Community banks across the state are preparing for a deluge of new regulations that will cut into their bottom lines, make their businesses more complex and, in some cases, force them to consolidate.

The changes come in the form of the federal Dodd-Frank Act, which passed last summer following the financial collapse and is beginning to be implemented.

And they come just as banks are beginning to recover from a particularly tough period brought on by an overload of nonperforming assets and a national recession.

One factor driving the impact on Indiana-based community banks—which average about 60 employees and $221 million in assets—is the sheer volume of the law. Dodd-Frank is predicted by some experts to ultimately produce hundreds, if not thousands, of new regulations, most of which are expected to start trickling out over the next couple of years.

“I have never seen a bill like this in terms of the scope and size and all of the regulations that are required to be issued,” said Claudia Swhier, a Barnes & Thornburg LLP partner who has practiced in the banking arena for three decades.

Within that red tape are specific provisions expected to add to the cost of doing business for banks of all sizes.

But while the regulations will hit all banks—and in some cases exempt community banks but not big players—some experts say smaller banks will feel the impact most.

Because their staffs are small, they’ll have to hire consultants to sort through the new rules and assure they comply. And they have fewer customers over whom to spread those additional expenses.

Ultimately, the costs could lead some banks to sell, but some bankers say it’s certain to cause them to recoup costs by charging more to customers.

“There is no revenue generation in compliance—it’s strictly cost,” said Tony Aaron, a partner in Ice Miller LLP’s business practice group who works with several community banks. “The more cost you have, the more revenue you need to generate to remain profitable. At the end of the day, those costs get passed along.”

‘The trickle-down effect’

Many experts expect the Consumer Financial Protection Bureau to be the most onerous aspect of Dodd-Frank.

The federal agency will create regulations that apply to all banks, although community banks’ primary federal regulator will be charged with enforcing them.

It’s unclear at this point exactly what those regulations will be. But the brunt of their impact will be on consumer credit, which could, in turn, more drastically affect community banks.

“[Community banks] tend to be more consumer-centric,” said Ron Wince, CEO of Phoenix-based Guidon Performance Solutions LLC, a management consultancy that works with small and large financial-services firms. “I think anybody that does a substantial amount of consumer lending is going to be impacted.”

Banks under a certain asset threshold will be spared from some aspects of Dodd-Frank under the letter of the law. In practice, though, bankers and banking experts say those provisions will still apply.

For example, one stipulation limits the amounts banks can collect in interchange fees from merchants through debit card transactions. The law says the limit applies only to banks with more than $10 billion in assets.

But smaller banks say they’ll also have to offer lower fees to remain competitive.

“Community banks compete in a marketplace with national and regional banks,” Aaron said. “And if community banks are charging above-market pricing, they’re going to lose business.”

The law’s requirements that banks raise additional capital also do not apply to banks with $500 million or less in assets.

But John Tanselle, a Krieg DeVault LLP partner focused in banking law, said higher capital requirements for large banks will raise the bar for what it means to be well-capitalized across the board.

And all sizes of banks dependent on solid levels of capital for such needs as expansion will have to follow suit.

“You’re going to see the trickle-down effect,” Tanselle said. “What they end up doing in the final analysis will become standard across the industry.”

Passing it on

Some banks also could be forced to raise capital to spread their increased costs, said S. Joe DeHaven, president of the Indiana Bankers Association.

But that will be difficult for community banks, which have limited access to capital markets, and have faced challenges in raising money from investors or through earnings in a sluggish economy.

That will leave many banks to recoup costs through added fees.

“That loss of fee income will cause a shift,” DeHaven said. “Banks will need to charge fees for things they currently give away.”

The most obvious target is free checking, but experts say other surcharges, such as fees for inactivity on credit cards, or reductions in interest rates, also are possible.

Warsaw-based Lake City Bank, which is opening a branch in Hamilton County this year, has a free checking program with a competitive interest rate—3.04 percent.

But to provide those perks, the bank requires participants to complete eight debit transactions a month, so interchange fees from those transactions can help offset the cost.

David Findlay, the bank’s president, said Lake City doesn’t want to eliminate free checking or lower its interest rate because those incentives help increase deposits, but regulations may require Lake City officials to re-evaluate.

“That’s a revenue giveaway for us,” Findlay said. “We can afford to do that because of the fee structure.”

For some banks, the regulations could be a tipping point that forces them to consolidate. Some experts say banks that already are financially struggling—or those that don’t have a good leadership succession plan in place—are most vulnerable.

Others say many of the smallest banks will be at risk.

DeHaven, however, thinks Indiana will see less consolidation than other states because Hoosiers already saw a wave of bank mergers in the 1980s.

Despite the challenges, he’s also optimistic about his members’ ability to adapt to the vastly changing landscape.

“The death of community banking has been written about for 40 years,” DeHaven said, “and there are still about 8,000 banks in this country.”

If Dodd-Frank has a silver lining, it will be in greater transparency for consumers.

Part of the regulatory burden, Wince said, entails revamping documents for products such as mortgages to make them more understandable for the public.

“Banks are feeling the pain and burden of trying to absorb it,” he said. “But, ultimately, the customers are going to be better off.”•