The DODD-FRANK ACT: Impact on Community Banks

May 18, 2011

By: Robert M. Vinton

 Both the intended and unintended consequences of the Dodd-Frank Act (“Act”) will have significant impact on the approximately 90% of outstanding banking charters that qualify as “Community Banks”. The Act is considered to be the most comprehensive piece of legislation dealing with banking reform since the Great Depression. While the 2011 GOP controlled Congress may stall some of its implementation, the most anticipated impacts on community banks should still include the following:

Preemption of State Consumer Protection Laws. Several provisions of the Act modify the extent to which federal consumer financial laws preempt state consumer financial laws. State laws are generally preempted only if they are inconsistent with federal law and are preempted for national banks and federal savings associations only if they prevent or significantly interfere with the bank’s or thrift’s exercise of powers granted to them by federal law. However subsidiaries and affiliates of banks and thrifts are made subject to state law despite potentially contrary provisions of the National Bank Act and Homeowners Loan Act. At this time it is unclear how these provisions will affect the regulatory landscape facing national banks and federal thrifts and the full impact of these modifications will likely not be seen until they become effective on July 21, 2011. National banks as well as thrifts will be regulated by the OCC. Will banks and thrifts be subject to more state supervision? It depends upon the OCC’s enthusiasm for preempting state laws and willingness of the courts to defer to or approve OCC determinations. Will state banks have an incentive to convert to national banks? Many factors could come into play including whether the bank has subsidiaries or affiliates, the location of the bank, how the burdens imposed by the state compare to those imposed by federal law and the extent to which the OCC chooses to exercise its preemption authority.

Consumer Financial Protection Bureau. Commencing January, 2011 the CFPB will be the primary rule maker over consumer financial protection statutes. It may be anticipated that the new regulations the CFPB creates will increase compliance costs for all depository institutions and will likely limit the fees that they can charge. To the extent new regulations increase the cost of doing business they will either have to be passed on to consumers or absorbed by smaller banks, exacerbating a small bank competitive disadvantage. Although the CFPB protection laws will apply only to institutions with more than $10 Billion in total assets the enforcement duties for under $10 Billion banks will remain with the bank’s primary federal regulator.

It Will be More Difficult for All Banks to Raise Capital. The definition of “Accredited Investor”, the group on which many community banks rely when raising capital in a private placement, has been amended to exclude the value of a primary residence in meeting the net worth requirement. This change limits the pool of investors and makes it more difficult to comply with registration exemptions.

Regulatory Burden. This provision of the Act applies primarily to thrift institutions. The Office of Thrift Supervision (“OTS”) will be closed and much of its staff will be merged into the Office of the Comptroller of the Currency (“OCC”). The present powers of the OTS will be divided and transferred among existing banking agencies with the Federal Reserve being a supervisory and rule making authority for thrift holding companies and is the rule making authority with respect to affiliate transactions, loans to insiders and anti-tying prohibitions.

Competitive Pressures. Competition for deposits will likely increase as a consequence of the FDIC assessment shifting from deposits to an asset based formula. The legislative history of the Act indicates that this change is intended to benefit community banks, however the unintended consequence of this change might lower or even eliminate any savings to community banks as larger banks will likely respond by amending business plans to shift away from non-deposit funding sources. Similarly, the new interchange rates applicable to $10 Billion institutions will undoubtedly impact community banks (which must compete). Community banks will likely be forced to choose between increasing fees or refraining from providing electronic banking services.

Interstate Branching. Well capitalized thrifts have been able to branch nationwide since 1992 and with the passage of the Act state and national commercial banks will have the same opportunity as long as the laws of the state in which the branch is to be located permit a state bank charter by that state to establish the branch. In recent years, larger banks have been expanding into nearby states or even nationwide and it is anticipated that strong community banks will now have an opportunity for the same expansion. It may be anticipated this change will increase competition within a community bank’s home state while the attractiveness of a local bank as a purchase prospect will be diminished.

Demand Deposits. The Act repeals the prohibition on paying interest on demand deposits effective July 21, 2011. The obvious effect will be to increase the cost of funds for all banks, thereby narrowing the net interest margins as banks will be forced to pay interest on demand deposits of business entities in order to retain customers. Non-interest demand deposit accounts (“DDAs”) will increase in value in a rising rate environment, and the consequence of paying interest on DDAs will have a significant negative impact on the value of DDAs. Summary. The Act, so heavily hyped as directed toward large institution reform, establishes a new regulatory framework for the entire financial industry. It will have a direct and immediate impact on community banking organizations. Although some provisions do not apply directly to community banks, it may be anticipated that the entire competitive environment will be drastically changed as large and small banks adopt “best practices” and respond to those provisions.

This Article is published for general information, not to provide specific legal advice. The application of any matter discussed in this article to anyone's particular situation requires knowledge and analysis of the specific facts involved.

Copyright © 2011 Fairfield and Woods, P.C., ALL RIGHTS RESERVED.

Comments or inquiries may be directed to:
Robert M. Vinton.