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As Wall Street Thrives, America's Little Guy Chokes on Paperwork

  • Small businesses are getting a shrinking share of lending pie
  • From QE to compliance, post-crisis policy has favored bigness

If some American banks are too big to fail, others have begun to feel they’re too small to succeed.

Just ask Joey Root, the president of First Liberty Bank in Oklahoma City with $310 million in assets. Root says small banks like his are being squeezed hard these days, even as the likes of JPMorgan Chase & Co. prosper. Small borrowers are losing out to big ones, too.

Community lenders like Root didn’t have much to do with the buildup of risks that triggered the 2008 crisis. And when the rules were tightened in response, as they had to be, there’s a case to be made that they took a disproportionate hit.

That argument makes a convenient stalking horse for the largest banks, now the fight over regulation is back on. So it’s viewed with great suspicion by Democrats. President Donald Trump announced his intention to do a “big number” on the Dodd-Frank Act, the most sweeping financial reform since the Great Depression, before an audience of small-business leaders.

They’re the kind of borrowers who have been shunted aside, the data show. Main Street-style business loans of $1 million or less are growing now, by 5 percent in the 12 months through September. But that’s after several years of contraction, and the recovery came later, and slower, than the overall market. So proportionally they’ve fallen: to 20 percent of total business credit from 35 percent in 2004.

First Liberty lends to nail salons and plant nurseries. Its collateral might be a suite of marble sinks, or a yard full of seedlings. “You can’t factor that into a machine that is going to give you the correct score, and tell you if that is the correct loan,” Root said.

Smaller banks say they’re struggling with added labor costs after adding compliance staff, while big banks spend millions to automate those decisions.

Some of the problems for small banks and borrowers pre-date Dodd-Frank, and others have nothing to do with regulation: Economic growth has been mediocre, and many households and small businesses are cautious about borrowing after the shock of 2008. Still, even the regulators in charge of the post-crisis tightening acknowledge there’s an issue that should be addressed.

“We should be heavily focused” on reducing the regulatory burden on community banks, Federal Reserve Chair Janet Yellen told the House of Representatives Feb. 15.

No Startups

The Fed recently exempted some regional banks from parts of the stress tests it conducts to make sure financial institutions have enough capital to weather a downturn.

Another problem for smaller borrowers: There are almost no new banks. Such lenders are key sources of credit for startups, or neglected borrowers, because they’re startups themselves -- on the lookout for clients that more-established lenders might have disregarded. A survey by regional Fed banks in 2015 found credit availability was the second-biggest challenge for startup businesses.

Read more: Obstacles to start-ups explained -- a QuickTake Q&A

In 2005, 167 new charters were granted. The total number of new banks operational since 2011 is four. One of those -- Bank of Bird-in-Hand of Lancaster County, Pennsylvania -- specializes in lending to the Amish.

When the Fed was founded in 1913, making credit broadly available -- to farmers, small manufacturers and households through economic shocks and seasonal shifts -- was a key goal.

Quest for Safety

Since 2008, the focus has been on resilience: ensuring the financial system doesn’t boom and bust. Because mortgage lending was central to the crisis, it’s no surprise that it’s been subject to tighter regulation.

Still, there’s an argument that banks and regulators have overshot in the quest for safety. Analysts at the Urban Institute in Washington found that 6.3 million additional mortgages would have been issued between 2009 and 2015 “if lending standards had been more reasonable.”

About 58 percent of mortgage lending initiated in the last quarter of 2016 went to people with credit scores of 760 or above, according to the New York Fed. In the same period of 2003, the top-rated group was getting only a 28 percent share.

Dan Kemp, a senior vice president at Security State Bank & Trust in Fredericksburg, Texas, says the cost to his bank of making a mortgage has about doubled from a decade ago. He’s concerned that higher costs are causing a consolidation among small banks and limiting credit as bigger lenders shy away from anything but plain vanilla loans. “There is too-big-to-fail and too-small-to-survive,”Kemp said.

Finding the right balance between tough oversight and an efficient flow of credit isn’t easy. There are distributional consequences of being either too tight or too loose, and U.S. bank regulators are loath to talk about them in public.

To address the issue more frankly, “they would have to admit that their regulatory policies are working at cross-purposes with their monetary policy,” said Michael Gapen, chief U.S. economist at Barclays in New York. “Even if you lower interest rates, it is no guarantee that banks will lend.” Or at least, lend to everyone.

‘It’s a Shame’

Bigness isn’t ascendant only in banking. Economic power is growing more concentrated across the board. There are fewer airlines, cable-TV providers and health insurers than there used to be. The share of companies with fewer than 250 employees has slid steadily since the Great Recession.

Root says there’s a scenario that keeps recurring at his bank. Say a one-man-shop plumber wants a loan. If the bank asks for five years of paperwork, the plumber may not have it. Getting it could mean several days off work. Even plugging some basic information into a computer could trigger a compliance deadline. And if Root decides not to make the loan, he has to keep impeccable records explaining why, and notify the would-be borrower, or face possible fines.

The emphasis on quantifiable reasons has a worthy goal: preventing discrimination. But taken altogether, lending to these types of people has gotten “too hard under the rules,” Root says. “It’s a shame.”

— With assistance by Dave Merrill

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