels said. “Between that, and all of the authority they have been given to rewrite existing regulations, and create new ones, it is a lot of power they have to affect community banks.”

The Durbin amendment

Perhaps the most immediate item under Dodd-Frank that impacts banking are the interchange rates that banks charge for debit card transactions. The so-called Durbin amendment that governs interchange rates puts a cap on fees that can be charged for debit card transactions and is meant to target the very large banks, Oswald Poels said. But, when the marketplace adjusts, it means the smaller banks will be negatively impacted, as well, she said.

As part of a debit card transaction, the merchant deposits a sales draft at their bank, and there is a charge that comes out of that to pay the cardholders bank for handling that transaction. The Durbin amendment authorizes the Federal Reserve to establish the interchange rate that is paid by the merchants to the banks. The Fed has proposed a capped rate of 12 cents per transaction, which is approximately 25 to 30 percent of what banks currently receive in interchange fees, Steiner said.

“The merchants would pay less, banks would receive less income, and most banks would say they can’t afford to offer this at a loss, and would therefore and make it up elsewhere, likely by passing it on to cardholders,” Steiner said. “It ends up being a gain for the merchant, and

a loss for banks and consumers.”

Steiner says banks have spent a lot of money over the last 20 years promoting acceptance of debit cards and the systems that support them, resulting in soaring use of debit cards over the last five years. In effect, the new law says the cost cannot be passed through for all of the supporting investments and systems used to promote and support debit cards.

“We will have to take some combination of actions to compensate for this loss of revenue,” Steiner said. “It will mean we are losing money on every transaction that a customer of ours does with a debit card. Through some combination of pricing and cost reduction, we will have to offset that somehow.”

Currently, a bipartisan coalition led by Sen. Jon Tester (D-Montana) is seeking to delay implementation of the Durbin amendment and study it for 15 months.

High capital standards

Another unknown under Dodd-Frank is that all banks will have to increase their capital thresholds and percentages, Oswald Poels said. Implementation of the act requires a study for capital levels that should be in place for all banks. Current percentages start at eight percent for Tier 1 capital, and 10 percent for risk-based capital, while some banks are required to maintain levels of nine to 12 percent, she said.

“The more money you have to put aside to meet capital standards, the less you have for what you were put in business to do, which is make loans,” Oswald Poels said. “Where it goes from here is unknown.”

Already, some 42 banks have failed this year because of continuing loan problems. Because smaller banks tend to make loans that bigger banks won’t touch, the increased burden stemming from Dodd-Frank makes for an uncertain future.

“Congress took a sledgehammer to get at a mosquito,” Oswald Poles said. “We are not happy that this is putting all of the (rulemaking) power in the hands of one director.”

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