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The Unknown Costs of Dodd-Frank Banking Regulations

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A recent study from the FDIC makes it clear that no one has any idea what compliance with financial regulations, including the Dodd-Frank financial reforms, actually costs.

Here's the language from the study's executive summary:

One question the study tried to address was how regulatory costs have changed for community banks over time. Unfortunately, the data available through Call Reports and other regulatory filings do not provide a breakdown of regulatory versus other types of noninterest expenses. As part of this study, the FDIC conducted interviews with nine community bankers to better understand what drives the cost of regulatory compliance at their bank (see Appendix B). Most interview participants stated that while no one regulation or practice had a significant effect on their institution, the cumulative effects of regulatory requirements led them to increase staff over the past ten years. Moreover, the interviews indicated that it would be costly in itself to collect more detailed information about regulatory costs. As a result, measuring the effect of regulation remains an important question that presents a challenge.

In short, no one knows nothing.

This is an important blind spot in our regulatory regime. Nearly everyone who doesn't actually work for a goliath international bank complains about banks that are too big to fail, too big to jail, and too big to manage. But it seems very likely that our attempts to impose further regulation on the financial sector are leading to even more consolidation and concentration in banking.

The facts of bank consolidation are striking. From 1984 to 2011, the number of small banks—those with assets of less than $25 million—declined 96 percent. The number of banks insured by the FDIC declined from 17,901 to 7,357. Meanwhile, banks with over $25 billion saw their share of industry assets rise from 27 percent to 80 percent.

Many critics of the banks assign the blame for this growing concentration of wealth and financial influence—and risk—to deregulation. But this runs contrary to the fact that the number of supervisory regulations applicable to banks has grown over the last few decades.

Oddly enough, in light of the increasing supervisory regulation imposed on banks, bank failures have been one of the largest sources of consolidation, as failed banks are consolidated with healthier banks. Why didn't increased regulation prevent these failures? Most likely because many of the regulations weren't aimed at safety and soundness. Instead they were put in place to accomplish other political goals—fair lending, law enforcement, national security and consumer privacy and protection.

The closest thing we've seen to deregulation is actually something else entirely. Instead of relaxing supervisory rules, the government relaxed structural rules that had discouraged the opening of new branches and made interstate mergers more difficult. And, of course, the Glass-Steagall wall between investment banking and commercial banking was torn down.

We know from long experience that smaller businesses are disproportionately impacted by regulatory costs. Compliance with environmental regulations costs 364 percent more in small firms than in large firms, according to a study by the Small Business Association. We don't know—no one knows, apparently—the costs of financial regulation, but it's probably safe to assume the same kind of disparate impact exists.

In other words, the effect of tightening of supervisory financial regulations, especially those not geared to safety and soundness, with the loosening of structural regulation has been to encourage consolidation.

You would think that finding a better way to measure the cost of compliance with financial regulation would be a top priority. But it's only starting to attract attention.

In a hearing Wednesday, the House Financial Institutions Subcommittee took a look at the FDIC report.

Here's what the committee statement said:

A portion of the report focused on the regulatory costs for community banks, where the participants stated that no one regulation, but rather the cumulative effects of all regulatory requirements weigh down their banks. The regulatory burden is also preventing new community banks from forming. No new community bank charters have been granted since 2011, due in part to the regulatory burden of Dodd-Frank.

A majority of the bankers interviewed also reported that their banks are increasingly relying on third-party consultants and service providers to assist with interpreting and implementing new or changing rules and regulations, citing their inability to understand and implement regulatory changes within required timeframes and their concern that their method of compliance may not pass regulatory scrutiny.

"The FDIC study attempts to quantify the growing burden of complying with the myriad of financial regulations for community financial institutions. This was a common theme for our subcommittee last Congress and I expect it will continue to be a common concern for community bankers going forward. In January of 2011, just six months after the Dodd-Frank Act was signed into law, we heard from a community banker in West Virginia who already hired an additional compliance officer to deal with the increasing complexity of compliance," said Financial Institutions Subcommittee Chairwoman Shelley Moore Capito (R-WV).

"I understand this is a difficult figure to quantify but we must keep up the discussion amongst policy makers, regulators, and community bankers about ways to reduce this growing burden. We need to have safely run financial institutions in our local communities, but we must ensure that the costs of compliance do not outweigh the benefits and that regulations emanating from Washington can be handled by Main Street lenders," Subcommittee Chair Capito added.

It's a start, at least.

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