Consumers lose when small banks can't compete

As Congress considers a major regulatory relief bill for the banking industry, lawmakers must remain focused on giving community banks relief from regulation that is harming the industry and reducing competition.

One of the strengths of the American economic system is our impetus for competition. We believe that more competition in the market makes things better for customers, since companies are forced to compete by making products and services better.

There is some downside to competition in that it can be a violent process where companies come and go, but most of us agree that competition breeds better and more choices for consumers, and that the customer reigns and should reign as the most important part of our economic system.

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But the current rules guiding the financial system are taking us in the wrong direction: The number of banks continues to decline each year and just a handful of de novo banks have formed since 2010.

Of course, there are some who argue that fewer institutions are better for the economy because institutions can be better controlled by the government and therefore stabilized in some way. The authors of one study, titled “Bank concentration, competition, and crises,” argue that increased bank competition could undermine financial stability. Similarly, a National Bureau of Economic Research paper notes that “concentrated banking systems” tend to have banks that are easier to monitor than banks in more competitive banking systems.
Yet these findings are in contrast with the financial crisis of 2009, where a small number of huge banks overseen by the government nearly toppled the entire U.S. economy.

The principle of fewer banks being regulated vigorously also assumes that the regulations make sense, which we know is not always the case. For example, legislators from both parties seem to agree that smaller banks should have been exempt from the Volcker Rule and certain capital and leverage ratios under the Dodd-Frank Act, which make more sense for large institutions.

Additionally, this fewer-is-better thinking also ignores research showing that lending to small and medium enterprises is less extensive in countries where major financial institutions dominate the banking sector. There is a risk to small businesses by having fewer banks, and we know that small businesses, not large ones, create by far the most jobs and innovate much more.

Just look at cable television, hated nearly universally by consumers because of service and pricing issues as the industry has consolidated into fewer and fewer providers. And look at how few big banks offer free checking any longer: A commonly cited survey by Bankrate.com says only 38% of banks surveyed offered non-interest-bearing checking accounts without fees or minimum balances, down from 76% in 2009. This is just one example of how regulation caused fewer banks to be able to offer free checking, which hurts consumers. Community banks (40% of which have fewer than 30 employees), in particular, are impacted by regulatory burdens and the associated effect on expenses and minimum returns required by investors. Half of community banks that are open to or are considering selling themselves cite regulatory costs as the reason. Regulatory burdens make it harder for community banks to compete, which can ultimately lead to fewer competitors and long-term harm to the consumer.

The bottom line: Having fewer banks gives more power to those banks and gives less power to us as consumers.

The engine of capitalism and the free enterprise system is the formation of new businesses that will supplant old businesses, a kind of economic Darwinism that is necessary for long-run growth in the economy.

Lawmakers must do what they can in this banking bill to reduce these regulatory burdens so that community banks — but more importantly, consumers — can benefit from fair competition.

Mary Ellen Biery, research specialist at Sageworks, contributed to this article.