In the 1946 classic It’s a Wonderful Life, James Stewart stars as George Bailey, the director of the Bailey Building and Loan Association in the fictional community of Bedford Falls, N.Y. Bailey faces numerous challenges to keep the Building and Loan afloat in order to continue supporting the people and businesses of his hometown. His chief challenge is Mr. Potter, the wealthy slumlord who repeatedly schemes to force Bailey out of business.
Although It’s a Wonderful Life is fictional, the Building and Loan is a prototype of a real, modern institution, the community bank. And in 2013, community banks are finding themselves under significant threats to their existence. Instead of being Pottered, they’re being Franked. Real towns, like the fictional Bedford Falls, will suffer if a miraculous change in policy doesn’t occur quickly.
The Dodd-Frank Act was intended to fix the perceived inefficiencies and failures in the American banking system that supposedly led to the financial crisis. However, my new research with the American Enterprise Institute suggests that it’s having at least one detrimental effect: The act is placing unwarranted and unsustainable pressure on community banks.
Community banks did not cause the financial crisis. They did not engage in predatory lending; their business model depends on gaining and maintaining the trust of the community. They did not originate subprime loans or securitize them; they issue and hold mortgages on homes and businesses owned by their long-term customers. They did not engage in complicated derivatives trading; like the Building and Loan, they largely stick to traditional banking activities such as taking deposits and making loans.
A community bank with $100 million in assets serving families, farmers, and small businesses in a rural area bears little resemblance to a $2.1 trillion global behemoth such as JPMorgan Chase. But rather than creating two or more distinct tiers of regulation, appropriately tied to the size, complexity, and risk posed by these two very different kinds of institution, Dodd-Frank builds on the existing system’s one-size-fits-all approach to regulation.
The Dodd-Frank Act was intended, in part, to eliminate “too big to fail.” Ironically, it may have an almost opposite effect, by making community banks too small to succeed. Almost 2,000 small banks vanished in the past decade, due mostly to mergers with larger banks. The number of banks with assets of less than $100 million decreased by more than 80 percent from 1985 to 2010, while the number of banks with assets greater than $10 billion nearly tripled. With an increased regulatory burden, over the next few years it seems likely that many small community banks will continue to merge into larger banks, or simply go out of business. Like Bedford Falls under the thumb of Mr. Potter, many communities will be the worse for it.
The FDIC has determined that approximately 1 in 12 American households don’t have a checking or savings account, and an additional 20 percent are “underbanked” — that is, despite having an account, they also rely on expensive “alternative” financial products such as payday loans and check-cashing services. Lower-income, rural, and minority Americans are much more likely to be unbanked or underbanked. These problems will only increase if community banks merge or disappear entirely.
The relationship-banking model used by community banks puts them in a position to offer financial services to families and small businesses that don’t neatly fit into the profiles used by large financial institutions. Although community banks cumulatively hold only 14.2 percent of total bank assets, they are responsible for nearly half of small-business loans, more than 40 percent of farmland and farming loans, and over one third of commercial-real-estate loans. In rural areas, community banks hold 70 percent of all deposits.
Dodd-Frank was intended to protect consumers and ensure the stability of the financial system, but if more community banks are forced to merge or go out of business, too-big-to-fail banks will get even bigger. And the small businesses and individuals that don’t fit neatly into standardized financial modeling, or are located outside metropolitan areas served by big banks, will find good loans and basic financial services harder to come by.
Before we lose more community banks, Congress must act.
Meaningful reform that distinguishes small, traditional community banks from sophisticated financial institutions requires a two-tiered regulatory framework. By more precisely addressing the risks posed by both types of institution, Congress could actually reduce systemic risk and protect consumers. Rather than devoting time and resources to addressing regulations that have little to do with their operations, community banks would be freed to serve their customers and invest in their communities. In contrast, the largest financial institutions would be subject to regulations and examinations properly tailored to their size, complexity, and role in the American economy and global financial system.
It’s a Wonderful Life may be an idealistic work, but its portrayal of the importance of the Bailey Building and Loan to Bedford Falls is spot on. Farmers, families, and small businesses, particularly in the most challenged parts of this country, depend on their community banks.
Clarence, George Bailey’s guardian angel, gave us a peek at Mr. Potter’s Bedford Falls, and it wasn’t pretty. With proper reform of Dodd-Frank, we can avoid that fate for America.
— Tanya Marsh is an assistant professor at Wake Forest University’s School of Law, where she teaches real-estate law, property law, and a seminar on the financial crisis, and an adjunct scholar at AEI.