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

By Alexandra R. Larch
2017, Vol. 9 No. 02 | pg. 2/2 |

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.


References

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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

Appendix H

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