Regulations Impose Severe Burden on Small Banks: Harvard Report

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A report from Harvard University could add fuel to a debate in Congress over providing regulatory relief for community banks.

The report, released earlier this week by the Kennedy School of Government, underscores a mantra in the industry that's often ill-defined: Small banks have been squeezed by regulation. 

The paper, using data from the Federal Deposit Insurance Corp., shows a steep decline in market share for community banks over the last two decades, particularly in the aftermath of the financial crisis. Researchers defined community banks as institutions with $10 billion or less in assets.

The timing of the report is notable. The Senate Banking Committee recently began a series of hearings on regulatory relief for smaller institutions, featuring testimony from regulators, such as the FDIC, the Office of the Comptroller of the Currency and the Federal Reserve Board. 

"The most interesting takeaway from this week is that the FDIC is apparently very aware of this paper, and they're trying to get out in front of it," said William Mayer, co-chair of the financial institutions group at Goodwin Proctor.

The academic paper, titled "The State and Fate of Community Banking," looks at the competitive landscape for small banks in the years after the 2010 passing of the Dodd-Frank Act. In subsequent years, community banks' market share, in terms of assets, fell 12%, researchers found.

Community banks also lost ground in several lending categories. Their market share of commercial-and-industrial loans fell 23%, and they also saw a decline in small business and residential lending.

"Obviously, the statistics are depressing," said Terry Jorde, senior executive vice president at the Independent Community Bankers of America, adding that "community bankers are living this every day."

A longer-term view shows an even more dramatic decline. From 1994 to 2014, community banks' share of the U.S. lending was nearly halved, from 41% to 22%. At the same time, market share at the five-biggest banks more than doubled. 

Consolidation has also occurred at a rapid pace. Total number of community banks plunged 69% over the two decades, to just over 6,000 institutions.

Small-town banks have been overshadowed by large institutions since the financial crisis, said Marshall Lux, a senior fellow at Harvard who co-authored the report. "This is a part of the country that got forgotten about," said Lux, who was once a chief risk officer at JPMorgan Chase.

Additional factors have contributed to the community banking’s decline. Legislation passed during the Clinton administration accelerated the pace of bank mergers, the report found. Advancements in technology have also been a factor.

Low interest rates have also made it difficult to operate a small bank, Mayer said. Faced with lower margins, many community banks have looked for noninterest sources of revenue, but fee-based businesses often involve high compliance costs.

"The amount of regulation that relates to fee generating activity is very substantial," Mayer said. 

The Harvard report also highlights the role that small banks play in providing financial services to farming communities. Since 2010, agricultural lending by community banks has surged 19%, while the five-biggest banks issued a smaller volume of farm loans.

In total, small banks provide 77% of all agricultural loans — and most of those loans are issued by banks with less than $1 billion in assets.

"Agribusiness is a very specific business, which involves very specific knowledge of the asset class," Lux said.

The ICBA was aware of the study before it was published, and will likely use the data as part its lobbying efforts to roll back regulations for community banks, Jorde said.

It is also likely that data in the Harvard report will appear in the coming campaign cycle, as presidential candidates discuss ways to improve middle-class opportunities. 

"When you take the political debate, and you put this study in the context of that, there really is a hand and glove dynamic that you observe," Mayer said.

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Community banking Dodd-Frank Compliance Small business Ag lending Law and regulation