You Can't Regulate Two Types of Banks with One Law

When Dodd-Frank was signed into law, its goal was to reform the banking industry in the U.S. What the bill failed to recognize is there is not one banking industry in the U.S.; there are two. As a result, regulatory actions aimed at restoring confidence in the U.S.'s large, capital markets banks – the so-called Wall Street banks – have had a devastating effect on smaller, Main Street banks and are now threatening their long-established role as the backbone of the American Dream.

Why be concerned about community banks, a segment of the banking industry that only controls approximately 24% of the nation's assets? It's a simple equation: 70% of the U.S. economy is driven by consumer spending. Consumer spending is directly correlated with jobs and employment. More than 65% of new jobs are created by entrepreneurs and small business. Almost 60% of loans to small businesses come from Main Street community banks and credit unions.

The truth is, government policies designed to de-risk the financial system, stabilize the economy and protect the consumer in the wake of the financial crisis failed to do so while undermining the community-based financial institutions that are a key source of economic strength. Consider this: the five largest U.S. financial institutions emerged from the financial crisis 20% larger than they were beforehand, while community banks and credit unions emerged worse off. In 2011 alone, we lost nearly 300 banks due to failures (92) and mergers (198); 813 institutions remained on the FDIC problem bank list and we had the lowest number of new banking charters ever (3).

Dodd-Frank raised compliance costs, reduced fee income and imposed more stringent capital requirements on small institutions that did very little to cause the financial crisis and that lack the financial and marketing resources of their larger brothers. As a consequence, Dodd-Frank made it harder for small banks and credit unions to fulfill their economic role of serving homeowners, small businesses and people who might otherwise be unbanked or underbanked in communities nationwide.

Lawmakers need to recognize the major differences between Main Street and Wall Street financial institutions and ensure policies are crafted appropriately for each. Specifically, we need to re-engineer our financial regulations and policies to address the vastly different resources, capital access options and business models that separate these distinct institutions. This means revising or repealing provisions in the Dodd-Frank Act – such as the capital ratio requirements in the Collins Amendment and the interchange fee limits in the Durbin Amendment – that place unfair financial and compliance burdens upon community banks and credit unions. It is crucial that we allow smaller financial institutions to perform their basic business of lending and investing in their communities without costly and unwarranted government interference.

Don't misunderstand: I don't wish to imply large banks are somehow bad and small banks are better. Each plays an important role in the economy and in society. What I am saying is that our policies need to recognize the significantly different risks and business models between large and small banks, and ensure that, in reforming one, we don't penalize the other.

Louis Hernandez Jr. is chairman and CEO of Open Solutions, a financial services technology provider. This post is adapted from his recent book "Saving the American Dream: Main Street's Last Stand."