WASHINGTON — The Dodd-Frank Act, which was designed to target the largest institutions, will end up hurting community banks, according to a paper released Tuesday by the conservative American Enterprise Institute.

"Although policymakers enacted Dodd-Frank to avoid too-big-to-fail situations, in reality, its effect is the opposite. The act will force greater asset consolidation in fewer megabanks by increasing the competitive advantage large banks have over smaller banks," Wake Forest University law professor Tanya Marsh and K&L Gates associate Joseph Norman wrote in the paper commissioned by the think tank.

The paper — which follows a theme commonly expressed by bankers, conservative pundits and GOP lawmakers — cites congressional testimony from banking executives and other public resources in arguing the compliance costs and standardization of financial products likely to result from the law could injure a community banking sector that is not being blamed for the crisis.

"Community banks were not responsible for the causes of the financial crisis determined by the authors of Dodd-Frank," the authors wrote. "Community banks did not engage in widespread subprime lending. They did not engage in securitization of subprime residential mortgages. Nor did they use derivatives to engage in risky speculation to maximize return. Community banks simply did not contribute to the financial crisis."

To be fair, the law explicitly sought to exempt smaller institutions from key provisions. For example, banks with less than $50 billion of assets avoided the enhanced supervision imposed on systemically important banks, and those with less than $10 billion of assets skirted examinations from the new Consumer Financial Protection Bureau. In another instance, a separate provision shifted a greater proportion of responsibility for funding the Federal Deposit Insurance Corp. to the largest banks.

But the paper aired a frequent concern about the law, arguing that the regulatory burden of following rules applied across the industry — including mortgage underwriting requirements — will put smaller institutions at an even greater disadvantage compared to larger counterparts.

"Although the regulatory costs associated with Dodd-Frank will annoy the large banks, they will constitute a blip on their balance sheets. They will have a far greater impact on community banks," the paper said. "Basic economic theory supports the presumption that smaller banks are disproportionately affected by the costs of regulatory compliance."

The results of this, the paper warns, could be significant considering the role community banks plays in providing financial services in areas the largest institutions have overlooked.

"Community banks are a vital source of credit and banking services to rural communities," the paper said.

The authors warned that the law could accelerate industry consolidation as smaller institutions get swallowed up by the costs of having to comply with the statute, and that would have an impact on banking customers in rural and other underserved areas that rely on the relationship lending practices of community banks.

"If community banks are forced to merge, consolidate, or go out of business as a result of Dodd-Frank, one result will be an even greater concentration of assets on the books of the 'too-big-to-fail' banks," the paper said. "Another result will be that small businesses and individuals who do not fit neatly into standardized financial modeling, or who live outside of metropolitan areas served by larger banks, will find it more difficult to obtain credit. Neither of these outcomes will protect consumers, the financial system, or the recovery of the American economy."

Still, many observers have suggested that, since smaller banks to a great extent did not engage in the kinds of risky lending practices targeted by Dodd-Frank, implementing the law should be relatively manageable for them compared to others.

"For example, in mortgage lending it was not the practices of community banks that brought down the system. These smaller banks are already engaged in safer lending practices. So they won't have to change their processes as much as an institution that was engaging in riskier lending," said Julia Gordon, director of housing finance and policy at the Center for American Progress.

Gordon, who said she agrees with the "parts of the [AEI] report … about the important role of community banks," argued that the impact of new international capital requirements set by the Basel committee is likely a greater concern for community banks. The latest Basel proposal would impose a new asset classification system for measuring capital levels that smaller institutions would have to incorporate.

"Of all of the various regulatory activity going on right now, it strikes me that the Basel III rules may have a bigger impact than Dodd-Frank on these institutions," Gordon said.

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