How the Dodd-Frank “Too Big to Fail” Legislation Hurts Small Banks

We have written numerous times about how the Dodd-Frank “Too Big to Fail” legislation is hurting smaller banks and interfering with loan approval for your small and medium-sized businesses.

Much of the regulation was designed to stop large money-center banks from taking depositor’s money and executing risky investments or engaging in risky transactions, which would thereby place the public at risk as well as the US financial system.

However, the unintended consequence of the law has created significant regulatory pressure on small and medium-sized banks, which has caused the regulators to take a one-size-fits-all approach to bank regulating. We can all agree the risks facing small and medium-sized banks are different than those facing the large money-center banks.

Compliance costs alone eat into the profits of the smaller banks, whose scale is smaller and has less profit than more major banks. The portfolios of the smaller banks are vastly different than those of larger banks as well. Most small banks lend into their communities and can assess the economy and risk related to their portfolio first-hand. This is not possible for the larger banks, as their footprint spans either a region of the US or the entire US. This leads to centralized decision- making with computer aided modeling to ensure that the loans are underwritten as conservatively as possible. Though not a negative thing, it’s different from how smaller banks are chartered to operate.

In most cases, the three “C’s” are used in small bank lending because the small town banker knows his customer. Credit, Character, and Collateral are what the small town banker relies on. Federal regulations do not see it the same way, causing conflicts between operation and management. The best way to manage it is to reduce the amount of loans and use the most rigid standards, which do not help the community that these smaller banks are chartered to help.

Congress has been listing to these smaller banks and indicated they would enact legislation to reduce the regulatory burden so they could operate like they should. It is important to note that very few smaller banks were affected by the financial crisis. The Republicans are attempting to provide relief for smaller banks while Democrats require that all of the Dodd-Frank provisions be in place for every bank regardless of size.

The Fed supports the changes for small and regional banks. However, it does not seem that these smaller institutions will be released from the “Too Big to Fail” category any time soon. As the economy continues to grow, and your need for working capital increases, please remember to call or email Capstone Corporate Funding, LLC at (212) 755-3636 or [email protected].