Regulatory Reforms to Help Small Business Financing

By SBE Council at 23 June, 2016, 4:30 pm

by Raymond J. Keating-

During and in the immediate aftermath of the financial meltdown that hit in 2008, the contradictory political and policy message was to both blame and bailout large banks.

The contradictions continued with the Dodd-Frank financial regulation measure, signed into law by President Barack Obama in July 2010. The legislation was billed as a fix, including a preventive against future bailouts. In reality, though, Dodd-Frank failed to address the problems that provided the foundation upon which the 2008-09 credit mess rested, such as federal “affordable housing” policies creating a disconnect between home ownership and economic reality, quasi-government entities like Fannie Mae and Freddie Mac privatizing profits and passing off losses to the taxpayers, along with loose monetary policy creating further distortions in the marketplace. Dodd-Frank cranked up regulatory burdens and costs, and actually increased the odds of future bailouts. In addition, loose monetary policy has been raised to unprecedented levels, and taxpayer exposure in the credit markets and in terms of bailouts has expanded.

Small Banks Hit Hard

The aftermath of the financial crises and the response to it (Dodd-Frank) has left many entrepreneurs and small businesses still without the capital they need to invest in, operate or expand their businesses. Speaker Paul Ryan believes there’s a “Better Way” to regulate, which will help small firms and our economy grow.

And while Dodd-Frank’s regulatory reach was supposed to be focused on so-called big banks, a new regulatory regime inevitably covers an entire industry, and in fact, small, community banks have suffered accordingly. For example, a study published in February 2015 by the Harvard Kennedy School’s Mossavar-Rahmani Center for Business and Government, titled The State and Fate of Community Banking and authored by Marshall Lux and Robert Greene, looked at the role of community banking in the marketplace, including its vital role in small business financing, and the impact of Dodd-Frank financial regulation law on these small banks. The authors note that while the community banks share of U.S. banking assets declined during the 2008-09 financial crisis, a far larger decline – about twice the rate –occurred after Dodd-Frank’s passage. For good measure, community bank consolidations ramped up after Dodd-Frank’s passage, with the authors noting widespread agreement that “larger banks are better suited to handle heightened regulatory burdens than are smaller banks, causing the average costs of community banks to be higher.”

“Collapse” in New Bank Entry

Also, a March 2015 report from the Federal Reserve Bank of Richmond noted that the sizeable decline in the number of community banks from 2007 to 2013 – shrinking by 41 percent – was not only about community bank failures, but about “an unprecedented collapse in new bank entry.” It was pointed out: “This collapse in new bank entry has no precedent during the past 50 years, and it could have significant economic repercussions. In particular, the decline in new bank entry disproportionately decreases the number of community banks because most new banks start small. Since small banks have a comparative advantage in lending to small businesses, their declining number could affect the allocation of credit to different sectors in the economy.” A key reason? “Banking scholars also have found that new entries are more likely when there are fewer regulatory restrictions. After the financial crisis, the number of new banking regulations increased with the passage of legislation such as the Dodd-Frank Act. Such regulations may be particularly burdensome for small banks that are just getting started.”

Another study from George Mason University’s Department of Economics – “How Are Small Banks Faring Under Dodd-Frank? ” by economists Hester Peirce, Ian Robinson, and Thomas Stratmann – surveyed 200 banks with less than $10 billion in assets across 41 states. The message was clear: Dodd-Frank, in fact, increased regulatory compliance costs for small, community banks, and forced banks to reconsider various product and service offerings.

A “Better Way” to Approach Regulation

These considerable problems have not been missed by everyone in Washington. “A Better Way to Grow Our Economy” – a regulatory reform agenda from the “Relieving Regulatory Burdens” Task Force led by U.S. House Speaker Paul Ryan (R-WI) – seeks to address many of the regulatory burdens plaguing financial institutions and, therefore, small business financing.

The report also highlights the considerable costs of financial regulation gone awry, such as:

-“Regulatory costs on credit unions have increased by $2.8 billion since Dodd Frank was adopted, with a disproportionate cost being borne by credit unions with less than $100m in assets. Furthermore, now one in every four employees is devoted to regulatory compliance rather than core business functions. In addition, higher regulatory compliance costs force companies of all sizes to pass those costs on to their customers in the form of higher prices and diminished credit availability.”

-“According to a survey by the Independent Community Bankers Association (ICBA), 73 percent of community bank respondents said regulatory burdens are preventing them from making more residential mortgage loans and 44 percent said they originated fewer first-lien residential mortgage loans in 2014 compared with the year before.”

-“Access to non-mortgage consumer credit has also declined sharply in the post-Dodd- Frank period. In the case of credit card lending, intrusive regulation by the CFPB, Basel III capital standards, and credit card ‘reforms’ enacted by the Democrats in 2009 have combined to deny millions of Americans the benefits and convenience offered by these products, while hiking the costs of those who are fortunate enough to still qualify for credit.”

“According to the FDIC’s National Survey of Unbanked and Underbanked Households released in October 2014, 7.7 percent of American consumers were unbanked and 20 percent were underbanked in 2013. One of the main obstacles for these groups in obtaining a checking or savings account is the fees associated with the accounts, which have gone up since the passage of Dodd-Frank.”

-“Dodd-Frank codifies ‘too big to fail’: Far from ending bailouts, the Dodd-Frank Act codified them—in the form of the ‘Orderly Liquidation Authority’ set forth in Title II of the Act. Under the Dodd-Frank regime, the largest financial institutions in America remain ‘too big to fail;’ in fact, they are even bigger now than they were before the crisis.

-“Dodd-Frank’s regime for designating ‘systemically important financial institutions’ (SIFIs) anoints a new generation of ‘too big to fail’ financial firms, signaling to market participants that these firms will benefit from government support in the event of their financial distress. In the words of Richard Fisher, the president of the Dallas Federal Reserve Bank, ‘as soon as a financial institution is designated systemically important . . . it is viewed by the market as being the first to be saved by the first responders in a financial crisis. SIFIs occupy a privileged position in the financial system.’ That implicit guarantee allows the bank to borrow more cheaply than its smaller competitors.”

The House regulatory reform agenda actually serves up assorted financial regulation reforms that deserves serious consideration and implementation.  For our purposes here, though, let’s highlight 6 reform measures related to what we’ve focused on this piece, and meant to enhance the economic soundness, transparency, and accountability of financial regulation:

1) “Turn CFPB into a bipartisan, five-member commission that’s focused on enforcing the law and creating financial opportunity for Americans. The [Dodd-Frank created Consumer Financial Protection Bureau] is headed by a single Director who serves a five-year term and may be removed by the president only for cause—that is, “for inefficiency, neglect of duty, or malfeasance in office”—rather than at will. Rep. Randy Neugebauer, chairman of the Financial Institutions Subcommittee, sponsored H.R. 1266, the Financial Products Safety Commission Act, which makes the CFPB a stand-alone agency governed by a five-member, bipartisan commission.”

2) “Subject CFPB to congressional appropriations to bring accountability and transparency to their operations. The bureau is exempt from the checks and balances of the budget and appropriations process, which means that its director can spend hundreds of millions of dollars with no oversight. At a minimum, the bureau must be subject to the same oversight as other product regulators. The Taking Account of Bureaucrats’ Spending Act, H.R. 1486, sponsored by Rep. Barr, places the CFPB on budget and restores Congress’s constitutional oversight role.”

3) “H.R. 2896 – Rep. Scott Tipton’s bill levels the playing field by allowing regulators to tailor their regulations to fit a bank’s or credit union’s small size and business model.”

4) “H.R. 1195, introduced by Rep. Robert Pittenger, creates a small business advisory board to ensure that job creators have the opportunity to weigh in on matters of concern, and for the CFPB to learn about market conditions affecting these businesses. H.R. 957, Rep. Steve Stivers’ legislation, ensures greater accountability at the CFPB by creating an independent Inspector General for the CFPB.”

5) “Task Force Solution: A new regulatory paradigm offers highly-capitalized, well-managed financial institutions an option for relief from excessive regulatory complexity. House Republicans support the option for strongly-capitalized financial institutions to qualify for significant relief from duplicative and overly burdensome regulatory mandates, thereby promoting a more resilient financial sector, simplifying an overly complex regulatory system, and reducing the power and influence of Washington bureaucrats. Put simply: If you are strongly-capitalized, you should only have to comply with a simple set of regulations rather than dozens of complicated and conflicting rules.

“Banks will opt in to this new regime only if it lets them better serve customers at lower prices – in other words, to become more competitive. This approach does not require anybody to raise a dime of new capital. Rather, it allows banks to choose to operate in a regulatory environment in which the governing principle is market discipline – not bureaucratic complexity – and in which equity investors stand in for taxpayers the next time a ‘too big to fail’ firm collapses.”

6) “House Republicans will protect hardworking taxpayers by ending Wall Street bailouts and ‘too big to fail’ (TBTF). We support repealing Washington bureaucrats’ ability to declare big financial companies as SIFIs that receive special government protection.

“House Republicans also support repealing Title II of Dodd Frank and replacing bailouts with enhanced bankruptcy. The House passed the Financial Institution Bankruptcy Act—H.R. 2947 sponsored by Rep. David Trott—to create a new subchapter of the Bankruptcy Code tailored to address the failure of a large, complex financial institution. In addition, H.R. 4894, sponsored by Rep. Lynn Westmoreland, repeals Dodd-Frank’s ‘Orderly Liquidation Authority’ to protect taxpayers from having to pay the costs of bailing out large financial institutions or their creditors.”

Representative Jeb Hensarling (R-TX), Chairman of the House Financial Services Committee, also released a sound reform plan to modernize the financial services regulatory framework and fix the serious flaws of Dodd-Frank. SBE Council President & CEO Karen Kerrigan voiced strong support for this effort, and we will provide a deeper dive into the Financial CHOICE Act next week, which mirrors some of the reforms offered by the GOP task force.

Make no mistake, the ability of small businesses to get financing is directly affected by the regulatory burdens and mandates placed on financial institutions. For good measure, as taxpayers, small businesses pay the price of taxpayer bailouts. The 2008-09 credit and economic mess should have reinforced the basic lesson that politics makes for a poor substitute for sound economics and finance. Unfortunately, though, regulatory agencies are doubling down on more regulation and politics.  The House regulatory reform agenda led by Speaker Ryan is trying to move matters in the right direction.

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Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

Keating’s latest book published by SBE Council is titled Unleashing Small Business Through IP: The Role of Intellectual Property in Driving Entrepreneurship, Innovation and Investment and it is available free on SBE Council’s website here.