The Mercatus Center has just released the results of a survey of 200 small banks (less than $10 billion in assets) that serve rural and small metropolitan markets in 41 states. More than 60 percent serve rural areas.

The results? The Dodd-Frank Act has definitely been good for lawyers. For small banks and their customers, not so much.

The summary:

  • More than 80 percent of small banks saw their compliance costs increase by more than 5 percent since Dodd-Frank
  • The median number of compliance officers doubled (from one to two people)
  • 71 percent report that the CFPB has affected their business activities
  • Over half report that CFPB and the Qualified Mortgages Rule has had a significant negative impact on their mortgage lending operations
  • Over 60 percent say that changes to mortgage regulations will have a “significant negative impact” on their earnings and over 90% say changes in mortgage regulations will have at least some negative impact on their earnings
  • Over 15 percent either have eliminated or plan to eliminate residential mortgage lending
  • Over a quarter of small banks anticipate that they will merge within the next five years

From the beginning, I have feared that one legacy of Dodd-Frank will be to promote consolidation of the banking industry, in large part because of the regulatory compliance costs it imposes.  It has been long understood that many regulatory costs fall disproportionately harder on small firms than large firms because many of the costs do not scale with output or size of firm.  So, for example, while Dodd-Frank might require Citibank to hire a few more lawyers for compliance or a new VP for compliance, that might be a small incremental expense for such a big bank.  Whereas if it requires a small bank to double the size of its legal staff or requires the senior management to spend more time on compliance instead of running the business, that might be relatively more expensive for the small bank.

The findings here — especially the substantial number of smaller banks that expect to merge in the next few years — is consistent with this prediction. On the other hand, the presentation indicates that the while the financial crisis itself promoted consolidation (presumably through forced mergers), the level of concentration has remained constant for the past few years. Having said that, there is certainly no evidence of a contrary trend of TBTF banks losing market share.

To be sure, there are other factors at work, including the continued shakeout from the financial crisis.  But this study provides some evidence consistent with the anecdotal evidence that Dodd-Frank is increasing the regulatory burden on small banks and providing a competitive advantage for large banks.  And this doesn’t even include the widespread perception that Dodd-Frank did not eliminate the “too big to fail” subsidy (although evidence on whether that perception is correct is still mixed).

One interesting, and unexpected finding (to me at least), is that some 70 percent of the banks report that the Durbin Amendment’s interchange fee regulations will have at least some negative impact on their earnings (slide 21).  Considering that the price controls in the Durbin Amendment apply only to banks with more than $10 billion in assets, this suggests that the amendment must be having some sort of indirect effect on interchange fees for exempt banks.  My impression had been that for at least for now the two-tiered structure of interchange fee pricing had held up, but this suggests that some dynamic is pushing down interchange fees for small banks too.  Is this because the routing rules are starting to bite or some other reason?  The authors of the study do not belabor this point, but if anyone in the industry has any insight into this, I’d be interested in hearing your thoughts in the comments.

Update: Looking again at the slide on concentration, what I now see is that although the market share of the five largest banks has remained constant (as I noted), the market share of smaller banks has continued to decline slightly. Which suggests that in recent year the growth has been for medium-sized banks, perhaps by merger of smaller banks to become medium-sized.