Saturday, November 10, 2012

Dodd-Frank and the Effect on the Banking Industry 

Is there such a thing as too small to survive?  Basically, the need for more capital, low interest rates, sluggish loan demand, and the dominance of the large banks have made it difficult for the small community banks to survive.  The question that needs to be asked is - is thing a good thing?  Another question to ask is should we be instituting the (state) government run community bank.  North Dakota has them now and it is the only state in the country that allows this type of bank.  However, this idea is catching on very rapidly in other states.

The article is in italics and the bold is my emphasis.  From Fortune:

Now that President Obama has been re-elected, analysts, consultants and dealmakers have turned from whether Dodd-Frank will be repealed to what it means for banks now that it's likely here to stay. The overwhelming conclusion: Thousands of small banks will soon disappear.

Emmett Daly, a Sandler O'Neill dealmaker who specializes in small banks, predicted at an industry conference put on by Mergermarket on Thursday that the number of banks in the U.S. would shrink to a few hundred. There are currently more than 7,000. Bill Egan, head of financial institutions investment banking at Bank of America Merrill Lynch, agreed, but said the weeding out process was likely to take more than a decade.

Indeed, the deal this week to buy bank adviser KBW by larger rival Stifel Financial appeared to be motivated by the belief that more banks would have to make deals. Says Rochdale Securities bank analyst Dick Bove, "It's fairly clear that 50% of the banks in the U.S. need to be recapitalized."

Kamal Mustafa, who heads up bank consulting firm Invictus and is a former Wall Street M&A banker, says it's not just Dodd-Frank. Low interest rates and the Fed's annual stress tests are making it tough for small banks to survive as well. His firm looked at bank profits and capital rules and came to this conclusion: Nearly 2,000 banks need to sell. "There are a large number of banks that are limping toward oblivion," says Mustafa. "Capital requirements have gone up too fast, and rates have gone too low. There's no way out."

Like post offices and small businesses in general, law makers are likely to come to the rescue of small community banks. What's more, at least so far small banks haven't done significantly worse under Dodd-Frank than big banks.

Still, it's probably true that all the rules we have lumped on the banking industry in a good faith effort to make our financial system safer will most likely make it harder for small banks to stick around. The real question is how much we should care.

Canada, afterall, has less than two dozen banks, and by most accounts it's banking system did pretty well in the financial crisis. What's more, the vast majority of lending, something like 90%,  in this country is done by the nation's 50 largest banks. So losing nearly 7,000 banks would only cut off credit to 10% of borrowers at most.

Joseph Mason, a finance expert at Louisiana State University, says there's no hard economic evidence to show whether small banks benefit the economy or not. Nonetheless, Mason says he falls into the camp that believes small banks are good for the U.S. He says competition matters. And while small banks only make up a small portion of lending, the types of loans they do, to local businesses that large banks might deny, may matter.

But all this comes at a cost. The Federal Deposit Insurance Corp. has spent tens of billions saving mostly small banks over the past few years. Is it worth it?

In the mortgage market there appears to be somewhat of an answer. Home loans are dominated by a few large banks, Wells Fargo and J.P. Morgan, mostly. Small banks have largely been pushed out. The result: Mortgage rates are about one percentage point higher than they would be if we had more competition. Apply that to all mortgages, and that higher interest rate costs consumers about $100 billion a year in extra interest. Not to mention all those who can't actually get refinanced. I'd say that's pretty good evidence that we should figure out a way to keep small banks around.

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