How community banks can compete in the wake of Dodd-Frank revisions

By Natallia Babrovich | 1 June 2017

Soon after being elected, Donald Trump signed an executive order for the US Treasury Department to revise the Dodd-Frank Act. This news arose tremendous enthusiasm among community banks, since they had been very seriously affected by this post-crisis legislative act. But what do challenger banks hope this revision will achieve? 

How Dodd-Frank affects community banks

Before Dodd-Frank, community banks didn’t engage in subprime lending, nor did they profit from derivatives that later became the major causes of the financial crisis. On the contrary, they remained focused on their traditional banking activities such as accepting deposits and reinvesting them as loans to local communities. Nevertheless, community banks have got in a tight corner after the adoption of Dodd-Frank.

Compliance difficulties

As stated in the American Action Forum research, financial institutions have spent more than $24bn as well as 61 million paperwork burden hours to comply with the new regulation. The majority of community banks were adversely affected by the Dodd-Frank reform, with 90% of them indicating the growth of compliance costs (Mercatus Center).

Adjusting systems and processes to compliance requirements affected community banks’ budget distribution and, as a result, instead of hiring new loan officers, community banks had to employ compliance specialists to interpret the arcane language of Dodd-Frank. 

Bigger banks, on the contrary, could afford to open up compliance departments to absorb new regulations. Since regulatory expenses are fixed costs, it’s far easier for big banks to cover such costs since they can spread them over a larger number of loans. Unfortunately, community banks don’t have the same number of customers to facilitate cost-effective compliance. 
To make things worse, community banks now must submit lengthy quarterly reports that are more in line with larger banks’ activities. To explain the issue, Easter George, the President of Kansas City Federal Reserve, mentioned that the report on risk-weighted assets currently has 57 rows and 89 pages of instructions.

Small business and mortgage lending problems 

After Dodd-Frank, community banks are now less flexible in their lending activities. The new regulation brought a standardized approach to defining who qualifies for a loan. As a result, even if a customer is known as a good borrower, community banks may not open a credit line in case the customer’s credit score is lower than the standard debt-to-income ratio. Though this rule helps to guarantee borrowers’ creditworthiness, it undermines the relationship-based model and discretion that are the essence of community banking. Consequently, restrictions in local decision making has made mortgage and small business lending more expensive and cumbersome.

More ACS expenses and less free-of-charge services for customers

Part of Dodd-Frank, the Durbin amendment limited the amount of fee that banks can charge retailers for debit card processing. Though the law supporters promised that community banks and credit unions would be spared from its effect, they didn’t exempt these financial institutions from re-routing the exclusivity and routing provisions requirements. 

As stated by Molly Wilkinson, an executive director of the Electronic Payments Coalition, the amendment requires issuers to add an additional ‘unaffiliated’ payment network to their debit cards, which leads to a substantial growth of administrative costs. She specified that authorization, clearing and settlement (ACS) expenses per transaction were 17 times higher in smaller financial institutions than among high-volume card issuers. As a result, most banks had to cover their losses by decreasing the number of free-of-charge services, such as checking accounts or overdraft courtesy, which caused discontent among customers.

Consolidation and closing down as the outcome

Unable to absorb new requirements and compliance costs, some community banks had to close, others merged or were acquired by other banks, and those who survived found themselves competing with bigger banks with far more financial resources. 

In fact, the Act has further exacerbated greater asset consolidation in a fewer number of banks. To illustrate the issue, the Institute for Local Self-Reliance mounted a short video where it illustrates the level of asset concentration in the U.S. banking sector. Compared with 1995, in 2014 the market share of giant banks grew from 22% to 63% in contrast to small banks, whose rates plummeted from 21% to only 9%. As a result, the market share of all community banks in the U.S. is now lower than the asset share of each of the four mega banks (JPMorgan Chase, Wells Fargo, Bank of America or Citigroup) alone.

Apart from this trend, statistics indicate a steady fall in the number of community banks (from 15,957 in 1985 to only 5,874 by the end of 2015). Though it all started before the crisis, since the second quarter of 2010 – right after Dodd-Frank was adopted – the rate of this decrease was twice as high as the one between Q2 2006 and Q2 2010 (Forbes).

What’s the worst case scenario?

If community banks continue to merge, consolidate, or, what’s worse, go out of business, it can jeopardize the safety and soundness of the US financial system. Small businesses, being the powerful engine of the US economy, have always heavily relied on community banks as their primary source of financing. Without strong support from community banks, the natural cycle of small business lending, employment growth, and economic expansion can significantly slow down. 

Indeed, a recent economic research of Dr. Hoai-Luu Nguyen from the University of California indicates that bank closures lead to a sharp and persistent decline by 13% in small business lending, with credit supply remaining on the same low level up to six years afterward. In the absence of physical branches, some counties can become underserved, turning into ‘banking deserts’ with limited access to affordable banking products and services, which makes it harder for inhabitants to manage finance or build wealth.

What’s the remedy?

The fate of Dodd-Frank is still unclear, and there are too many rumours about its complete repeal or replacement with a less stricter legislative act. While the solution is hanging in the air, community banks can try to adapt their business strategies to the current circumstances through available technologies that increasingly define competitiveness in the banking sector.

In particular, technologies such as mobile banking and fintech innovations can help xhalenger banks compete with bigger rivals while staying close to customers. Using a mobile banking app, community banks can uphold the personal touch even without face-to-face interactions though reaching customers in geographically remote or rural areas. Community banks can also revise their capability to increase the number of customers using digital channels. In particular, online applications for banking products and services can ensure seamless customer journey across digital channels, and facilitate more effective sales process.

Thus, instead of opening additional branches, community banks can ‘become bigger’ by offering more digital services to customers. For example, a banking app can appeal to a younger generation, which can potentially increase a community bank’s customer base. With this thought, Radius Bank, a $900m asset Boston-based community bank, closed almost all branches and focused on online and mobile banking targeting millennials and technophiles. To attract a younger and tech-savvy generation, Radius Bank presented short ads reminiscent of an 8-bit Super Mario Bros game. The bank managed to increase the number of online account openings per week from five to over 500 in two years.


Dodd-Frank still remains one of the most hotly debated topics in the banking and financial services industry. The Trump administration has a lot of work ahead to ensure economic stability and security as well as strike the right balance between financial institutions of various sizes. Still, no one knows for sure how exactly the changes will affect community banks. In these circumstances, instead of relying on a more favorable legislation, community banks can turn to modern technological solutions to stay afloat in this highly competitive environment. 

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