Nearly five years after the failure of Lehman Brothers and three years after the passage of Dodd-Frank, the most comprehensive financial services regulatory reform since the Great Depression, a few things are clear.
First, the mega banks are just fine. In the second quarter of 2013, Bank of America saw a 63% increase in net income, Citigroup posted a 42% increase, JPMorgan Chase recorded a 32% increase, and Wells Fargo "only" logged a 19% increase. Headlines boast of the "record profits" enjoyed by the mega banks.
Second, community banks are definitely not fine. Even before the Financial Crisis, smaller banks saddled with a growing regulatory burden found it difficult to compete with more efficient mega banks. The result was a greater consolidation of assets in the hands of a few companies. The number of banks with assets of less than $100 million decreased by more than 80% from 1985 to 2010 while the number of banks with assets greater than $10 billion nearly tripled over the same period. A mere 7.6% of banks currently hold about 86% of all banking assets in the United States. The regulatory burden imposed by Dodd-Frank, the well-intentioned but flawed response to the Financial Crisis, has exacerbated the problem. Brokers who arrange bank mergers are already experiencing a significant uptick in business.
Third, consumers are the big losers. Financial activities that are fundamental to the average American are only worth the time of a mega bank if they involve a completely standardized product and a completely standardized borrower. You either fit in the box or you don't. As a result, millions of Americans are left out of that box altogether. Community banks traditionally serve non-standard customers who lack the deep credit history or documentation necessary for the model-based transactional lending used by large financial institutions. Self-employed workers, seasonal workers, farmers, and people transitioning to work are generally unattractive to the mega banks but have been served by community banks. When community banks fail and merge, what is the result?
According to the FDIC, one in four American households are either "unbanked" or "underbanked." They tend to rely on services like payday loan operations and, increasingly, by pawnshops. These non-traditional lenders impose far higher interest rates and fees than banks -- interest rates range from 2.5% to 25% per month -- that's 30% to 300% per year! In addition, these lenders are not currently subject to the same consumer protection regulations as traditional financial institutions.
A new report by the New York Times reveals that the pawnshop industry grew from approximately 6,400 locations in 2007 to 10,000 in early 2012. Pawnshops are clearly filling a void left by receding community banks. Robbie Whitten, chief executive of Money Mizer Pawn and Jewelry of Columbus, Georgia told the New York Times: "The way the banks have tightened up so much on making small loans and making equity loans, we've kind of evolved into, I like to call it the poor man's bank." Cash America International, a publicly traded pawnshop company, explains that its growth was due to "traditional consumer lenders ... exiting the market." Jerry Whitehead of Pawnshop Consulting Group notes that pawnshops are focused on consumers who are "getting forgotten in the banking system."
So, five years after the failure of Lehman Brothers, the mega banks have rebounded, community banks that serve vulnerable niches of American consumers, and which played no role in causing the Financial Crisis, are failing, and non-traditional lenders are expanding. This is clearly not the outcome that the authors of Dodd-Frank intended. We need to fundamentally rethink our approach to financial services regulation and reverse the tide of community bank failures and mergers, a completely unintended consequence of Dodd-Frank. If we can't (or don't), then traditional credit and banking services will be eliminated or become more expensive for small businesses, those living in rural communities, and millions of American consumers and businesses that are challenging or less profitable for large banks to serve.