The Latest Danger From Deregulation: Community Banks
Although economists often warn of the dangers from lax oversight of large banks, Michigan Ross Professor Jeremy Kress cautions that deregulation of small banks also poses substantial risks.
In a new academic journal article, op-ed essay, and media appearances, Kress makes the case that when community banks fail, they tend to do so in groups — and that can lead to a broad financial crisis.
“Over the past two years, policymakers have systematically rolled back safeguards on so-called community banks. These deregulatory initiatives — many of which took effect Jan. 1 — are likely to expose the financial system to underappreciated risks,” Kress writes in the essay for American Banker. “Even worse, these new risks will be more difficult for the banking agencies to detect because regulators have loosened community bank supervisory oversight.
“To be sure, policymakers should not stifle community banks with excessive regulation. But appropriate oversight of small-bank risks is necessary to preserve the long-term viability of the community bank sector,” Kress writes.
In the journal article, Kress and coauthor Matthew Turk of Indiana University identify and expose three myths that have led to the deregulation of community banks. “While these claims have gained near-universal acceptance among legal scholars and policymakers, none of them withstands scrutiny. Contrary to the conventional wisdom, community banks were key participants in the 2008 crisis, were not uniquely burdened by post-crisis reforms, and continue to thrive economically,” the authors write.
The article concludes by describing a suggested new framework for regulating community banks to reduce future risks.
Jeremy Kress is an assistant professor of business law at the University of Michigan Ross School of Business.
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