I’ve written on several occasions of my hypothesis that the eventual legacy of Dodd-Frank will be to promote consolidation of the banking industry, driving out small banks and entrenching too big to fail. One reason for this is the well-recognized theory that the costs of regulatory compliance often fall relatively more heavily on small than large businesses because not all types of regulatory compliance scale with size (the other is the possible entrenchment of a TBTF subsidy in capital markets, for which as an empirical matter the jury still seems to be out).
For example, many paperwork-type regulations require businesses to fill out the same number of forms regardless of whether they are large or small. The big business might have more zeroes in its balance sheet, but the time and effort to fill out the forms aren’t proportionately more expensive. In addition, the big firm might be able to gain economies of scale in regulatory compliance that smaller firms might not. As a result, as a ratio to the size of the firm, small firms often pay more in regulatory compliance costs than large firms. This phenomenon is not unique to financial regulation, but exists with respect to many different types of regulation (for example, compliance with environmental regulation rules often have this effect). I discuss the same argument in the context of CFPB compliance in this law review article.
This article in the Wall Street Journal last week provides supporting evidence for the hypothesis that compliance with Dodd-Frank is proportionally more expensive for small banks than large, creating a competitive advantage for large banks:
More small banks are selling themselves, and executives say Washington regulations are a big reason why….
Bank of Commerce, which generated just $441,000 in net income last year, was forced to boost spending on internal personnel and outside audit work to cope with added regulatory hurdles stemming from the financial crisis, on top of the anti-money-laundering laws, credit-reporting rules and many other regulatory issues the bank already was dealing with, Mr. Sturges said. “It’s across the board. When you only have 20 employees, any increase is a lot,” he said.
In a period when low interest rates are squeezing small banks, the costs of adhering to new regulations are taking a toll. Executives from at least a half-dozen small banks that have agreed to be acquired in recent months said the increasing regulatory burden was a factor in their decisions.
The executives said the new rules aren’t scaled for banks of their size. While the Dodd-Frank financial-overhaul law and other new rules were aimed at reducing the problems caused by big banks, small banks must deal with many of them as well, and the costs don’t necessarily get lower as the banks get smaller.
“When they created ‘too big to fail,’ they also created ‘too small to succeed,'” said Dan Baird, chief executive of Capital Funding Group Inc., which last October sold its CFG Community Bank, a Maryland bank with $481 million in assets, to MVB Financial Corp.
Note also the political consequence of this–to the extent that big banks are competitive beneficiaries of Dodd-Frank, that fact will lead them to generally oppose reforms to the law (and its regulations) that lessen their competitive advantage, even if those reforms would increase efficiency in the market.