Pottow on Small Banks and CFPA

University of Michigan Law Professor John Pattow, who specializes in Bankruptcy and Commercial Law, talks about the effects of a Consumer Financial Protection Agency (CFPA) on small banks:

Leaving aside the irony of the ABA’s new-found populism, the real objection to this argument is that it’s absurd. Simple economics suggests the CFPA would actually help small banks, for at least two reasons.

First, regulatory compliance costs are largely fixed. Big issuers do indeed have an advantage with fixed costs, as they can spread the costs over more borrowers. But the plain vanilla rule would lower fixed regulatory costs by providing one-time, simple-template approval for products underwritten by the CFPA. Smaller issuers should rejoice in this reduction of fixed costs as it chips away at the current advantages the regulatory structure accords large lenders.

Second, and more important, plain vanilla products will achieve a transparency long overdue in the financial products market. Markets depend on consumer choice, and consumer choice is missing when consumers cannot understand or compare the terms and conditions of financial products.

The current credit market, with its indecipherable multi-page contracts, is not competitive. Actually, that’s not true: It’s perniciously competitive — the competition focuses on better hiding fees in small print. Burying terms in legal documents is an activity where larger banks again hold the advantage. By contrast, a true plain vanilla market would remove the obfuscation and refocus the competition on price. Once more, smaller lenders would benefit from this increased transparency and leveled playing field.

To be sure, there may be some industry segmentation. Smaller institutions will likely gravitate toward the plain vanilla products, and the mega-banks might specialize in the exotica. But this likely mirrors current practice: Small banks are inclined toward simple products that can be explained readily to small bank customers, just as the bigger banks are likely to pursue the complex products tailored ones for larger customers. By reducing the costs of plain vanilla products, we would be helping, not hurting, the little guy.

I wrote about the issue, and my worries and hopes about it, for The Atlantic’s Business Channel. This does make me less worried that a CFPA would be just another hurdle that would hurt small banks, and would give them an actual competitive edge instead.