WASHINGTON — The Dodd-Frank Act has become the catchall for a litany of alleged harms, not the least of which is the decline of small banks.

Sen. Marco Rubio, R-Fla., a presidential contender, charged earlier this month that the reform law is "eviscerating" the community banking industry — an all-too-common refrain, even if his data proved to be overstating the case.

Yet while it's clear that the banking industry continues to shrink, how big a role Dodd-Frank is playing in the decline is debatable. Below we offer a look at what the financial reform law has meant for small banks, along with some of the other economic and market forces that are contributing to industry consolidation.


Overall, the total number of banks in the country has been gradually declining for decades.

There were more than 18,000 institutions in the 1980s, compared to just over 6,400 in the first quarter of 2015, according to the Federal Deposit Insurance Corp.

Despite a myriad of competing forces on the financial services industry over that period, the rate of consolidation has proven to be fairly gradual, averaging out around 3.5% each year. The pace did slow somewhat in the mid-2000s, but the shrinking has never stopped or reversed.

On average, it is only slightly higher since the passage of Dodd-Frank in 2010, falling by about 4% per year since 2009.

Small banks continue to make up the vast majority of the financial services industry — 98% of banks have fewer than $10 billion of assets, while 89% are smaller than $1 billion.

The biggest impact of consolidation has been on the largest and very smallest banks, according to a 2014 FDIC report. Institutions smaller than $100 million declined by 85% from 1985 to 2013, while banks with more than $10 billion of assets nearly tripled.

The credit union industry has evolved in a similar fashion. The number of federally insured credit unions has slowly fallen from roughly 18,000 around 1980 to just over 6,200 in the first quarter of 2015, according to the National Credit Union Administration. The smallest institutions — those with fewer than $10 million of assets — have taken the biggest hit over that period.

But some regulators do not blame Dodd-Frank for causing the recent decline.

"Right now when we look at consolidation trends in credit unions, we're not able to pick up a shift or acceleration" since Dodd-Frank was passed, said Ralph Monaco, a senior economist with the NCUA. "That's not to say Dodd-Frank is not having an effect, but along with other factors moving the industry toward consolidation, it's not having an outstanding effect."

It's worth noting that while the number of financial institutions continues to decline, the financial services sector is growing. The spoils are simply shared among fewer players. The banking industry now controls over $15 trillion of assets, while the credit union industry oversees more than $1 trillion of assets.


The raw numbers alone don't necessarily give a complete picture. For critics of the law, it remains clear that Dodd-Frank is at the root of the industry's problems.

"Since the fall of '08 we have lost one community bank a day seven days a week … as a result, quite truthfully, of, obviously competition from nonbanks, but most particularly by a huge regulatory burden, some 12,000 pages of proposed and final rules in Dodd-Frank," Frank Keating, president and chief executive of the American Bankers Association, warned in a television interview on Tuesday.

It would be difficult to imagine that Dodd-Frank hasn't had any impact on the industry given its vast scope, but parsing out whether the law is the definitive factor that leads a bank to close or merge is much more difficult.

"No single institution is going to tell you, 'I closed because of Dodd-Frank,' but what they will tell you is, 'in no way did Dodd-Frank help me stay open,'" said James Ballentine, executive vice president of congressional relations and political affairs at the American Bankers Association.

On the ground, the story community banks tell is a more complicated one. Bankers seem more inclined to point to specific, troublesome rules within the law, rather than blaming Dodd-Frank in its entirety. In fact, much of the law is focused on winding down the country's largest institutions and reining in non-banks.

"If Dodd-Frank was written exactly as it's written except there was no Consumer Financial Protection Bureau, no Title X of the law, community banks really wouldn't feel much of the impact from Dodd-Frank — it would be marginal at the most," said Camden Fine, president and chief executive of the Independent Community Bankers of America.

He added that while the consumer agency has been responsive to some of ICBA's concerns, "they have not gone nearly far enough."

Smaller banker complaints have probably been loudest over new mortgage restrictions, including the CFPB's "qualified mortgage" rule.

That's the one that has "caused the greatest amount of distress internally," said Jill Castilla, president and chief executive of Citizens Bank of Edmond in Oklahoma.

Castilla notes that the $253 million bank has had to increase its compliance spending from 3% of the bank's budget in 2008 to nearly 15% today, with the new mortgage rules being the biggest driver. The bank used to designate about half of a compliance officer's time for every production lender; that figure is now up to one and a half.

"Our processes haven't changed that much and our underwriting hasn't changed much at all since Dodd-Frank — this is just for meeting the paperwork criteria," she added.

Numerous others have gone before Congress over the past five years to raise similar concerns. Moreover, there's evidence some banks are now paying a premium to bring in new compliance officers, thanks to growing demand.

"I think psychologically, after going through the financial crisis, banking regulators and examiners have reacted in a way where their relationship has changed with the banks they supervise," said Brian Gardner, a policy analyst at Keefe, Bruyette & Woods. "They've become much more circumspect of management."


Dodd-Frank is far from the only challenge for the community banking industry. Observers pointed to difficulties surrounding the Basel III capital standards, fair lending requirements and the Financial Accounting Standards Board's proposed current expected credit loss model, just to name a few.

"Dodd-Frank is a part of the regulatory burden, but there are many regulations in addition to Dodd-Frank and it is the accumulation of those regulations over time that comprise the regulatory burden that banks must absorb into their cost structures," Thomas Hoenig, vice chairman of the FDIC, said in an interview.

One effect that remains unclear is whether the growing regulatory burden, including from Dodd-Frank, is adding pressure on small banks to merge, at least on the margins. One survey of about 200 small banks conducted by the Mercatus Center in 2013 found a quarter of the respondents predicted being involved in a merger or acquisition over the next five years.

"I do think there's a lot of regulatory fatigue," said Castilla of the industry at-large, adding that Citizens of Edmond plans to stay independent and has no intention of merging. "I think there's maybe a greater temptation to merge because of compliance costs and the economies of scale you're able to gain when you combine."

Still, the 2014 FDIC study on bank consolidation found little evidence of increased activity so far.

"The rate of total attrition through failure or merger has been far lower among community banks than among non-community banks since 1985 — a disparity that has become even more pronounced over the past decade," the report says.

The FDIC study also noted that when a community fails or closes voluntarily, another community bank has acquired it two-thirds of the time.


There appear to be a number of interrelated factors hitting the industry, with Dodd-Frank being one among many.

Observers point to key legal changes in the industry that have contributed to historical consolidation — the Riegle-Neal Act of 1994 expanded interstate banking and led to a wave of mergers and the Gramm-Leach-Bliley Act drove consolidation by permitting banks, securities firms and insurance businesses to merge. Technological changes, such as the expansion of debit and credit cards, may also advantage larger institutions.

More recently, the lack of new banking charters is playing a big role — as banks continue to merge and close, there's been little influx of new institutions to balance that out. That's a critical factor to consider when looking at the decline in the number of banks over the past several years.

Just four new banks have opened their doors since 2010, including one that was approved before Dodd-Frank was signed into law. Regulators granted more than 100 bank charters a year for decades leading up to the crisis.

There are likely several factors behind that slowdown, in addition to concerns about regulation. The interest rate environment has hovered near zero in recent years, likely deterring investors from entering the market. A Federal Reserve working paper from last year found that at least three-quarters of the decline in new charters is attributable to the weak economy and low interest rates.

Critics also complain about heightened requirements from the FDIC for approving a new bank, including a seven-year probationary period for de novo banks instituted in 2009, up from a three-year threshold. The agency issued new guidance last fall clarifying some of those standards for new banks, likely in the hopes of encouraging new investment.

Still, there are others that see Dodd-Frank — and burdensome regulation in general — as the root of the problem. A Harvard University working paper released earlier this year argues that Dodd-Frank is hurting the community bank industry.

"The big picture in this election cycle is regardless of which side wins, this is a piece of legislation that needs to get fixed," Marshall Lux, a senior fellow at Harvard's Kennedy School and one of the paper's authors, said in an interview.

The paper finds that the share of total assets controlled by banks with less than $10 billion in assets has shrunk twice as fast since Dodd-Frank was put into effect. The community bank share of total assets fell 6% from the second quarter of 2006 to the second quarter of 2010, and by more than 12% in the following period through the second quarter of 2014.

"Consolidation is not inherently a bad trend, but policymakers should be concerned that a critical component of the U.S. banking sector may be withering for the wrong reasons — inappropriately designed regulation and inadequate regulatory coordination," the paper concludes.

At the same time, others warn that loud calls for banking reform to help smaller institutions is akin to a wolf-in-sheep's-clothing mission to win relief for bigger banks, too. There's been pushback, for example, against a proposal that would allow banks of all sizes to count mortgages held in portfolio as "qualified" under CFPB's QM rule — a provision that community banks have been urging.

"The Republican agenda is to get regulatory relief for the big banks and use the small banks as the lever to do so," said Adam Levitin, a professor at Georgetown University.

Are community banks "too small to succeed"?

The issue of Dodd-Frank's impact on small banks is part of a broader debate at play about whether small banks have what it takes to compete in today's financial markets. While this argument can take many forms, it often centers around two separate concerns: whether community institutions have the economies of scale to go toe-to-toe with the biggest banks; and whether the "too big to fail" crowd has unfair advantages that slants the playing field in their direction.

"Larger banks generally are more profitable and efficient than smaller banks, which may reflect increasing returns to scale," according to a 2012 GAO study looking at the impact of Dodd-Frank on the banking industry.

The report found that banks with more than $10 billion of assets generally had higher returns on assets and equity, except during the worst of the financial crisis.

"There are lots of economies of scale in banking and small institutions don't have those — it makes it harder for them to compete in a lot of markets, particularly residential markets and credit cards, and those are big consumer finance markets," said Levitin.

Critically, economies of scale also come into play when banks respond to new industry rules.

"When a smaller bank has to add a compliance person or two, that has a bigger impact than for any large bank hiring more compliance staff," KBW's Gardner said.

At the same time, many in the industry point to ongoing concerns about how the largest banks in the system are treated and the impact that has on smaller institutions. Critics point, for example, to the disparate treatment small banks receive from law enforcement when rules are broken.

The largest banks "write giant checks for fines and penalties, but their boards of directors, senior managers are not held to account," said ICBA's Fine. "Whereas in a community bank, even a relatively mild violation of a regulation will bring sanctions of senior management and sanctions on the board — individually, I'm not talking collectively."

Additionally, some point to funding advantages that the biggest banks may gain for their size and market assumptions that the government would bail them out during another crisis, regardless of changes to the system under Dodd-Frank.

"The community banking industry's biggest danger is the 'too big to fail' crowd and what they've done to the financial system," said Simon Johnson, a professor at MIT. "A bank like Citigroup or Bank of America has the government behind them, and they can borrow more cheaply and they can fund themselves at a lower cost."

Fine added that "community bankers are not afraid of the competition" if the largest banks were forced to operate on a level playing field. That includes equal enforcement of banking laws, which many charge is lacking from the system.

Still, it's worth noting that the size of the funding subsidy is still hotly debated. And community bankers point to the strength of their relationship banking model, which can be an advantage in some markets, such as small business lending.

"The relationship has value, and I think that has always been a competitive advantage," said Castilla. "I continue to leverage that, and I think it can counteract some of those drives to scale that are required to be more efficient in some respects."

Ian McKendry and Joe Adler contributed to this story.

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