On July 21, 2010, President Barack Obama signed into law the historic financial regulatory reform bill known as the Dodd-Frank Wall Street Reform and Consumer Protection Act. Although much of the act applies only to large banks, 10 important provisions directly impact community banks.
1. Interstate branching. Interstate branching is now permitted. An institution may now enter a new state by acquiring a branch of an existing institution or by setting up a new branch without merging with an existing institution in the target state. A depository institution’s ability to establish a de novo branch may be limited by a state’s restrictions on intrastate branching. Interstate branching creates opportunities for community banks looking to acquire branches from struggling depository institutions in states where the community bank does not currently have a presence. It may also increase competition within the community bank’s home state, as a significant legal barrier to entry no longer exists.
2. Interchange fees. Interchange fees must be “reasonable and proportional to the cost” of the card network’s expense for processing the transaction. Card issuers who, together with their affiliates, have less than $10 billion in assets are exempt from the interchange transaction fee limitation. However, the cap on interchange fees for large banks will create market pressures that force fees down for all institutions. Community banks can expect a drop in interchange revenue. This section of the act is effective one year from enactment and final rules can be expected within nine months from enactment.
3. Mortgage lending. The act makes significant changes to the requirements for making mortgage loans. Common practices such as stated income loan applications, yield spread premiums, prepayment penalties and mandatory arbitration provisions are prohibited or restricted. New regulations will require a lender to verify a mortgage borrower’s ability to repay the loan. A violation of the “ability to repay” standard may be raised as a foreclosure defense by a borrower against the lender. The act creates a safe harbor for “qualified mortgages,” which must meet several criteria, including points and fees of less than 3 percent of the loan amount. Community banks will have to assess whether they can justify the increased compliance and management costs in order to continue to originate mortgage loans.
4. Consumer Financial Protection Bureau. A new Consumer Financial Protection Bureau will be created under the Federal Reserve that will have rule-making, enforcement and investigative authority over consumer financial protection statutes. We can expect to see many new consumer protection regulations over the next few years. Many of those regulations will increase compliance costs for depository institutions or limit the fees they can charge. Community banks may find it more difficult than larger institutions to absorb the increased compliance costs and reduction in income.
5. Unfair, deceptive, or abusive acts or practices prohibited. The new CFPB is specifically authorized to take action and promulgate rules to prohibit unfair, deceptive or abusive acts or practices in connection with any transaction with a consumer for a consumer financial product. Unfair and deceptive acts are already prohibited by the Federal Trade Commission Act and many state laws. The term “abusive” is new. The act provides minimal guidance as to what activities will be considered abusive. This will likely be an area of significant consumer litigation in the future. It is important to note that state attorneys general are specifically granted the authority to enforce the regulations promulgated by the CFPB against national banks and federal thrifts, which will likely result in increased enforcement of consumer regulations.
6. Loss of federal preemption. Subsidiaries of national banks and federal thrifts will lose the benefits of federal preemption. National banks or federal thrifts with subsidiaries that do not comply with state laws in reliance on federal preemption need to think about changes to their structures or complying with state laws with which they are not currently in compliance. An example would be a mortgage subsidiary of a national bank that does not currently comply with state mortgage licensing or lending laws.
7. Elimination of OTS. The Office of Thrift Supervision is eliminated. The Office of the Comptroller of the Currency will regulate federal thrifts, the FDIC will regulate state-chartered thrifts and the Federal Reserve will regulate savings and loan holding companies. Federal thrifts need to plan for the change in regulator and their holding companies need to plan for the change in regulator and the new capital requirements.
8. Trust-preferred securities and holding company capital requirements. Small bank holding companies (less than $500 million in assets) and medium-sized bank holding companies (less than $15 billion in assets) are not required to make a capital deduction for trust-preferred securities issued before May 19, 2010. This is a rare piece of good news from the act for those institutions. Medium-sized holding companies, however, will have the same type of risk-based capital and leverage capital requirements that are required of an insured depository institution. This change will make it more difficult for those companies to meet capital requirements or raise capital to support their bank subsidiaries, growth and acquisitions.
9. Changes to deposit insurance assessment base. The act changes the assessment base to relate to the liabilities of the institution rather than the institution’s deposits. The assessment base will be an amount equal to the average consolidated total assets of the insured depository institution during the assessment period, minus the sum of the average tangible equity of the insured depository institution during the assessment period and an amount that the FDIC determines is necessary to establish assessments consistent with the risk-based assessment system found in FDIA 7(b)(1) for a “custodial bank” or a “banker’s bank.” This will likely cause larger banks that rely on funding from other than U.S. deposits to shoulder an increased burden of deposit insurance premiums.
10. Interest on demand deposits. The act repeals the prohibition on depository institutions paying interest on demand deposits, effectively allowing depository institutions to offer interest checking to business customers. This will increase community banks’ cost of funds as they may need to pay interest on demand deposits of business entities to retain such customers.
Although the act creates a lot of uncertainty for community banks as to how the regulations will apply to them, it is certain that community banks will see increased compliance costs. The steady stream of regulations that will be promulgated over the coming months and years will undoubtedly impose additional restrictions and burdens on community banks, and may raise more questions than they provide answers. We will have to wait until those regulations become final before we know exactly how the Dodd-Frank Act will affect community banks.
S. Katherine Rizzo is a banking and financial services attorney at Stinson Morrison Hecker LLP in Kansas City. Contact her at 816-691-3230 or krizzo(at)stinson.com.
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