Central Ohio community bankers say implementing 5,000 pages of new regulations will cost a bundle-and may not protect consumers all that much.

Community bankers remember, none too fondly, the regulatory burdens that accompanied the Sarbanes Oxley Act of 2002. Today, they're similarly wary of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

Enacted in response to the 2008 financial collapse, Dodd-Frank is intended to prevent another such crisis. But instead of targeting only the "too big to fail" institutions that were deemed responsible for the economic mess, the law establishes an entirely new regulatory framework for all financial institutions.

If Dodd-Frank came as a disappointment to bankers in Central Ohio, it didn't come as a surprise. "Did anyone think we'd go to the financial brink of the planet and not get a new law? I don't think so," says Heartland Bank President and CEO G. Scott McComb.

"This was supposed to be a bill that reined in Wall Street banks for not adhering to sound financial principles, but Congress has a difficult time separating large institutions from community banks," says Community Bankers Association of Ohio President and CEO Robert Palmer. "We got sucked in like a vacuum on Dodd-Frank, even though community banks had nothing to with the financial collapse."

For community banks--defined as institutions with no more than $10 billion in assets--Dodd-Frank carried both good and bad news. It requires larger, non-community banks to fund a greater portion of premiums collected by the Federal Deposit Insurance Corp. (FDIC), which picks up the tab for protecting depositors when banks fail. But the bill also caps the debit card electronic interchange fees that banks may collect, which may cut revenue.

As for the new Consumer Financial Protection Bureau (CFPB), also a product of Dodd-Frank, community bankers are reserving judgment. Still in its infancy, the CFPB is presently leaderless. President Barack Obama's nomination of former Ohio Attorney General Richard Cordray to head the bureau remained mired in a political stalemate in the U.S. Senate as of early October.

The community banking industry lobbied hard as Dodd-Frank took shape in Congress, but with only mixed results. "During the debate there was a lot of rhetoric to recognize the differences between community banks and larger institutions. The carve-outs for community banks are well-intentioned, but some of them won't work," says Michael Van Buskirk, president and CEO of the Ohio Bankers League.

Several regulatory agencies are writing the rules that will implement Dodd-Frank. "It's on a fast track by Washington standards," Palmer says. In the meantime, community bankers continue lobbying to change or eliminate the provisions they find onerous.

Lower FDIC Premiums

In a big win for community banks, Dodd-Frank shifts the FDIC insurance premium calculation from a deposit-based formula to one based on assets.

"Large institutions have access to other sources of funding besides deposits, so community banks bore a disproportionate share of the FDIC funding cost. The new formula recognizes that, so big banks will bear a greater portion of the FDIC cost," Palmer says.

The Independent Community Bankers Association (ICBA) reports banks with less than $10 billion in assets were paying approximately 30 percent of total FDIC premiums, even though they held only 20 percent of total bank assets. Dodd-Frank increases the minimum FDIC reserve ratio from 1.15 percent to 1.35 percent, but exempts community banks from the cost of the increase. That will mean lower assessments on almost all community banks, saving them roughly $4.5 billion over the next three years.

Heartland Bank, with more than $550 million in assets and 22 Central Ohio offices, will see $400,000 in FDIC premium savings in 2011. "That's significant for us," McComb says.

The law also permanently sets the FDIC insurance level at $250,000 per depositor, eliminating any chance of a reversion to the $100,000 insurance cap that prevailed before the financial meltdown. It also provides unlimited FDIC coverage for non-interest-bearing transaction accounts, such as business payroll accounts.

"This is a big advantage, because a lot of companies park money in a checking account," says Christopher Cole, ICBA senior vice president and senior regulatory counsel. "Community banks compete against big banks for that business. Increased FDIC coverage eases any concerns customers might have about their deposit levels at a smaller institution."

Regulation & Examination

Dodd-Frank shutters the Office of Thrift Supervision (OTS), which regulated many non-bank savings associations, and transfers its responsibilities to other agencies.

"As a federal savings and loan, OTS was our primary regulator. Now the OCC (Office of the Comptroller of the Currency) becomes our primary regulator. We expect to have our first OCC examination [in 2011]," says Sarah Wallace, chair of the board of directors of First Federal Savings and Loan Association in Newark. The $200 million thrift has six offices.

OTS employees were folded into the OCC. "I hope they'll work together to understand the differences between thrifts and commercial banks. The OCC obviously knows regulations and compliance, but it's not as familiar with our business model," Wallace says.

The Federal Reserve now has supervisory authority for savings and loan holding companies, while the FDIC will oversee state-chartered thrifts.

Whatever agency is knocking on an institution's door, regulation has already been stepped up in the aftermath of the financial crisis. Some say that's like closing the barn door after the cow has wandered off. "We need Congress and regulators to pay attention before a crisis hits, but their history is to wait for a crisis," Van Buskirk says.

Examiners are being more aggressive in safety and soundness exams. "They can require a bank to take additional loan writedowns and raise more capital," Cole says. "That's happening especially in geographic areas that were hit hard by the recession. Ohio is one of those areas. A bank [previously] could go back to shareholders for more capital or use trust preferred securities, but Dodd-Frank eliminated them as a way to raise capital."

Trust preferred securities (TRuPS) issued prior to May 2010 are grandfathered in as Tier 1 capital for bank holding companies with less than $15 billion in assets. Going forward, TRuPS cannot be used as Tier 1 capital by any bank. The law makes an exception for holding companies with less than $500 million in assets, but Cole says there's no market for TRuPS, so they're not a viable capital option even for small institutions.

Protecting Consumers

One of most hotly debated Dodd-Frank provisions was creation of the CFPB, an independent agency charged with ensuring fairness and transparency for mortgages, credit cards and other financial products and services.

The CFPB will enforce consumer financial protection laws for large banks. The FDIC's newly established Division of Depositor and Consumer Protection (DCP) will enforce CFPB's rules for community banks.

The bureau will collect data on costs, benefits and risks associated with bank products and services. It's also is responsible for implementing Dodd-Frank's numerous mortgage lending reforms.

Some community bankers predict many prospective homebuyers will be shut out of the market by the new rules. "The government is really getting into mortgage loan pricing and structuring," Wallace says. "For decades, community banks have helped middle class and less fortunate families by structuring mortgage loans that allow them to be responsible homeowners. We had flexibility to do that, but now it appears we can't help customers who don't fit this cookie-cutter mold the government has laid out."

Additionally, the CFPB will be rewriting bank disclosure requirements. That may turn out to be good news for borrowers and depositors who've struggled to make sense of paragraphs of tiny type written in convoluted legalese. "Disclosures shouldn't be so complicated and overwhelming that consumers don't know what they're signing," McComb says. "Frankly, if it's properly administered it could be the best thing ever. Customers will understand what they're signing."

Bankers say CFPB regulations would be easier to accept if other financial services entities were required to follow the same rules. "Dodd-Frank doesn't cover all of the functional competitors of banks, such as insurance companies, mortgage brokers, payday lenders and others. This shadow banking system inherently has a lower cost of doing business. It's not regulated and examined like banks, and it has no capital requirements," Van Buskirk says.

"The shadow banking industry has 80,000 unregulated financial and credit providers," Palmer says. "It would be good for the economy, consumers and the industry if the CFPB moves to regulate them. CFPB has indicated it will, but that's yet to be seen."

Interchange Fees

One of the fiercest Dodd-Frank skirmishes has involved limits on electronic interchange fees--the money banks charge merchants every time someone swipes a debit card to make a purchase.

Dodd-Frank's so-called Durbin Amendment, sponsored by Democratic U.S. Sen. Richard Durbin of Illinois, gave the Federal Reserve authority to regulate interchange fees. Initially, the Fed decided to cap fees at 7 cents per card swipe unless a bank could prove a higher actual cost, with an absolute limit of 12 cents per swipe regardless of cost.

The Durbin Amendment exempted community banks from the fee limits, but community bankers still hated it. "This is government price fixing, pure and simple," McComb says.

Bankers said the proposed fees were too low and would force them either to take losses or to charge customers for using their debit cards. "The 7 to 12 cents only covers the technical costs of processing," Palmer says. "It doesn't cover the cost of fraudulent debit transactions, such as freezing or reissuing the card."

In an ICBA survey, 93 percent of community banks said they'd be forced to charge customers for debit card and checking services that had previously been free. "That's not a good solution for customers who are accustomed to paying nothing for their debit card," Palmer says.

As for the fees charged to merchants, "The reality is competition with the big banks will force us to the market price," says Charlie Cecil, president of First City Bank, a $60 million institution with a single office in Upper Arlington. "If our debit card price tag is noticeably higher than the rest of the market, the long-term viability of our product will be in question."

"Ultimately, for community banks' debit cards to be accepted by merchants, they must adopt the lower fees as designated by the Fed. Otherwise, merchants won't want community bank cardholders' business," Palmer says. "Now the customer has been inconvenienced and doesn't know where his debit card can be used."

In late June, prodded by intense lobbying from the banking industry and by threats of new legislation, the Fed backed away from the 7- and 12-cent limits. A final ruling on the Durbin Amendment set the fee limit at 21 cents per swipe, plus 0.05 percent of the transaction amount. On a $200 debit card purchase, that means a bank may charge the merchant up to 31 cents.

Both banks and merchants said they weren't happy with the Fed's final rule, but the grumbling was muted, and neither side seemed likely to go to war to overturn the rule.

The Regulatory Burden

Community bankers are beginning to feel the burden of Dodd-Frank's additional regulatory, disclosure and compliance mandates. All told, the legislation imposes about 5,000 pages of new regulations on an already heavily regulated industry. "Provision after provision we're asking, where did this come from? How does it make the public safer from another financial crisis?" Wallace says.

"It's an avalanche of new regulations," says Van Buskirk. "No one intended to do harm, but how can it not be burdensome for community banks, especially the very small ones?"

"Dodd-Frank's legislative best practices will become industry best practices in the fact that they become the expected behavior. The expense of that and the value to the institution then become the questions," Cecil says.

"We've literally had to change every mortgage disclosure in the last two years because of other changes," Wallace says. "So now we wait again as Dodd-Frank's new rules fall into place. Each time it's thousands of dollars, and the costs wreak havoc on a community bank."

"We don't have the luxury of having a large and dedicated compliance department like the big banks do," Cecil says. "It takes considerable time and resources to train our staff and then implement the changes. It definitely shifts the focus away from our customers."

Still, Cecil remains optimistic. "It will be burdensome, certainly," he says, "but I have confidence that community banks as an industry will figure it out just like every other change we've managed."

Others aren't so sure. "Can we as an industry compete in this invasive regulatory environment?" Wallace wonders. "How big do you have to be to absorb the costs and survive? Only time will tell."

"The majority of community banks are resilient, but there's only so much that Congress can keep overloading on them," Palmer says. "In my opinion, Dodd-Frank will result in the acceleration of the consolidation of the community banking industry."

Lisa Hooker is a freelance writer.

Reprinted from the November 2011 issue of Columbus C.E.O. Copyright © Columbus C.E.O.