The Impact of the Dodd-Frank Act on Small U.S. Banks
52 Pages Posted: 15 Jul 2019 Last revised: 20 Nov 2019
Date Written: Nov 15, 2019
I develop a dynamic structural model to study the quantitative impact of the Dodd-Frank Act on small banks' operation costs. Banks in my model face a minimum capital requirement which constitutes a capacity constraint on lending for any given capital level. This constraint may be relaxed by raising capital financed by internal funds. Loosening the capacity constraint enables a bank to lend more and increase profits due to economies of scale associated with compliance costs. Exploiting the timing of Dodd-Frank's implementation in 2010, I structurally estimate its impact on all non-interest costs small U.S banks face, including entry costs that are not observable in data. I find that Dodd-Frank has heightened entry costs and compliance costs by 18% and 15% respectively. These increases induce a strong selection effect on small banks: less profitable banks exit in the short run while those who survive become 45% more profitable and less likely to exit in the long run. As a result, overall stability of the banking industry is promoted while small bank loan market concentration rises and total small bank lending drops by 13%.
Keywords: The Dodd-Frank Act, Small Banks, Economy of Scale, Compliance Burden, Entry Costs
JEL Classification: G21, G28, L11
Suggested Citation: Suggested Citation