Opponents of financial reform have been trying to argue that the Dodd-Frank Act is bad for consumers and bad for small businesses because it hurts small banks. In fact, the lawmakers who drafted the Dodd-Frank Act took great care to protect and strengthen the country’s rich network of community banks, helping to ensure that we avoid the concentration that exists in the banking sectors of so many other countries which are dominated by just a handful of very large institutions.
Our system, which relies on nearly 8,000 community banks, is better equipped than the more concentrated banking systems of other countries to meet the needs of consumers and small business owners. By building relationships with their customers and their communities, community banks play a critical role in local economies, supporting economic growth and job creation by providing credit to consumers and small businesses in towns across America.
The authors of the Dodd-Frank Act understood the important role of community banks and that they were not the cause of the crisis. That is why Dodd-Frank is focused on constraining risk at the largest institutions and on closing gaps in regulation for activities, like derivatives trading, that are not central to the business of community banks. The legislation does, however, contain several important provisions that put community banks on more equal footing with their competitors and strengthen their important role in our financial system.
First, the Dodd-Frank Act raises deposit insurance protection to $250,000, providing greater protection for one of community banks’ core sources of funding.
Second, Dodd-Frank ensures that the cost of deposit insurance is born by the institutions that engage in the riskiest activities and that, consequently, benefit the most from its protection. Dodd-Frank does this by requiring insurance premiums to be based on total liabilities, which are a more accurate reflection of risk than deposits alone. As a result, the premium burden will shift away from smaller institutions to larger, riskier banks.
Third, Dodd-Frank provides that large financial institutions will be subject to heightened prudential standards, including requirements to hold more capital and maintain larger liquidity buffers. Requiring larger institutions to hold more capital and liquidity will make these firms less likely to fail and help them withstand financial stress. An additional benefit is that these higher prudential standards will force large institutions to bear the costs of the risks they create and will therefore discourage them from becoming so big in the first place. Community banks, which do not pose the same type of risks to the system as large firms, will not be subject to these obligations.
Fourth, Dodd-Frank levels the playing field between small banks and nonbank financial service providers, such as payday lenders and independent mortgage brokers. A major failure of our regulatory system prior to the crisis was that these institutions were allowed to compete against community banks for the same customers without playing by the same rules. Dodd-Frank corrects this deficiency by giving federal regulators the ability to regularly examine nonbank financial services providers and to prohibit unfair and deceptive practices in which they may engage.
Fifth, Dodd-Frank works to protect small banks from excessive supervisory burdens. The regulator responsible for monitoring the safety and soundness of community banks will also bear responsibility for enforcing rules promulgated by the new Consumer Financial Protection Bureau. This will allow small banks to avoid multiple exams.
Finally, the Dodd-Frank Act reduces the unfair funding advantages enjoyed by the largest institutions prior to the crisis by setting out a process for those institutions to be wound down, broken apart, and liquidated when facing imminent failure. Under this new process, culpable management will be replaced, creditors will suffer losses, and shareholders will be wiped out. Large institutions, not community banks or taxpayers, will pick up any costs incurred in resolving a large financial institution through this process.
Because of all this, Camden Fine, the President and CEO of the Independent Community Bankers of America, was right when he said that financial reform represented a “huge policy shift and bodes well for community banks.” We are committed to ensuring this holds true for our nation’s community banks as we continue to implement this critical legislation and strengthen our nation’s financial system.
Neal Wolin is Deputy Secretary of the Treasury.