This article makes 10 predictions about the effects the Dodd-Frank Wall Street Reform and Consumer Protection Act will have on community banks. The Dodd-Frank Act is lengthy (over 2,300 pages) and complex, so this article focuses only on the parts that are likely to affect community banks, i.e., those institutions of $10 billion in assets or less that have minimal or no involvement with proprietary trading, securitizations or other exotic financial products.

  1. Significantly increased cost of doing business. Even the smallest of community banks will need to significantly increase the financial and management resources it dedicates to compliance and risk management. Regulators will feel pressure to enforce the letter of the law in administering hundreds of new regulations. Dodd-Frank decimated Federal preemption of state law and that will significantly raise the cost of doing business with consumers across state lines. Loss of preemption and the sheer volume of regulation will fuel a significant jump in litigation targeting banks. Finding creative ways to share and reduce costs across institutions (and possibly a merger partner) will be critical to survival.
  2. Unrealistic and burdensome CFPB regulations. The new Consumer Financial Protection Bureau is a largely autonomous bureau within the Federal Reserve, disconnected from the safety and soundness aspect of bank regulation. Dodd-Frank imposes sweeping requirements as to hiring of women and minorities, but no particular requirement as to banking experience and competence. One of the CFPB's first initiatives is an insistence on radically shortened and simplified credit card disclosures. It is not clear that CFPB personnel grasp the extent to which financial product characteristics and a score of overlapping federal and state lending and disclosure laws drive the current complexity of credit card agreements. This will not be the last of new regulations and directives that are enacted without a clear understanding of underlying banking law and business principles.
  3. Heightened compliance costs for bank affiliates. Dodd-Frank eliminates procedural hurdles to bank regulators conducting regular and rigorous examinations of nonbank affiliates, including functionally regulated subsidiaries like broker-dealers. Although the various regulators are supposed to avoid duplication of efforts, as a practical reality, duplicative examinations and conflicting regulatory directives will occur.
  4. Heightened capital requirements. Counter-cyclical capital requirements likely will apply in the future. Trust preferred securities will no longer count towards regulatory capital in all but the smaller bank holding companies. Regulators will exercise largely unfettered discretion to require an above-regulation capital increase for particular institutions.
  5. Deposit insurance increases. For now, banks under $10 billion will not be specially assessed to help the FDIC increase the reserve ratio for the Deposit Insurance Fund. And, the new assessment base that looks at total liabilities vs. total deposits should not result in a material change for most community banks. But, the FDIC remains badly undercapitalized considering its significant projected losses and how little there is in the deposit insurance "fund." The FDIC therefore will likely find a way to increase premiums for smaller community banks as well. Another revenue-raiser is the FDIC's new power under Dodd-Frank to charge examination fees and to use its expanded back-up examination and enforcement authority to require reports (and presumably charge fees) from institutions it traditionally has not examined.
  6. New game in commercial deposits. Dodd-Frank repealed Reg Q's prohibition on paying interest on demand deposits. On one hand, Reg Q unnaturally restricted banks ability to compensate large demand deposit customers and cost banks market share in the cash management business. On the other hand, Reg Q also played an important role in reducing the industry's overall cost of funds. Now that commercial demand deposits can chase the highest returns, banks may experience a less stable core deposit base. But, banks have a historic opportunity to bring huge sums back into the banking sector if they are prepared to service and accurately price this money.
  7. Muni security meltdown. Given the severe problems in the municipal finance market, Dodd-Frank regulated munis with a light hand and gave the GSEs a complete pass. Banks that rigorously evaluate and trim unwarranted exposure to muni securities in their portfolio will be rewarded for their prudence.
  8. Banks become less desirable to non-bank acquirers. Dodd-Frank heightens the requirement that bank holding companies (and companies deemed to be a holding company due to degree of control or other reasons) act as a source of financial strength to the bank. This will look and feel like a guaranty obligation and will dissuade a number of otherwise-desirable acquirers from participating in bank M&A and depress pricing in the banking sector compared to other business sectors.
  9. Further chilling of home mortgage market. Dodd-Frank enacts much stricter appraisal and underwriting standards, adds severe penalty provisions and gives borrowers additional defenses to foreclosure. These measures increase the liability exposure for originators and servicers and make mortgages less attractive to the industry. GSEs continue to subsidize below-market rates and prevent creation of a true private market.
  10. Reduced margin for error. Given significant cost pressures and increased volatility of core deposit funding, banks that recognize their tiny margin for error will invest in pricing technology to rigorously examine existing and new loans and deposits to ensure that no potential revenue or unnecessary cost is ignored.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.