This summer, the most comprehensive overhaul of the financial services industry since the Great Depression was signed into law: the Dodd-Frank Wall Street Reform and Consumer Protection Act. Passage of the Act was just the beginning, though, as many of the implementation details must still be ironed out by regulators. But at first glance, the Act appears to be a mixed bag for community banks, with some potential benefits and some drawbacks. Following is a look at some key provisions of the Act and how they may affect community banks.
Increased regulatory burden – The Act will create an estimated 5,000 pages of new regulatory rules banks must follow, including at least 290 new rule makings, 27 new regulatory burdens, 60 additional studies and 90 new reports.
For example, there are new disclosure/reporting requirements related to business accounts, new Home Mortgage Disclosure Act (HMDA) reporting obligations, and new provisions that will make it harder for banks to move loans off their books. Also, banks must ascertain upfront whether small business loan applicants are women or minority-owned, and follow new rules designed to discourage discrimination based on gender, race or ethnicity.
While the intent of such rules and requirements is laudable, they will inevitably result in higher bank costs. For example, banks may have to hire additional employees just to make sure they remain compliant. This will likely be more harmful to community banks, whose costs will increase disproportionately in comparison to larger banks that benefit from economies of scale.
Creation of the Consumer Financial Protection Bureau (CFPB) – This is the new federal agency charged with protecting consumers’ financial interests. The CFPB will have the power to regulate a wide range of financial products and services, including mortgages, credit cards and other bank products.
The good news for community banks is examinations for banks with less than $10 billion in assets will still be conducted by their primary regulator — the CFPB will not supersede this authority. However, the agency will have wide discretion in deciding what constitutes “unfair, deceptive or abusive” business practices, as stated in the Act. Since community banks often serve small niche customers, this may make it more difficult for them to tweak underwriting requirements to meet their customers’ unique needs.
Regulation of debit card interchange fees –The Act limits how much banks can charge merchants for processing debit card transactions (or interchange fees). Along with insufficient funds (or NSF) charges, such fees are a large source of income for most banks and enable them to offer other transactions and services (like online banking) for free.
It’s estimated that this provision may potentially reduce interchange fee income by up to 50 percent, forcing banks to compensate by eliminating or charging for services that are currently offered for free. A silver lining is that banks with less than $10 billion in assets are exempted from these limits. In reality, though, many experts say community banks may be forced to lower their interchange fees in order to compete with larger banks for merchant card processing business.
Change in FDIC insurance assessment base – The FDIC insurance assessment will be calculated based on total assets instead of total deposits, lowering premium expenses for most community banks. However, Federal Home Loan Bank (FHLB) advances are now subject to FDIC assessments.
The big unknown is whether this provision will intensify deposit competition and raise deposit pricing by large banks. An estimated 5 basis-point increase in deposit rates could negate any “static” premium savings for community banks.
Change in FDIC insurance reserves – These changes include an increase in the minimum reserve ratio from 1.15 percent to 1.35 percent of insured deposits. Banks with less than $10 billion in assets are not required to plug the current shortfall for meeting the new minimum until 2020, but after that date, all banks must contribute toward the new 1.35 percent minimum, regardless of size. Larger banks, meanwhile, will need to pay an incremental deposit insurance premium to help fund the current shortfall.
Also, the 1.5 percent hard cap on the deposit insurance fund has been eliminated, giving the FDIC unrestricted authority to increase the ratio. Many experts believe this could lead to even higher premium increases after 2020.
Increase in FDIC deposit insurance limit – This limit is increased to $250,000 per insured individual account. Also, the Transaction Account Guarantee (or TAG) program provides full deposit insurance coverage for noninterest-bearing transaction accounts for two years beginning on December 31, 2010.
“Allowing the TAG program to expire in this environment could cause a number of community banks — already under stress — to experience deposit withdrawals from their large transaction accounts, and would risk needless liquidity failures,” said FDIC Chairman Sheila Bair in announcing the extension.
The unknown here is how much assessments will have to increase to account for the expected growth in insured deposits. Higher levels of insured deposits will raise the deposit basis for determining how much funding is needed to meet the higher reserve ratio requirements.
Impact on capital standards – Before the final legislation was passed, there was concern that community banks would not be allowed to count Trust Preferred securities as part of their Tier One capital, which could send them below mandatory capital levels. But the final legislation allows banks with less than $15 billion in assets to continue to count existing Trust Preferred securities as capital.
However, new Trust Preferred offerings are not acceptable as regulatory capital. The result will be one less source of available capital at a time when community banks will be under increased pressure to raise more capital. Some experts say this could result in more community bank mergers, downsizings and, ultimately, failures.
Higher standard for federal preemption – Federally chartered banks have been able to sell products based on standards established by federal regulators. Under the new law, however, these banks will have to meet state consumer protection laws in all states in which they operate. This could lead to higher fees in order to make up for additional compliance costs required to sell these products.
Call us with your questions about the potential impact of financial reform on your bank.