The impact of the Dodd-Frank Act on small business

There are concerns that the Dodd-Frank Act (DFA) has impeded small business lending. By increasing the fixed regulatory compliance requirements needed to make business loans and operate a bank, the DFA disproportionately reduced the incentives for all banks to make very modest loans and reduced the viability of small banks, whose small-business share of C&I loans is generally much higher than that of larger banks. Despite an economic recovery, the small loan share of C&I loans at large banks and banks with $300 or more million in assets has fallen by 9 percentage points since the DFA was passed in 2010, with the magnitude of the decline twice as large at small banks. Controlling for cyclical effects and bank size, we find that these declines in the small loan share of C&I loans are almost all statistically attributed to the change in regulatory regime. Examining Federal Reserve survey data, we find evidence that the DFA prompted a relative tightening of bank credit standards on C&I loans to small versus large firms, consistent with the DFA inducing a decline in small business lending through loan supply effects. We also empirically model the pace of business formation, finding that it had downshifted around the time when the DFA and the Sarbanes-Oxley Act were announced. Timing patterns suggest that business formation has more recently ticked higher, coinciding with efforts to provide regulatory relief to smaller banks via modifying rules implementing the DFA. The upturn contrasts with the impact of the Sarbanes-Oxley Act, which appears to persistently restrain business formation.

That is from Michael D. Bordo and John V. Duca.

Comments

Wouldn't it be great to be able to read this analysis in its entirety? Anyway, the decline of balance sheet lending can be reasonably attributed to the increased regulatory scrutiny, but the authors would need to evaluate the impact on Dodd-Frank to the total availability of credit for small business. Alternative financing sources (shadow banking) has exploded over the last 4-5 years to meet the market need as the larger banks have tightened their policy. I'm also skeptical of any correlation of small business formation to regulatory changes when those changes are less than 6 weeks old.

The Dodd-Frank Act was a Trojan Horse for a number of bad legislative/political ideas. It may well have a few good things in it too because after all they had to hide their nefarious actions behind something. But mostly it was a laundry list of special interest legislative actions that were undoubtedly paid for in cash in a back room somewhere.

Frank didn't hide that. He called lobbyists into his office for bull sessions. That's how the law got written. It's carve-outs stapled together. And it gives discretionary authority to officials who will report to Democratic pols. Waivers ! Waivers! Waivers! Cha-ching!!!!

Worst political class in this nation's history.

Frank 'n Dodd was written by lobbyists for the Big Banks, as Art points out. The intent was to increase the pain of the compliance burden-for small banks, thus making them easier targets for takeover-by the Big Banks.

"The FDIC has basically gotten very tough across the board, and that makes it very difficult for banks to operate because of these regulatory burdens. What happens is that so many banks just started selling out," said Ken Thomas, a longtime economist and banking consultant based in Miami.

"Most of the new regulations came from the adoption of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which President Trump has vowed to "do a big number on" because he believes it's too burdensome for all banks, especially smaller ones". [SNIP]

One of the many lessons I've learned from Cowen is to always be on the lookout for findings that confuse correlation with causation. I often confuse the two. For example, the small loan share might be attributable to "complacency", and fewer small firm startups. Cowen wrote a book about this phenomenon. Or as I have pointed out many times, investment in "productive capital" has been in decline, and small business is mostly about productive capital; ergo, the small loan share might be attributable to an over emphasis in productive capital for small business. Another example is from my own experience commuting from my low country home to the sunbelt city where my office is located. What is obvious is that all the bankers who once shared a flight with me, flying between from one sunbelt city to another to meet with small business borrowers, don't any more. Why is that? Fear of flying?

What's interesting is that two of the authors had earlier claimed that "regulatory uncertainty" was the cause of lower lending, and not Dodd Frank. Here is an earlier paper in 2016: http://www.nber.org/papers/w22021.pdf

The regulatory uncertainty in the earlier paper did focus on Dodd Frank, but found larger banks were affected more: "...three statistically and economically meaningful results arise using relative indexes of individual bank asset characteristics. First, the negative effects of economic policy uncertainty (EPU) on loan growth are greater for larger-sized banks. One explanation for the size effect is that it may reflect a greater importance of national uncertainty for larger banks that tend to be more geographically diversified than smaller banks. Second, the negative effect of economic policy uncertainty on bank lending growth is smaller in magnitude for more highly capitalized banks. This suggests that the shock-absorbing buffer effects of greater capitalization that tend to reduce economic policy uncertainty effects outweigh the potential offsetting selection effects, the latter of which reflect that higher capitalization rates could be associated with greater risk aversion among banks.2 Third, the depressing effect of economic policy uncertainty on bank lending is significantly but quantitatively only somewhat smaller at banks with more cash assets, with no significant correlation with differing levels of securities holdings."

Shocked, shocked that a (mostly) fixed cost has disproportionate effects. The real question (imho) is why haven't banks simply factored this in to SB loans? (not that I know anything about banking regulation, but such irrational behavior smells like government's ham-handedness again). Actually, the REAL question is why have we as a society tolerated this behavior in our money lenders? It seems to me (as simple minded as I am) that if banks aren't lending to the small guys then their tables at the temple door should be smashed and new bankers recruited.

"if banks aren't lending to the small guys then their tables at the temple door should be smashed and new bankers recruited."

Yes, that's what we did. Now we're dealing with the effects.

I had assumed that it was spelled Fraud-Dank.

The Chicken-Dinners-Per-Dollar ratio is higher if you're trying to raise money from the owners and managers of community banks. In any case, those guys are usually Republicans. When your guys run casino banks, you extend a competitive advantage to casino banks. Make your check out to the order of the Barnett Frank Retirement Fund.

I'm surprised the community bank trade group didn't push for or get a Dodd-Frank law more favorable to them. As TC pointed out in a recent column, they are in every single congressional distract, are well-liked, and have immense lobbying clout. As I understand it, the community bank trade group came out neutral on Dodd-Frank, and that made it politically possible to get the law through Congress.

One can assess Dodd's judgement by the fact that he actually moved his family to Iowa in 2007 when he was running for President.

http://www.mcclatchydc.com/news/politics-government/article24471664.html

And then he was the other half of the famous 1985 Kennedy-Dodd waitress sandwich.

http://nymag.com/nymetro/news/politics/national/features/2165/

Default rates on C&I loans have gone down as well. If they are making fewer bad loans that doesn't seem like a bad thing.

Attributing the post-recession decline in defaults that peaked in the recession back to pre-recession levels to improved regulations would appear specious at best. Defaults went up, they came down. As one would expect. https://csbcorrespondent.com/blog/community-bank-commercial-loan-default-rates-–-current-and-projections

This isn't true. An economist named Alex Tabarok recently proved that regulations can't harm businesses. I wish Prof. Cowen wouldn't be so credulous.

DFA and other rules make directors and management directly liable for incorrect call reports. Most errors occur in the estimate for the Allowance for Loan and Lease Losses. To avoid errors, it is best to make the most creditworthy loans rather than loans with a lot of risk such as small business loans, eg., restaurant loans for a new stove., small farm euqipment loans.

Probably Dodd-Frank is too restrictive.

On the other hand, push-cart vending is universally criminalized in America and is never the topic of discussion.

You cannot vend out of the back of a pickup truck or a motorcycle-sidecar, or even be a sidewalk vendor.

Some topics get discussed and others do not.

In this manner untold millions of people are prevented from starting up their own little capital

You always go on about this. Is there really a demand for 'untold millions' of people selling fruit and bottled water and hot dogs and gum from the backs of pickup trucks by the side of the road?

"Despite an economic recovery, the small loan share of C&I loans at large banks and banks with $300 or more million in assets has fallen by 9 percentage points since the DFA was passed in 2010, with the magnitude of the decline twice as large at small banks. Controlling for cyclical effects and bank size, we find that these declines in the small loan share of C&I loans are almost all statistically attributed to the change in regulatory regime"

Statistical attribution?

Is this what economists do when they have no grasp of reality whatsoever?

I suspect a simpler phenomenon at work-the credit cycle. Banks became more stringent in granting credit to businesses after their epithanatic experience in 2008.

The same thing happened with mortgage lending.

The end.

Given the explosion in small business sole proprietor startups that economists confuse with workers, I ask how much debt is needed by an Uber or Lyft transport contracting small business, a rooming house, bnb, short term housing rental small business, a handyman/messenger business?

In bad times, many people find ways to get income without being employee or business. In good times people start businesses, often at a transition point - the good job that enabled a passions ends so turning the passion into a business is the now or never. Both have the barrier of getting beyond the people you know.

Uber, taskrabbit, airbnb help with getting setup, and then supply customers. No flyers, dbas, tax iS a for paying business taxes, etc. No need for debt to pay lawyers. No need for a bank to handle credit card payments.

Easy small business startup!

In one of my news feeds:

"Chapman spent a few hours a night on the project, and start-up costs were minimal, about $200 he says. He bought a domain name for $2.99 a year and set up a Shopify account via a $14 trial. The most expensive thing was when he started spending $100 a day on a Facebook advertising budget. LDSman.com went live on Nov. 11, 2016."

Headline is he sold the business for $10 million after a few years.

The Internet and all the automated business startup systems have made creating a business so easy, economists confuse businesses with workers.

A sole proprietor business is a business, not a worker.

A sole proprietor business without incorporation, ads, lawyers, bank advisor, employees, is still a business, not a worker.

If you want to navel gaze about the lack of new business formation in the US, talk to an accountant about Sarbanes-Oxley.

But prepare yourself first. It will be a depressing story that will make you want to go clean your room.

Since SarBox only applies to listed companies, I suggest you find yourself a more intelligent accountant.

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