Are Government Regulations Killing Community Banks?

The Government Accountability Office (GAO) recently released a report that finds that “macroeconomic, local market and bank characteristics” (i.e. interest rates, market competition, bank size, etc.) have had a more profound impact on the performance of community banks than government regulation. Needless to say, GAO’s conclusion has attracted criticism from the community banking sector.

Over the past several years, community banks have not performed as well as their counterparts. “The larger banks are doing a much better job of banking millennials, a segment that all of a sudden now has jobs and has money,” said Kevin Halsey, a consultant at Capital Performance Group. “They’re much better positioned than the community banks with their marketing budgets and with their digital presence to really grow core funding from the consumer base.”

This is reflected in the data. From 2010 to 2017, the number of community banks has dropped by 24% and total small business loans by community banks have decreased by 16%.

In the report, GAO developed an econometric model and conducted numerous surveys to determine the causes of these declines. After analysis, the authors conclude that macroeconomic factors (i.e. gross state product, interest rates, etc.), local market conditions (i.e. unemployment rates, market competition, etc.), and bank characteristics (i.e. bank size, level of equity capital, etc.) have had a stronger impact on community banks than the regulatory environment. Overall, regulation has had only a “generally modest effect” on community banks.

The report’s findings have already received a fair share of criticism from the community banking sector. Preston Kennedy, chairman-elect of the Independent Community Bankers of America, says, “It hit me wrong…It just didn’t add up.” Peter Dugas, the managing principal at Capco’s Center for Regulatory Intelligence, argues, “It’s not entirely accurate to say regulation has minimal impact … There are hundreds and hundreds [of regulations]. And it’s more than just rules. There’s examiner guidance and speeches and enforcement actions.”

Community bankers also point to other government reports that seem to counter GAO’s findings. According to a joint survey by the Federal Reserve and the Conference of State Bank Supervisors, “inferred compliance costs for community banks increased from $4.5 billion in 2014 to $5.0 billion in 2015 and then to $5.4 billion in 2016.”

A 2017 letter by the Dallas Federal Reserve goes further arguing, “The data indicate
small-business loans make up a smaller part of portfolios among banks of all sizes. The pullback in small-business lending is a product of several factors, with regulatory burden among the most prominent.”

Still, the criticism from the community banking sector has not bothered GAO Managing Director Lawrance Evans. “The data on small business loans is imperfect, but when you look at it and analyze it rigorously, you can explain a significant chunk of what’s taking place with macroeconomic fundamentals,” Evans said. “Are regulations having an impact? Yes, but the market is likely more important than what you’re hearing.”

Earlier this year, Congress passed the Economic Growth, Regulatory Relief and Consumer Protection Act that provided regulatory relief for community and regional banks. With only a few months to go before the midterms, it is unlikely that Congress will pass any additional regulatory relief legislation for the financial sector.