The Effect of Dodd-Frank on the Profitability of Community Banks: An Econometric Model

Conclusion

By examining explanatory variables for 82 banks in the years 2010-2014 factors affecting each dependent variable have been determined. Return on Equity is influenced negatively by growth of total deposits, cost efficiency, bank loan portfolio, non-performing loans, interest rate, and FRASE index, and positively affected by credit quality, assets, and real GDP. Return on Assets is influenced positively by the net interest margin, credit quality, and real GDP, and negatively by the FRASE index, non-performing loans, cost efficiency, and growth of total deposits. The Net Interest Margin is influenced negatively by inflation, and the interest rate and positively by non-performing loans. According to the models, there has been an impact on the profitability of banks since the enactment of the Dodd-Frank Act. This is evidenced by the negative correlation between profitability and the FRASE index. This correlation indicates that more regulation in a state decreases bank profitability. In addition, there was a positive correlation between asset size and profitability. This is interpreted as the smaller a bank is, the less profitable it will be. To conclude, a small bank and regulations will both negatively impact profitability. These findings are similar to findings by Naceur and Omran (2011). The Dodd-Frank Act requires more liquidity and there is evidence that holding deposits negatively affects profitability. However, the Dodd-Frank Act may have impacted the credit quality of banks and increased the quality of loans held. There is evidence that high quality loans increase profitability.

Extensions of Research

This study was based on the premise that the Dodd-Frank Act affects each of the explanatory variables and that these variables determine a bank’s return on equity, return on assets, and net interest margin. This study may be subject to omitted variable bias as there are many factors which may impact a bank’s profitability which were not included. It may be beneficial for future researchers to look into other regulations and their effects on different industries. In addition, sometime macroeconomic data is logged, however, it is not in this study. It may behoove a researcher to see if the data becomes more significant if it is logged. The economy was still recovering from a recession for the years available to sample; a more accurate study may be possible after the economy has recovered for a longer period. Eighty-two banks were used for this study, for future studies, larger and separate samples of community and non-community banks might lead to more accurate results.

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References

Al-Ubaydli, O. & McLaughlin, P.A. (2015). RegData: A numerical database on industry-specific regulations for all United States industries and federal regulations, 1997-2012. Regulation & Governance, doi: 10.1111/rego.12107.

Arellano, M. & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. Review of Economic Studies, 58.2, 277–297.

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Athanasoglou, P. P., Brissimis, S. N., & Delis, M. D. (2008). Bank-specific, industry-specific and macroeconomic determinants of bank profitability. Journal of International Financial Markets, Institutions and Money, 18.2, 121-136.

Bloomberg L.P. (2015). Data. Retrieved from Bloomberg database.

Blundell, R. & Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data models. Journal of Econometrics, 87, 115-143.

Board of Governors of the Federal Reserve System (US), 30-Year Conventional Mortgage Rate© [MORTG], retrieved from FRED, Federal Reserve Bank of St. Louis https://research.stlouisfed.org/fred2/series/MORTG, April 25, 2016.

Dietrich, A., & Wanzenried, G., (2011). Determinants of bank profitability before and during the crisis: Evidence from Switzerland. Journal of Financial Markets, Institutions and Money, 21.3, 307-327.

Evans, L. (2012). Impact of the Dodd-Frank Act Depends Largely on Future Rule Making. United States Government Accountability Office, 12. N.p.

Federal Deposit Insurance Corporation. (2015). Deposit Market Share Reports. Retrieved from https://www5.fdic.gov/sod/sodMarketBank.asp?barItem=2

Kanas, A., Vasiliou, D., & Erotis, N. (2012). Revisiting bank profitability: A semi-parametric approach. Journal of International Financial Markets, Institutions and Money, 22.4, 990-1005.

Lux, M., & Greene, R. G. (2015). The State and Fate of Community Banking. Harvard Kennedy School. N.p.

Marsh, T. D., & Norman, J. W. (2012). The Impact of Dodd-Frank on Community Banks. Wake Forest University Legal Studies, Paper No. 2302392.

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Naceur, S. B., & Omran, M. (2011). The Effects of Bank Regulations, Competition, And Financial Reforms on Banks' Performance. Emerging Markets Review, 12.1, 1-20.

Ozkan, S., Balsari, C. K., & Varan, S. (2014). Effect of Banking Regulation On Performance: Evidence from Turkey. Emerging Markets Finance & Trade, 50.4, 196-211.

Pierce, H., Robinson, I., & Stratmann, T. (2014). How Are Small Banks Faring Under Dodd-Frank?" George Mason University, N.p.

Pierce, H., & Miller, S. M. (2015). Small Banks by the Numbers. Mercatus Center, 2000–2014. N.p.

US. Bureau of Labor Statistics. Consumer Price Index for All Urban Consumers: All Items [CPIAUCSL], retrieved from FRED, Federal Reserve Bank of St. Louis. https://research.stlouisfed.org/fred2/series/CPIAUCSL, April 25, 2016.

US. Bureau of Economic Analysis. Real Gross Domestic Product [A191RL1Q225SBEA], retrieved from FRED, Federal Reserve Bank of St. Louis. https://research.stlouisfed.org/fred2/series/A191RL1Q225SBEA, April 25, 2016.

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Appendix A: Banks & Locations Data

Bank Code	Bank Name	State	Community Bank
1	Peoples United Bank	CT	No
2	Webster Bank	CT	No
3	PB Bancorp, Inc	CT	Yes
4	Salisbury Bancorp, Inc.	CT	Yes
5	SI Financial Group, Inc.	CT	Yes
6	United Financial Bancorp, Inc.	CT	Yes
7	Boston Private Financial Holdings, Inc.	MA	Yes
8	Bershire Hills Bancorp, Inc.	MA	Yes
9	Brookline Bancorp, Inc.	MA	Yes
10	Chicopee Bancorp, Inc.	MA	Yes
11	Century Bancorp, Inc.	MA	Yes
12	Meridian Bancorp, Inc.	MA	Yes
13	Enterprise Bank and Trust Company	MA	Yes
14	Independent Bank Corp/MA	MA	Yes
15	Westfield Finanacial, Inc	MA	Yes
16	Bar Harbor Bank & Trust	ME	Yes
17	Camden National Corporation	ME	Yes
18	First Bancorp, Inc.	ME	Yes
19	Northeast Bancorp	ME	Yes
20	Lake Sunapee Bank Group	NH	Yes
21	Hudson City Bancorp	NJ	No
22	Valley National Bancorp	NJ	No
23	BCB Bancorp Inc	NJ	Yes
24	First Constitution Bancorp	NJ	Yes
25	Cape Bancorp, Inc.	NJ	Yes
26	ConnectOne Bancorp	NJ	Yes
27	Lakeland Bancorp	NJ	Yes
28	Maguyar Bancorp, Inc	NJ	Yes
29	Northfield Bancorp, Inc.	NJ	Yes
30	OceanFirst Financial Corp.	NJ	Yes
31	Oritani Financial Corp	NJ	Yes
32	Ocean Shore Holding Co.	NJ	Yes
33	Providnet Financial Services, Inc	NJ	Yes
34	Peapack-Gladstone Financial	NJ	Yes
35	Parke Bancorp	NJ	Yes
36	Sussex Bancorp	NJ	Yes
37	Stewardship Financial Corporation	NJ	Yes
38	Two River Bancorp	NJ	Yes
39	Unity Bancorp, Inc	NJ	Yes
40	Bank of NY Mellon	NY	No
41	Citigroup	NY	No
42	First Niagara Financial Group Inc.	NY	No
43	M&T Bank Corp	NY	No
44	New York Community Bancorp, Inc	NY	No
45	JPMorgan Chase & Co	NY	No
46	Signature Bank	NY	No
47	The Bridgehampton National Bank	NY	Yes
48	Financial Institutions	NY	Yes
49	TrustCo Bank Corp	NY	Yes
50	Arrow Financial Corp	NY	Yes
51	Chemung Financial Corp	NY	Yes
52	First of Long Island Corp	NY	Yes
53	Flusing Financial Corp	NY	Yes
54	Suffolk Bancorp	NY	Yes
55	Tompkins Financial Corp	NY	Yes
56	FNB Corp	PA	No
57	Fulton Financial Corp	PA	No
58	PNC Financial Services Group	PA	No
59	Bryn Mawr Bank Corp	PA	Yes
60	First Commonwealth Financial Corp	PA	Yes
61	Orrstown Financial Services, Inc	PA	Yes
62	S&T Bancorp Inc	PA	Yes
63	Univest Corp of Pennsylvania	PA	Yes
64	ACNB Bank	PA	Yes
65	AmeriServ Financial Inc.	PA	Yes
66	Beneficial Bancorp Inc	PA	Yes
67	CNB Financial Corp	PA	Yes
68	Codorus Valley Bancorp	PA	Yes
69	First Citizens Community Bank	PA	Yes
70	DNB First, National Association	PA	Yes
71	The Fidelity Deposit and Discount Bank	PA	Yes
72	First Keystone Community Bank	PA	Yes
73	Republic First Bancorp, Inc	PA	Yes
74	Fox Chase Bancorp, Inc.	PA	Yes
75	Mid Penn Bank	PA	Yes
76	National Penn Bancshares	PA	Yes
77	Northwest Bancshares	PA	Yes
78	Norwood Fianncial Corp	PA	Yes
79	Prudential Bancorp	PA	Yes
80	Penns Wood Bancorp	PA	Yes
81	QNB Bank	PA	Yes
82	Royal Bancshares of Pennsylvania, Inc	PA	Yes

Appendix B: Correlation Matrix Appendix C Variable Descriptions

Variable	Measure	Notation	Expected Effect
Return on Equity	Net income / average common equity	ROE
Return on Assets	Net income / average assets	ROA
Net Interest Margin	Net interest income / earnings assets	NIM
Bank Code	Corresponding code with each bank's name	BCode	?
Time Code	Corresponding code with each time period	TCode	?
Community Bank Status	<10 billion in assets is considered a community bank	BankStatus	-
Total Deposit Growth	The percentage change over a one year period of total deposits	TotDepG	?
Interest Income Share	The percentage of interest based income divided by non-interest income	IntIncShare	?
Cost Efficiency	Total operating expenses / total revenue + total deposits	CostEff	-
Credit Quality	Reserve for loan loss / total loans	CreditQual	+
Diversification	(Non-interest income / gross income)^2 / (interest income / gross income)^2	Div	?
Bank Portfolio	Total consumer loans / total commercial loans	BankPort	?
Non-performing loans	Sequential growth from year before of loans in default (that do not accrue interest)	NonPerG	-
Herfindahl-Hirschman Index	The market shares of each state that the bank are headquartered	HHI	?
Consumer Price Index	The percentage change of the CPI lagged one period for all urban consumers in the Northeast	CPI	+
Interest Rate	The percentage change of the 30 year annual interest rate lagged one year	IntRate	+
Real Gross Domestic Product	The percentage change of RGDP each year	RGDP	+
Assets	The bank’s total assets for each year	ASSETS	?
Log Assets	The bank’s total assets for each year logged	LOGASSETS	?
FRASE Current Index	Ratio of the impact of federal regulations on a specific state’s industry to impact of regulation on the nation	FRASECUR	-

Appendix D: Descriptive Statistics

	Mean	Median	Maximum	Minimum	Std. Dev.
ROA	0.71	0.79	2.46	-2.87	0.54
ROE	6.73	7.78	26.65	-52.44	6.81
NIM	3.46	3.47	6.66	1.19	0.59
CREDITQUAL	1.45	1.32	5.98	0.00	0.66
DIV	2,692,880	0.45	157,000,000	0.00	17,352,034
BANKPORT	8.44	0.58	930.96	0.01	72.48
INTINCSHARE	6.73	4.78	163.95	-85.37	14.32
TOTDEPG	7.59	4.97	132.46	-23.53	13.89
COSTEFF	0.01	0.01	0.03	0.00	0.00
NPLG	5.78	-3.25	1871.20	-68.95	101.93
HHI	970.58	769.77	1740.00	476.11	343.48
RGDP	0.02	0.02	0.03	0.01	0.01
CPI	0.33	0.02	1.59	-0.13	0.63
INTRATE	-0.03	-0.13	0.33	-0.16	0.19
ASSETS	64979.82	1805.369	2572274	445.578	330234
LOGASSETS	3.481498	3.256504	6.410317	2.648924	0.758645
FRASECUR	1.18414	1.196959	1.291662	0.892552	0.07188

Appendix E: ROE Dependent Variable: Model Results

*10% **5% ***1%

Model

Dependent Variable:	Return on Equity	1		2		3		4		5
	Regressor
Coefficient	Lagged ROE	-0.222379	***
T-Statistics		-4.641318
P-Values		0.0000
Coefficient	Growth of Total Deposits	0.042634	***	0.017546		-0.088893	***			-0.024719	***
T-Statistics		3.120637		-1.530967		-2.684342				-2.789861
P-Values		0.0019		0.1271		0.0078				0.0057
Coefficient	Interest Income Share	0.002709		0.014365						0.053697	*
T-Statistics		0.2229633		1.150026						1.853102
P-Values		0.8186		0.2513						0.0651
Coefficient	Cost Efficiency	-204.8525		-765.8297	***					-722.0357	***
T-Statistics		-1.184075		-7.28034						-4.593356
P-Values		0.2376		0						0.0000
Coefficient	Credit Quality	0.744468		4.740938	***	1.773751		2.127958	*
T-Statistics		0.953958		2.654656		1.473657		1.914029
P-Values		0.3411		0.0085		0.1419		0.0568
Coefficient	Diversification	4.51E-09		3.23E-09
T-Statistics		0.209837		0.501367
P-Values		0.834		0.6166
Coefficient	Bank Loan Portfolio	0.004794	**	0.000723		-0.007029	***	-0.005287	***
T-Statistics		2.214442		0.159839		-5.887582		-11.84652
P-Values		0.0278		0.8731		0.0000		0.0000
Coefficient	Non-Performing Loans	0.001342	***	-0.001771	*	-0.002343	**
T-Statistics		5.487847		-1.861327		-2.081315
P-Values		0.0000		0.064		0.0385
Coefficient	Market Concentration	-0.003152	**	0.000648		-0.002475		0.000163
T-Statistics		-2.410379		0.297074		-0.792956		0.089649
P-Values		0.0167		0.7667		0.4286		0.9286
Coefficient	Inflation	-218.384	***	-0.114589
T-Statistics		-16.29475		-0.25318
P-Values		0.0000		0.8004
Coefficient	Interest Rate	1.152717	**	-2.984662	**			0.914768	**
T-Statistics		2.037336		-2.318289				1.966565
P-Values		0.0428		0.0213				0.0504
Coefficient	Change in RGDP	2.917723	***	194.0825	***
T-Statistics		0.085212		2.560604
P-Values		0.9322		0.0111
Coefficient	FRASE Current	26.20471	*	-84.99074	***	-15.12968
T-Statistics		1.694851		-2.399252		-0.870833
P-Values		0.0914		0.0172		0.3847
Coefficient	Assets			0.0000425		0.001809	***
T-Statistics				0.826166		2.901016
P-Values				0.4096		0.0041
Coefficient	Log Assets	-42.43464	***
T-Statistics		-6.355648
P-Values		0.0000
	Wald-test (x2)	154.92		13.57753		74.94697		70.59398		17.1347
	P-value	0.0000		0.0000		0.0000		0.0000		0.0000
	Degrees of Freedom	(14,232)		(13,233)		(7,239)		(4,242)		(3,243)
	AB test AR(1) (p-value)	0.2542		0.1213		0.0002	***	0.1128		0.1131
	AB test AR(2) (p-value)	0.9036		0.2354		0.376		0.2852		0.2576
	J-statistic	28.63165		13.27295		19.95601		16.9328		13.44474

Appendix F: ROA Dependent Variable: Model Results

*10% **5% ***1%

Model

Dependent Variable:	Return on Assets	1		2		3		4		5
	Regressor
Coefficient	Lagged ROA	-0.11401	***					-0.163621
T-Statistics		-3.330133						-5.606098
P-Values		0.001						0.0000	***
Coefficient	Growth of Total Deposits	-0.003856	***	-0.001541		-0.001688	**
T-Statistics		-6.394816		-1.519691		-1.96318
P-Values		0.000		0.1300		0.0508
Coefficient	Interest Income Share	-0.001538		0.00179		0.001819	***
T-Statistics		-1.386022		1.27512		4.525778
P-Values		0.1671		0.2035		0.0000
Coefficient	Cost Efficiency	-46.10715	***	-70.00679	***	-69.3976	***
T-Statistics		-4.319749		-11.49931		-10.40749
P-Values		0.0000		0.0000		0.0000
Coefficient	Credit Quality	0.132974	*	0.525914	***	0.55464	***	0.208041	***	0.227217	**
T-Statistics		1.659269		2.735755		3.073517		4.391417		2.441165
P-Values		0.0984		0.0067		0.0024		0.0000		0.0154
Coefficient	Diversification	5.73E-10		1.45E-10				6.94E-10		-1.53E-09
T-Statistics		0.409704		0.179957				0.628326		-1.570014
P-Values		0.6824		0.8573				0.5304		0.1177
Coefficient	Bank Loan Portfolio	-0.000107		1.65E-05				0.000178		-0.000554	***
T-Statistics		-0.805297		0.063815				1.047966		-8.20177
P-Values		0.4215		0.9492				0.2957		0.0000
Coefficient	Non-Performing Loans	-6.52E-05		-0.000112	**	-0.000136	**
T-Statistics		-1.151886		-2.111089		-2.340998
P-Values		0.2506		0.0358		0.0201
Coefficient	Market Concentration	-0.00029		-0.00011
T-Statistics		-1.594879		-0.473904
P-Values		0.1121		0.636
Coefficient	Inflation	-8.384053		0.001042						0.034889
T-Statistics		-8.407179		0.025535						1.13654
P-Values		0.0000		0.9797						0.2569
Coefficient	Interest Rate	0.094854		-0.186681		-0.221118	**	0.083999	**	0.050837
T-Statistics		1.665884		-1.252933		-1.968304		2.207945		1.14635
P-Values		0.0971		0.2115		0.0502		0.0282		0.2528
Coefficient	Change in RGDP	-0.661256		14.82982	*	15.78036	**
T-Statistics		-0.265494		1.740556		2.484227
P-Values		0.7909		0.0831		0.0137
Coefficient	FRASE Current	-0.951036		-7.303051	*	-8.005292	**
T-Statistics		-0.746545		-1.924799		-2.723464
P-Values		0.4561		0.0555		0.0069
Coefficient	Assets	1.93E-07		3.69E-06
T-Statistics		0.255622		1.016637
P-Values		0.7985		0.3104
Coefficient	NIM	0.425958		0.237762	**	0.221161	***
T-Statistics		2.81375		2.217571		2.512385
P-Values		0.0053		0.0276		0.0127
	Wald-test (x2)	22.04917		24.87189		42.53674		17.33273		16.62161
	P-value	0.0000		0.0000		0.0000		0.0000		0.0000
	Degrees of Freedom	(15,231)		(14,232)		(9,237)		(6,240)		(5,241)
	AB test AR(1) (p-value)	0.1021		0.711		0.0748	*	0.6988		0.0686	*
	AB test AR(2) (p-value)	0.8278		0.3571		0.3628		0.5684		0.657

Appendix G: NIM Dependent Variable: Model Results

*10% **5% ***1%

Model

Dependent Variable:	Net Interest Margin	1		2		3		4		5
	Regressor
Coefficient	Lagged NIM	-0.135579	***
T-Statistics		-4.419571
P-Values		0
Coefficient	Growth of Total Deposits	0.001211		0.0072
T-Statistics		0.83382		0.477729
P-Values		0.4052		0.6333
Coefficient	Interest Income Share	0.001625		-0.000485		-0.000971				-0.000753
T-Statistics		1.559869		-0.359968		-1.450526				-0.513956
P-Values		0.1202		0.7192		0.1482				0.6078
Coefficient	Cost Efficiency	-5.404967		1.361259				-4.227795		1.297272
T-Statistics		-1.436229		0.208903				-0.555831		0.257015
P-Values		0.1523		0.8347				0.5788		0.7974
Coefficient	Credit Quality	0.065634		0.058518				0.102466
T-Statistics		1.0544747		0.528938				0.811536
P-Values		0.2926		0.5974				0.4179
Coefficient	Diversification	3.29E-10		-1.85E-10
T-Statistics		0.0866369		-0.321003
P-Values		0.3872		0.7485
Coefficient	Bank Loan Portfolio	4.90E-04	***	-3.36E-05
T-Statistics		7.913676		-0.154244
P-Values		0		0.8776
Coefficient	Non-Performing Loans	0.000384	***	9.80E-05		0.000149	***			0.000162	***
T-Statistics		5.845872		2.611361		4.224368				3.520371
P-Values		0		0.0096		0.0000				0.0005
Coefficient	Market Concentration	0.000284		-0.000379		-0.000344
T-Statistics		1.083485		-1.231675		-1.49662
P-Values		0.2797		0.2193		0.1358
Coefficient	Inflation	7.285612	**	-0.050034		-0.059862	**	-0.05197	**
T-Statistics		2.158094		-1.06382		-2.426619		-2.266222
P-Values		0.0319		0.2885		0.016		0.0243
Coefficient	Interest Rate	-0.083257		-0.162524		-0.201545	***
T-Statistics		-0.831332		-1.009467		-4.936669
P-Values		0.4066		0.3138		0.0000
Coefficient	Change in RGDP	-6.836565		0.137335
T-Statistics		-1.357096		0.016532
P-Values		0.1761		0.9868
Coefficient	FRASE Current	0.112943		1.068448
T-Statistics		0.07641		0.304873
P-Values		0.9392		0.7607
Coefficient	Assets	0.00000158	***	7.83E-07		-5.80E-05		2.69E-05
T-Statistics		-4.69457		0.33901		-1.425494		0.58416
P-Values		0		0.7349		0.1553		0.5597
Coefficient	Assets2					1.11E-11		-3.98E-12
T-Statistics						1.420814		-0.481378
P-Values						0.1567		0.6307
Coefficient	Log Assets					2.165943	**
T-Statistics						2.466267
P-Values						0.0144
Coefficient	ROA			0.138247		0.144513	***			-0.022064
T-Statistics				1.384181		3.782389				-0.267735
P-Values				0.1676		0.0002				0.7891
Coefficient	ROE			-0.001807				0.003307		0.003685
T-Statistics				-0.394199				1.189613		0.853875
P-Values				0.6938				0.2354		0.394
	Wald-test (x2)	48.4524		102.2585		25.8496		3.078968		5.308015
	P-value	0.0000		0.0000		0.000		0.0064		0.0001
	Degrees of Freedom	(14,232)		(15,231)		(9,237)		(6,240)		(5,241)
	AB test AR(1) (p-value)	0.3215		0.1046		0.0896		0.1327		0.1202
	AB test AR(2) (p-value)	0.616		0.104		0.0616	*	0.1412		0.1504
	J-statistic	20.2971		21.69154		14.98535		22.41962		32.3475
	Prob(J-statistic)	0.009269		0.00991		0.452473		0.00764		0.000173

Appendix H: FRASE Score Map