Has Dodd-Frank Reduced Competition?

These days, loyal readers may note that our publications here at The Mendenhall have been coming in at less than their usual frequency. As I have written elsewhere, this is partly the result of the cheaply partisan, non-ideological nature of the current American political climate rarely being worthy of deeper analysis, but it is also a product of each of the editors’ personal and professional constraints. In order to ameliorate this condition, however, I thought that I would serve two masters by sharing what some of my own recent research has accomplished. In that spirit, I will be writing several posts summarizing my recent works.

The first of these, and likely my first dissertation chapter, is a working paper (available here) entitled, “Commercial Bank Competition, Riegle-Neal, and Dodd-Frank.” Its task, as the title might imply, is to empirically test whether two major pieces of legislation—The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010—can be said to have had distinguishable effects on the state of competition in American commercial banking. The reasons for asking this question are straightforward but deserve a moment of explanation.

In 1927, the McFadden Act, named for Rep. Louis Thomas McFadden (R-Pa) was passed on the recommendation of Comptroller of the Currency Henry May Dawes, banning banks from opening branches in more than one state. In current parliance, it prohibited competition across state lines, much as legislators still insist upon doing in markets for insurance today. Further exacerbating the anti-competitive regulatory climate were states which enacted “unit banking” laws, which prohibited anyone from owning more than one bank even within the same state.

By the early 1980s, however, a deregulatory push was sweeping the commercial banking sector, arguably influenced by the new Reagan administration but more probably the result of new sources of competition in the form of Money Market Mutual Funds (MMMFs), credit unions, and other substitutes for commercial banks emerging and not being subject to the same stringent regulations. Commercial banks, which had for years faced caps on the interest rates that they could pay, were up against other business models that faced no such stritctures. As a result, banks successfully lobbied to have their shackles loosened.

At roughly the same time, in 1984, the number of commercial banks in the U.S. peaked at an all-time high of over 14,000 firms. According to the now-largely-discarded Structure-Conduct-Performance (SCP) Paradigm, the competitiveness of a market is a function of the number of firms in that market. More firms make a market more competitive (e.g. less monopoly power to set prices and quantities), and fewer firms guarantee less competition (more monopoly power). Thus, the subsequent, precipitous fall in the number of commercial banks in the U.S. (the number is now roughly half that of 1984) would, in that framework, indicate skyrocketing monopoly power.

What was happening? After 1984, states were able to make bilateral agreements allowing their respective banks to operate in one another’s territory. The interstate banking revolution had begun—but slowly. This generally only worked well with neighboring states when it was practiced, and not all states took to it quickly. After the first ten years, however, in 1994, the federal government stepped in once again for another major round of deregulation with Riegle-Neal, abolishing all state-imposed restrictions on interstate banking competition.

This is where my paper poses the first of its questions: did Riegle-Neal reduce monopoly power? Dispensing with the often misleading heuristic of number of firms in the market in favor of empirical outcomes, it finds that monopoly power was decreased, on average, throughout the U.S. by anywhere from 1.38 to 1.53% and that the abolition of state banking restrictions resulted in an increase of anywhere from 37.5 to 53.4% of output above pre-Riegle-Neal levels, with deposit spreads (the difference between interest charged and interest paid by banks) reducing from an average of 3.3% to 3.06% since the law was enacted. Overall, it had a clearly pro-competitive effect.

What of Dodd-Frank? As I note in the paper, a 2014 working paper by Peirce, Robinson, and Stratmann,

“found that a large majority of respondents reported burdensome compliance costs, including hiring new personnel and contracting with outside compliance experts, leading banks to consider altering their product and service off erings, including but not limited to ending their provision of residential mortgage loans. They report that ‘[m]ore than eighty percent of respondents saw their compliance costs rise by more than five percent since 2010’ (Peirce, Robinson, and Stratmann, 2014). Like the 1935 act, this has the potential to not only force existing banks out of the market but to raise structural barriers to entry, potentially—so we shall test—diluting the effects of contestability and decreasing competitiveness in the commercial banking market.”[i]

The empirical results on this question are admittedly more mixed, as there is less data to be considered on merely six years of data since its enactment, but they decidedly lean toward saying that Dodd-Frank has had a pro-monopolistic, anti-competitive effect. Evidence derived here indicates, in one specification, a 7.6% increase in the average degree of monopoly power across American banking markets since the enactment of Dodd-Frank.

The most viable counter to this result is the next observation that I make in the paper: that interest rate spreads did not move in the direction that we would have predicted post-Dodd-Frank if monopoly power was increased. From 1994 to 2010, spreads fell rather consistently, with an average of 3.14%. After 2010, this trend appears to have continued. However, one could just as well argue that the years-long downward trend in rates simply overpowered any monopoly effects on spreads, and we can theorize that spreads may have fallen all the more in the absence of Dodd-Frank. Either way, I am inclined to trust the fuller model used in the paper and the more complex systems of equations that it utilizes to derive the slope of the industry demand curve than to focus too heavily on movements in one variable.

This is, to my knowledge, the first empirical test of its kind on competitiveness effects of Dodd-Frank. I will grant that the question is still new and that the answers will become clearer with more time and evidence, but before the recent political fervor to act in favor of repealing Dodd-Frank has fully passed, it appears worthwhile to look at hard evidence on the effects of this legislation and the possibility that by pushing small banks out of the market and reducing competition, Dodd-Frank might be moving banking market conditions quickly in the wrong direction.


[i] Peirce, Hester, Ian Robinson, and Thomas Stratmann. “How Are Small Banks Faring Under Dodd-Frank?” Working Paper no. 14-15. February 2014. Mercatus Center. https://www.mercatus.org/system/files/Peirce_SmallBankSurvey_v1.pdf.

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