November 4, 2010


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The Robert E. Nolan Company is an operations and technology consulting firm specializing in the banking industry. Since 1973, we have helped banks innovatively redesign processes and apply technology to improve service, quality, productivity, and costs. Our consultants are senior industry experts, each with over 15 years of specialized experience. This depth, coupled with our collaborative approach, enables us to expedite and magnify improvement initiatives for our clients.

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The Impact of Dodd-Frank on Community Banks
Robert Grasing

Community bankers are dealing with the immediate issues presented by the new financial reform act and are anticipating what the impact will be as other provisions are ironed out over the next two years. Simply put, the new regulations will reduce fee income, increase the cost of funds for banks, and result in significant internal regulatory compliance and reporting costs.

There are reports that many small banks are concluding that the amount of change will require them to sell out to larger banks. There have been more than 120 bank failures so far this year. And, while the signs of economic recovery are registering faint positives, the year-over-year statistics are unsettling. Banks started amending their fee structures in anticipation of the regulation changes earlier this year; consequently, fees from deposit accounts are down more than 7% from the same period in 2009. Assets are down by 1%, and credit card balances are down 2.5%, reflecting a cautious public.

The changes in NSF fees and the lower interchange rate represent the most obvious reductions in fee income. While the interchange rate change is targeted at banks with more than $10 billion in assets, smaller community banks are expecting they will have to follow suit. This will put bottom-line pressure on every community bank, and bankers are discussing various steps to recapture that revenue. A comment on the changes by JPMorgan Chase's chairman and CEO, Jamie Dimon, was succinctly put: "If you're a restaurant and you can't charge for the soda, you're going to charge more for the burger." Community banks are planning a variety of pricing moves to recover lost income, including eliminating free checking and instituting a monthly fee that is waived only if a significant monthly average balance is maintained. Other banks are opting to direct customers to ATMs rather than tellers. They are structuring lower fees on deposit accounts with a maximum of two teller visits per month.

The cost of funds is growing as well with a regulation change that will allow interest on business deposit accounts, and this will likely impact the community banks more than the money center or super-regional banks where larger or more sophisticated commercial customers already have sweep accounts.

The hidden but real variable cost that will play out for all banks is the cost of compliance, which relates to additional reporting and procedures that will be necessary to comply with regulation changes. These changes will include:

  • Adding staff in compliance
  • Adding work for new business and credit staff
  • Adding procedures (time) to open accounts

This additional time to open new accounts will logically limit cross-sale opportunities and either lengthen the customer's wait time or increase the number of banking staff. Martin Zorn, Chief Administrative Officer for Tennessee Commerce Bank, was recently quoted in Bank Systems and Technology: "There is going to be more regulation, so in preparation we need to go to IT and all other departments to find efficiencies to do what we are doing more cost-effectively."

From our discussions with CFOs and CEOs, we know that this is exactly what the efforts of the next two years will focus on. Activities will be directed to significantly reducing operating expenses. The necessary reductions will not simply come from incremental changes in targeted areas. The changes will require a dramatic reduction in labor costs and process time, but improving the customer experience will need to be kept a primary objective. Bankers need to work actively and systematically to offset the additional costs and loss of revenue so that when the economic recovery is finally complete, bank performance improves as well.