In this Economic Policy Paper, we quantify the cost of increased regulation on community banks. We do so by modeling the impact of new regulatory costs as the hiring of additional staff, resulting in higher total compensation and lower profitability. We then analyze the changes in the distribution of community bank profitability.
Banks may respond to regulation by increasing training, by shifting staff to activity that generates less revenue or by doing nothing differently. In all cases, the bank’s response will manifest itself in lower profits, as if the bank altered its head count. By way of example, we find that the median reduction in profitability for banks with less than $50 million in assets is 14 basis points if they have to increase staff by one half of a person; the reduction is 45 basis points if they increase staffing by two employees. The former increase in staff leads an additional 6 percent of banks this size to become unprofitable, while the latter increase leads an additional 33 percent to become unprofitable.
This approach to quantification has three main advantages. First, it captures the “bottom line” from a wide range of regulatory cost effects. Regulatory costs may not manifest themselves as the hiring of more staff. Such costs could present themselves as less revenue, since staff may spend more time on non revenue-generating activity. Alternatively, training expenses for staff may increase. Regardless, our approach to quantification captures the full range of increased costs or lower revenue, as both result in lower earnings.
Our approach has a number of limitations. Our approach does not measure any of the “psychological” costs of increased regulatory activity; account for dynamic changes in the risk-taking of banks (e.g., the bank takes on more risk in response to higher fixed costs); recognize the potential that new regulation could increase firm profitability by, for example, increasing confidence in the banking system.
The smaller institutions tend to be older, somewhat more highly rated and more rural, and to have higher agriculture-related loan concentrations. The smallest community banks—those with assets less than $50 million—also have noticeably lower profitability levels. Hiring of one FTE reduces ROA by approximately 23 basis points for the median bank with assets below $50 million. For this stylized example, we assume that the compensation costs for each additional FTE are $70K for rural banks and $90K for urban banks. 2 Each additional FTE reduces the median bank’s ROA by the same amount. For example, if a bank in this size category needed to hire four FTEs, the change in ROA would be roughly 90 basis points. Assuming compensation of $42K and $54K for staff in rural and urban markets leads to a reduction in ROA of 13 basis points for the median bank with assets below $50 million if it were required to hire one FTE. Each additional $7K in compensation costs reduces the median bank’s ROA by approximately 2.25 basis points. For example, if a rural bank needed to pay $91K in compensation costs for the incremental FTE, the change in ROA would be nearly 30 basis points.
To do so, we utilize a representative scenario in which we impose a proportionally higher regulatory cost burden on smaller banks. That is, a smaller bank has a relatively higher cost of regulation compared to a larger bank. This approach is consistent with research that suggests fixed-cost and economies-of-scale components to regulatory compliance.3 In this scenario, we also report the new hypothetical hires due to additional regulation as a percentage of the number of FTEs at the median firm within each banking size cohort. As designed, the impact on profitability is most significant for the smallest institutions. The median bank with assets below $50 million would experience a drop in ROA of nearly 23 basis points, while the median firms in the larger size cohorts would encounter a decline of 11 basis points or less.
Deaton Engineering Client DiFUSION Technologies Receives 510(k) Clearance
Deaton Engineering’s medical device client, DiFUSION Technologies receives 510(k) clearance of their Xiphos interbody implants for spinal fusion.
DiFUSION Technologies Xiphos™ line Receives 510(k)
DiFUSION Technologies Inc., a medical device company focused on the development and commercialization of its proprietary CleanFUZE™ antimicrobial technology for orthopedic implants, announced the 510(k) clearance of its new Xiphos™ line of posterior interbody devices indicated for intervertebral body fusion of the lumbar spine, from L2 to SI, in skeletally mature patients who have had six months of non operative treatment.
DiFUSION Press Release
See DiFUSION Technologies’ full press release at DiFUSION Technologies Receives 510(k) Clearance of Xiphos