Why are small banks disappearing?

In 1994, nearly 500 banks were headquartered in California. Today, there are fewer than 180. By the end of the year, if current trends hold, Californians will have only one-third the number of banks to choose from for their mortgage, small business and personal savings needs than they did just a couple of decades ago.

There are a few reasons for this disturbing trend, which is happening across the country. But the most important one — the reason I hear more than any other from bankers who decide to merge, sell or close their institution — is the increasing federal regulatory burden.

That doesn’t mean I oppose all regulation. In the wake of the financial crisis, regulatory changes were necessary, and provisions in the Dodd-Frank Act passed in 2010 helped improve financial stability. But nearly a decade after the crisis, we’ve ended up with too many duplicative and sometimes contradictory rules that don’t always promote safety and soundness, and may actually hinder banks from serving their customers and growing local economies.

For example, I recently heard from a bank in Southern California that, to its great regret, had to end its mortgage loan program. Dodd-Frank’s mortgage regulations and disclosures meant the bank would have to purchase expensive software to manage the new layers of red tape — so expensive, in fact, that the bank was going to lose money on every single loan.

Getting community banks out of the business of helping qualified Americans buy homes can’t have been what Congress intended when it passed Dodd-Frank. It makes sense to recalibrate some elements of that law to ensure that it’s working properly.

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A proposal in the House would take important steps in that direction. The Financial CHOICE Act, which the Financial Services Committee recently voted to send to the floor, includes several sensible provisions that the banking industry endorses, as well as others that require further study and analysis.

Among the measures I support: The legislation would allow regulators to tailor their oversight to the unique risk profiles of individual financial institutions; provide greater opportunities for banks to appeal decisions by their examiners; and ease some requirements on mortgages that banks hold in their own portfolios (meaning they retain all the risk). The overall effect of these and other provisions would be to give banks more breathing space and consumers more choices.

Though banks adjust as best they can for the sake of their customers, the smallest banks have too few assets to keep up with ever growing compliance costs. Indeed, the vast majority of banks that have disappeared are community banks. At the end of 2016, California had just 11 small banks left; in 1994, these banks accounted for nearly half of the industry in the Golden State.

Some have pointed to strong bank profits as an argument for why reform is unnecessary. Profitability is, of course, a sign of economic strength that we should celebrate; profitable banks benefit their customers, investors, employees and broader communities.

However, the topline profit figure doesn’t tell the whole story. Increased regulatory compliance costs limit bankers’ ability to reach underserved communities. Moreover, tunnel vision on bank profits ignores macro-level trends.

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Since Dodd-Frank was passed, just four new banks have formed nationwide. (The newest, I’m pleased to report, is in Orange County.) This abysmal pace of startups is principally due to the extraordinary regulatory burden placed on small banks and the excessive sums of capital new-bank investors are required to put up.

Our economy performs best with a healthy and diverse mix of banks to meet customers’ needs — large, small and everywhere in between. Without reasonable reform in Washington, California’s banking sector will continue to shrink and become less diverse. Californians — and all Americans — will pay the price in terms of lost opportunities for growth.

Rob Nichols is president and CEO of the American Bankers Assn.

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