Small community and regional banks struggle to compete, in part due to the regulatory requirements imposed by Dodd-Frank after the 2008 financial crisis. These regulations are a minor cost of doing business for the too big to fail banks. From Financial Times:
Amid a renewed push in Washington for regulatory relief for the country’s community banks, research by Marshall Lux — JPMorgan’s former chief risk officer for consumer businesses, now a senior fellow at Harvard’s Kennedy School — has concluded that they were hit hardest by new rules.
Community banks lost 6 per cent in market share between 2006 and mid-2010, during the worst of the crisis. But, since the passage of Dodd-Frank in early 2010, the decline in market share has doubled to more than 12 per cent.
“What if Dodd-Frank created a too-small-to-succeed problem in addition to the too-big-to-fail problem?” said Mr Lux, who is based at the Mossavar-Rahmani Center for Business and Government at Harvard’s John F. Kennedy School of Government. “This research suggests it has.”
America’s smaller bank sector has long been a hot topic given its importance to communities, but the topic has met with renewed interest in Washington in recent months. These small banks are estimated to provide 70 per cent of US agricultural loans and 50 per cent of small business loans.
Community banks’ share of the US lending market has fallen from more than 40 per cent in 1991 to 22 per cent last year. At the same time, the market share of America’s five biggest banks has jumped from 17 per cent to 41 per cent.
The problem is that the regulations require a bank to set up new systems and then monitor them. This is a fixed cost, so it requires similar levels of investment regardless of the bank size. That is, a bank with 100x as much in assets does not need to spend 100x as much in compliance. It’s an advantage for the too big to fail banks.
In addition, a major reason for consolidation and mergers in the banking business is that the too big to fail banks have an advantage in cost of capital. The federal bailout and subsequent Dodd-Frank provisions for ongoing bailouts provided both an implicit and explicit backstop for the banks. But only for the TBTF banks, not for the small community and regional banks.
This advantage in cost of capital was largest, of course, during the crisis. The GAO now estimates that it has been reduced, but their study also shows that in the event of another crisis, the advantage will once again be to the big banks. See this WSJ article.