Why we must base the banking regulation debate on real data
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America’s financial landscape is changing and not necessarily for the best. Small banks and the credit they provide are disappearing under the Dodd-Frank Act, and yet senators would never know this after listening to the recent Congressional testimony of Federal Reserve Chairman Janet Yellen.

During the hearing, Sens. Sherrod BrownSherrod Campbell BrownSenate confirms Rouse as Biden's top economist Democrats push Biden to include recurring payments in recovery package Padilla has 'big Chuck Taylors to fill' in replacing Harris MORE (D-Ohio) and Elizabeth WarrenElizabeth WarrenOvernight Health Care: Biden says US will have enough vaccine for all adults by end of May | Biden calls on all states to vaccinate teachers by the end of March | Texas, Mississippi lift mask mandates Biden picks for financial agencies offer preview of regulatory agenda Becerra tells Warren he will do 'thorough review' of executive actions on drug prices MORE (D-Mass.) led their witness through a series of questions that generated answers to frame a spirited defense of the Dodd-Frank Act. However, independent analysis highlights important inaccuracies in Chairman Yellen answers that undermine the Democrats’ defense strategy.

The defense of the Dodd-Frank Act flows from the answers to three basic questions: Hasn’t the extra capital required by the Dodd-Frank Act made the system safer? The administration says it’s hard to get a bank loan, but isn’t credit readily available? Didn’t banks just post record earnings?

Affirmative answers to these questions, if true, are designed to support only one conclusion: that the Dodd-Frank Act must stay.

In answering the senators’ questions, Chairman Yellen’s played her part. That she confirmed the senators’ narrative is no surprise. To protect its new Dodd-Frank powers, the Fed must align itself with the fight against Dodd-Frank repeal.

Given the Fed’s interest in preserving its powers, committee members must consider independent analysis of the economic data. Once they do, I expect that many will agree that the witness was too quick to agree to with the Brown-Warren Dodd-Frank defense.


One particular issue of concern relates to Yellen’s testimony on the availability of small business credit. In response to Sen. Brown’s prodding about bank credit availability, Yellen cited a survey by the National Federation of Independent Business that found only 4 percent of small business respondents having difficulty securing “all of the credit they need” and just 2 percent citing credit access as a problem.


Yellen’s reference to an association’s survey is puzzling since the pace of small business lending can be tracked using regulatory data collected by the Federal Reserve and other federal banking regulators. In fact, the government’s own data show remarkable weakness in small business lending.

In June 2008, before the financial crisis took hold, regulatory data indicate total nonagricultural small business lending of $711.5 billion. In June 2016, eight years after the financial crisis, total lending to small business was $613.8 billion. The Federal Reserve’s own data show that small business lending is 14 percent below its pre-crisis level.

The Federal Reserve Chairman missed the opportunity to explain a fundamental “supply problem” that is restricting the supply of small business bank credit under Dodd-Frank. The Fed’s own research shows that smaller banks play an outsized role in providing small business credit. Moreover, when small banks are acquired by large institutions, lending to small businesses generally suffers. Thus a significant reduction in the number of small banks will likely reduce bank small business credit. This is precisely what is happening under the Dodd-Frank Act.

Regulatory data indicate that, in 2008, the 8,345 banks with less than $10 billion in assets supplied $388.8 billion in small business loans. By 2016, only 5,954 of these banks remained, providing $308.4 billion in small business credit. The demise of nearly 2,400 small banks, along with the the regulatory burden of Dodd-Frank on surviving small institutions, coincides with a 21 percent decline in community bank small business lending. Moreover, the largest banks have not filled the lending gap. The dollar volume of small business loans made by banks with more than $10 billion in assets actually declined by 5.35 percent over this period.

Small business lending aside, the headline numbers on the banking system’s capitalization and earnings, cited by Sen. Warren might lead one to believe that banks have become wildly prosperous under the Dodd-Frank Act. One look at the data shows that this interpretation is an illusion — the banking industry is significantly underperforming by historical benchmarks.

The data tell us that, overall, bank lending growth remains anemic. Bank earnings, while at record dollar amounts, are inflated by the record level of assets in the system. On a return basis, industry average return on assets is 20 percent to 40 percent below rates typically recorded in pre-crisis years.

The weakness in banks’ current average return on assets is especially notable since banks normally post their strongest asset returns in the mature stages of an economic expansion, before the credit cycle sours. The current economic recovery is already old by historical standards. In other words, current rates of return — as poor as they are — are likely to be as good as they get under Dodd-Frank.

And while the mega-banks must have more capital under the Dodd-Frank Act, the concurrent increase in concentration of assets among the largest institutions may have only increased, and not decreased, systemic risk. Indeed, many senior federal bank regulators remain unconvinced that Dodd-Frank has fixed the too-big-to-fail problem.

A sound case for or against Dodd-Frank reform must be based on real data, and not a false narrative. It is ironic that, in their hearing statements, Sens. Brown and Warren both accused the Trump administration of playing fast and loose with the data. When Senate Banking Committee members reflect on the accuracy of testimony regarding Dodd-Frank reforms, they would be wise to recall the words spoken by their colleague Sen. Brown: “Just because people in high places say it’s true doesn’t make it so.”

Paul Kupiec is a resident scholar at the American Enterprise Institute, where he studies systemic risk and banking regulation. He previously served as director of the Center for Financial Research at the Federal Deposit Insurance Corporation and chairman of the Research Task Force of the Basel Committee on Banking Supervision.

The views expressed by contributors are their own and are not the views of The Hill.