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With Dodd-Frank, is the cure worse than the problem
Five years following a near collapse of the real estate market, community banks and credit unions in Northeastern Minnesota and Northwestern Wisconsin are yet to fully rebound from the financial impact.
A BusinessNorth analysis of their income shows it collectively dipped the most in 2009 and, except for credit unions in Northwestern Wisconsin, still hasn’t rebounded to the pre-recession level in 2006.
Much of the past impact was related to property devaluations that occurred in tandem with the recession. Equity values literally vaporized for borrowers while their income also declined. In some cases, collateral requirements could no longer be met, and some loans became troubled in the eyes of regulators.
Financial institutions have largely addressed that problem, but a new one has emerged – one that impacts both lenders and borrowers: the Dodd-Frank Wall Street Reform and Consumer Protection Act. It originally was intended to address the financial chaos created by too-big-to-fail institutions that securitized subprime mortgages and sold risky derivatives. Over time, the legislation blossomed into approximately 400 complicated new regulations that heavily impact local banks.
“Community banks had nothing to do with the problem,” said Larry Johnson, president and CEO of North Shore Bank of Commerce in Duluth. That assessment is echoed in a May 2013 analysis by the American Enterprise Institute, which said “Community banks simply did not contribute to the financial crisis.”
Nonetheless, locally owned financial institutions were lumped with investment banks and placed under much-tighter government scrutiny.
“They painted the entire industry with a broad brush,” said Kenneth Johnson, chief operating officer at North Shore, forcing small banks to meet the same complicated standards as larger ones that have much more financial ability to support a team of experts to interpret the federal rules.
A work in progress
The Dodd-Frank legislation has swelled to exceed 2,000 pages, but regulatory agencies still haven’t completed the rule-writing task. Additional stipulations will be added as time goes on.
Even worse, “There’s no end in sight,” said Steve Burgess, president and CEO of Superior-based National Bank of Commerce. As of May, only half of the rules had been finalized.
“The regulations are very cumbersome and pose many challenges,” said Gary Ellefson, president of Northern State Bank in Ashland. “We’re definitely spending more time keeping up to date on new regulations, and that’s an added expense.”
Bank regulations already were complicated before the passage of Dodd-Frank, Burgess said, “but nowhere near this extent. We’ve never seen anything like this.”
Some requirements, according to the American Enterprise Institute’s study, give regulators “very little discretion in terms of deciding how the implement the relevant provisions.” Others, however, are discretionary, which makes community bankers nervous because compliance is subject to interpretation.
Some, including Ellefson, have hired outside consultants to help interpret the rules.
“We’ve used an outside accounting firm to help us,” he said.
Before Dodd-Frank, North Shore Bank employed one person to ensure regulatory requirements were met. Now, the staff has grown to three, said Ken Johnson, who addresses such issues through affiliations with the American Bankers Association (ABA)
and Minnesota Bankers Association.
“This has tripled our compliance costs,” he said. According to a 2012 paper written by the ABA, the enhanced rules will hit the entire community banking community equally hard.
“The new rules and recordkeeping requirements will create pressure to hire additional compliance staff instead of customer-facing staff. It will also mean more money is spent on outside lawyers and consultants, reducing resources that could be directly applied to serving a bank’s customers and community,” ABA said.
Dodd-Frank makes no differentiation between large and small banks.
“Whether you originate one loan or 1,000 loans, you have to understand it,” Larry Johnson said, and that may force smaller community banks to eliminate some services, such as originating mortgages, or to outsource the service.
“The reforms are so comprehensive that they will require full-scale transformation
of mortgage lending systems and processes. Some banks will evaluate whether to continue to make mortgages, because these changes will require burdensome implementation efforts and increased regulatory guidance from federal agencies,” ABA observed in its Dodd-Frank evaluation.
“On the mortgage side, you either comply or you can’t be in the business anymore,” Larry Johnson said.
Having fewer banks offering loans would reduce competition. The American Enterprise Institute predicts the Dodd-Frank might even trigger a future crisis by forcing industry consolidation, creating additional “too-big-to-fail” megabanks.” And if that happens, it would invalidate the original intent of Dodd-Frank.Previous BusinessNorth Exclusives Articles:
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