For the majority of commercial banks, the heart of their earnings, profits, and their very existence is the ability to make viable loans to firms and individuals.
When a bank extends credit to customers, it is risking depositor savings, stockholder investments, jobs, and the reputation of the lending institution. Lending officers and their support teams play a pivotal role in the expansion of the bank, the health of the business community, and the overall economy of the state and nation. If they want to be successful, it is critical that they evaluate the risk of all loan requests.
The importance of lending is made clear to new hires the day they start. They are told the bread-and-butter career path of greatest potential and distinction is the apprentice program of the so-called “credit” function.
Today, the local and national growth engine of commercial bank lending is sputtering. In the wake of the financial meltdown associated with the real estate collapse of 2007-2009, and the emergence of a plethora of Dodd-Frank style “fix-it” legislative initiatives, normal risk-taking in the commercial banking and regulatory community has virtually ceased operating. Without risk-taking, the commercial banking industry no longer has a reason to exist. And in the absence of evaluating and assuming studied risk, the dynamics for economic expansion and job creation have slowed to a crawl.
So how do the Dodd-Frank regulations, which became law in 2010, help or hinder commercial banks in their vital role as growth-enablers? The purpose of the statute, like so many other regulatory tomes already on the Federal Register, is to avert future massive bank failures or insolvencies.
To that end, a key feature of the legislation is its requirement that all banks attract and hold more capital on their balance sheets (chiefly stock investments in their banks from investors, along with greater retained earnings). By moving toward higher ratios of liquidity and capital as a percent of total bank loans and investments, Dodd-Frank oversight seeks to build a greater “buffer” to shield financial markets from the type of seizures and transaction failures that degenerated into the general panic and stultifying economic uncertainty that have gripped the nation over the last five years.
Among the benefits derived from higher capital-to-loan ratios is a greater comfort level for investors and lenders. After all, strengthening the “rainy-day” portion of a household’s balance sheet (e.g., greater savings, liquid cash, checking account balance, equity on one’s home) provides households with more flexibility and leverage to surmount nasty, unexpected financial events.
Another advantage to mandating higher proportions of liquidity and capital on bank balance sheets is the reinforcement of confidence in the U.S. dollar. Sounder capital ratios for banks, regardless of size, bolster the profile of U.S. financial and real estate markets as safe havens for international capital. That’s because most investment capital will go where it’s invited, and stay where it feels welcome and secure.
A closer look, however, suggests that several downsides to Dodd-Frank are causing pushback at community banks and within international institutions. Some mortgage bankers fear the act could potentially discourage lenders from extending credit. The worry is that Dodd-Frank provisions ban lenders from making residential mortgages unless they’ve made good-faith determinations — based on borrower-provided data — that borrowers can repay the loan. In normal times, that concern may seem overwrought. But reading the fine print of the act, some mortgage bankers worry that the provision is too subjective and leaves mortgage lenders open to lawsuits from borrowers in any foreclosure action.
Elaborating on the open-endedness of the regulation, E. Robert Levy, executive director of New Jersey’s Mortgage Bankers Association, says it is very difficult for lenders to assess a borrower’s ability to repay a loan if the borrower lives in an area that has been badly affected by economic decline. In particular, he believes that some lenders, especially community bankers, would simply opt to make standard, plain-vanilla loans rather than develop sophisticated loan products that would help more borrowers. He further notes that the Dodd-Frank Act would fail to prevent state regulators from taking enforcement action against lenders. He warns that different requirements imposed by states, compared with those of the U.S. Consumer Financial Protection Bureau, could lead to regulators applying an “inconsistent interpretation” of consumer protection rules.
Another reason why Dodd-Frank could curtail mortgage lending, including loans that banks believe are well within the bounds of creditworthiness, is that the legislation imposes immense new costs on lenders big and small. Locally, for example, a Comerica branch manager observed that, since last summer (roughly a year after Congress passed the law), more than 1,500 Comerica lending officers and staff were obliged to enroll in a Mortgage Lending Registry that required trips to a federally approved center where each individual had to submit to a thorough background check and be fingerprinted.
Referring to Dodd-Frank employee compliance costs, Frank Keating, president and CEO of the American Bankers Association (ABA) in Washington, D.C., recently quoted one banker’s frustration: “For the first time, his bank devotes more work hours to complying with regulations than to lending. … He now has 1.2 employees performing regulatory compliance for every one employee focused on lending and bringing in business.”
Dodd-Frank also has affected the willingness to lend on the part of U.S. branches of international banking organizations. Since spring 2011, two immense banks — United Kingdom’s Barclays PLC and Germany’s Deutsche Bank AG — have altered the legal structures of their huge U.S. subsidiaries in order to shield themselves from regulations embodied in Dodd-Frank. Deutsche Bank, for example, with roughly $354 billion in assets and 8,652 employees in the U.S. (making it among the largest banks in America), reorganized its U.S. subsidiary and shed its “bank-holding company” classification. In doing so, Deutsche Bank intended to shield itself from the new regulations requiring it to pump $20 billion of new capital into its U.S.-based facilities.
In this regard, Dodd-Frank’s efforts to bolster capital reserves at U.S. banks that represent arms of overseas owners actually pile onto the work of other regulators. For example, the Federal Reserve became the regulator responsible for setting rules and monitoring the liquidity and adequacy of capital buffers. In addition, the Federal Reserve became the new agent, under the law, tasked with subjecting banks to periodic financial “stress-testing.”
Stress-testing is a double entendre, in the sense that it purports to simulate the survivability of financial institutions to economic turmoil comparable to 2008-09 — but, in actuality, it stresses the employees, directors, and shareholders being examined.
According to the ABA, federal regulators have issued 4,870 Federal Register pages of proposed and final rules in conjunction with Dodd-Frank. Already there are more than 240 rules, with many more to come. Keating says that what the public may not understand is that managing this mountainous regulatory burden, not counting 50 new or expanded regulations unrelated to Dodd-Frank that banks have been obliged to accommodate over the past two years, is overwhelming to small community banks.
“The cost of regulatory compliance as a share of operating expenses is two and a half times greater for small banks than for large banks,” he says. “What is a significant challenge for a bank of any size is overwhelming for the medium-sized bank.”
Clearly, time and money expended on satisfying regulator demands leaves less time and money for making loans.
Yet another source of friction between provisions of Dodd-Frank and lenders involves credit cards and small individual and commercial loans, as well as mortgages. For decades, lenders have inserted provisions into private loan contracts that are known as “mandatory arbitration clauses.”
Arbitration clauses are generally considered beneficial to both the lender and the borrower, because they offer consumers (borrowers) a relatively quick, inexpensive means of resolving small-claims disputes ($125). Lenders, too, avoid lengthy and often costly litigation. In fact, this legal facility is so mutually cost-effective that Congress has protected its use since 1925 via the Federal Arbitration Act. Moreover, a 2011 decision by the U.S. Supreme Court weighed in favorably in support of arbitration clauses, thereby turning back challenges to an 86-year success story.
Nevertheless, under current administrators, Dodd-Frank — plus its more recent Durbin Amendment — still endeavors to outlaw mandatory arbitration for firms making residential mortgage loans. Specifically, it has given the newly created Consumer Financial Protection Bureau power to investigate, limit, and ban mandatory arbitration clauses in a wide range of consumer financial services that are in the “public interest” — and Washington’s aggressive Consumer Bureau gets to decide “public interest.” Bottom line: Banks increasingly view consumer lending with trepidation.
Whether consumers truly benefit from these added regulations is an open question. On paper, the plethora of new rules seems well-intentioned, with consumer safety in mind. But if, in response, community banks downsize lending or dissolve operations, then the ultimate impact of Dodd-Frank on community growth and employment will have been counterproductive.
A local branch manager for a large regional bank in metro Detroit described two such situations. Dodd-Frank sets a cap on the fees that banks can charge on credit cards involved in merchant (sales) processing. What this means, however, is that banks must attempt to charge higher fees on other customer accounts or services (for checking accounts or overdrafts caused by checks written by non-bank customers) in order to make up for normal revenue that now is being denied by the regulators.
To bankers, these rules represent especially treacherous and repugnant overreach by bureaucrats, for the simple reason that the rule-makers have no direct knowledge of the creditworthiness of credit card or debit card holders; nor do regulators go face-to-face with bank customers who must be notified of the bank’s intention to raise fees, penalties, or loan rates to compensate for mandatory price controls (caps) on other bank products.
In reality, community bankers must now obtain from customers pre-authorization to install higher fees, in which case customers often bolt in search of greener pastures.
What’s more, a senior community bank compliance risk manager in metro Detroit notes serious side effects of the Dodd-Frank Act that relate to personal and small-business lending; Dodd-Frank requires banks to extract from borrowers much more information on their income than ever before.
In other words, unless banks become considerably more customer-intrusive, they will likely fail to placate regulators and the loan will be denied. Examples of this are already legion: In prior years, lenders verified the actual pay stubs of individuals requesting personal loans. Such scrutiny helped legitimize likely sources, size, and timing for prospective loan repayments.
Now, under Dodd-Frank, greater depth, proofs, and volumes of documentation are necessary; among the data required are comprehensive tax returns of borrowers. For an individual in a K-1 partnership consisting of six companies, tax returns and income statements must accompany a mortgage loan request on all six firms before the loan can be considered.
In conclusion, it should be evident that people function better when they feel secure in their interactions with others, especially when it involves large financial transactions, borrowings, and provision of savings and investments for retirement and health care. To the extent clear, logical, consistent, and flexible regulations can provide peace of mind to borrowers and lenders alike, they will contribute seamlessly to confidence throughout the economy and financial system. Effective regulatory legislation augments safety, garners respect, and promotes ongoing cost-consciousness.
The issues raised by Dodd-Frank’s implementation suggest revisiting its cost/benefit ledger soon, and frequently.
After all, decades of new regulations have been devised to counteract waste and fraud associated with other government regulatory programs, such as Medicare. Even so, taxpayer losses continue to mount.
Ultimately, there are no easy answers when it comes to consumer protection. Nevertheless, for most of the 236 years that our nation’s economy has functioned, the finest guardian of consumer well-being has been competition among financial firms.
Consumer protection is further enhanced by an absence of “too-big-to-fail” government shielding of imprudent company behaviors, and a tried-and-true customer responsibility for selecting banks with the most reputable track records for serving financial needs. db