The Impact of Regulation on Banks and the Ventures The Loan To
Edward Gamble, Ph.D, CPA, CMA, MBA, Assistant Professor of Accounting
Due to its human and physical geography, Montana is disproportionately served by community banks relative to most other states in the nation. Because of this, the health of community banks is important to the health of Montana’s economy. This proposal continues my work with Dr. Gary Caton with two new projects spread over the next two years. The first of these will look at the impact of the Dodd-Frank Act on bank loan portfolios. The second research project will survey Montana-based banks with the intent to learn first-hand how financial regulation is impacting Montana community banks, and which regulations are particularly challenging for such banks’ competitiveness.
Signed into law in July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA) is some 3,000 pages of regulation and policy guidelines intended to modernize U.S. financial regulation, limit future financial crises, and protect consumers. Much of the law was left intentionally vague in order to give regulators such as the Federal Reserve Bank, the Securities and Exchange Commission and the new Consumer Financial Protection Bureau room to tailor the new regulations to the needs of the specific constituency. As with any new regulation, there are intended consequences, such as regulation modernization, and unintended consequences, such as tilting the competitive playing field in favor of one or another sets of players. The specific aim of the first proposed project is to analyze how community banks have changed their lending behavior as a result of the DFA. Specifically, we plan to study whether the DFA has caused community banks to cut back on lending to small ventures, to consumers, and to mortgage borrowers. This work is intended for submission with and eventual publication in a high quality finance or entrepreneurship journal. Dr. Caton is submitting a separate application for a research fellowship for this project. 3 The specific aim of the second proposed project is, through survey methodology, to assess Montana banker perceptions of both the effect on bank performance and strategic direction of regulation compliance and to gather suggestions for regulation and policy changes. The survey will focus on the impact of the DFA, but we plan to also ask about other compliance-related issues resulting from other regulations, for example, the Community Reinvestment Act and the Bank Secrecy Act. My coauthor on this project is Gary Caton (MSU), who is submitting a separate application for this project.
Significance of the Project
Working under the relationship banking model, community bankers have deep knowledge of both their local economic environments and their borrowers, and their loan decisions tend to be made locally. In contrast, non-community bankers work under a more numbers-based, algorithmic lending model in which credit scores reign above personal knowledge and loan decisions tend to be made more centrally. Given this dichotomy in lending styles, the community banking model tends to be more suitable for both smaller communities and smaller borrowers. Although it is the fourth largest state in landmass, Montana is 43rd in population (see http://worldpopulationreview.com/states/), a combination that makes for a disproportionately large number of small communities more suitable for the community banking model. According to the U.S. Small Business Administration’s 2018 Small Business Profile, there were 118,315 small businesses in Montana employing 244,668 Montanans. These numbers represent 99.3% of businesses operating in the state and 65.2% of employed Montanans, respectively. According to Lux and Greene (2015), community banks provide some 46% of all commercial real estate loans, over 50% of all small commercial and industrial loans, and some 77% of all agricultural loans. Combining these two sets of statistics points out the importance of community banks for Montana’s economy, as well as that of the U.S. Since interstate banking was deregulated back in the early 1980s, the number of banks operating in the U.S. has declined by nearly two-thirds (see Madura, 2018). This industry consolidation has reduced the number of relationship-based community banks available to make small business and agricultural loans. Similarly, changes in banking regulation can have the unintended consequence of reducing lending in these areas. For example, the DFA’s more stringent underwriting and documentation requirements, which are intended to increase the quality of loan assets, also forces small banks to reconsider whether this type of loan is worth the compliance costs. In the first project, we intend to use banking data to analyze how community bank loan portfolios have evolved since the DFA was signed into law as a result of the financial crisis, while in the second project we plan to develop a survey instrument to discover from Montana bankers themselves what their perceptions are of the effects on their banks of the DFA.