Compounding the costs: The regulatory tsunami and small businesses

A gust of new regulations on lenders would add headwinds for beleaguered small businesses

By Dan Brown and Krista Shonk
ABA Viewpoint

From COVID-19-related closures to labor shortages and inflation, small businesses have faced enormous obstacles in recent years. But rather than finding ways to alleviate burdens on small businesses, the federal government is poised to impose still more regulations to make access to capital even more expensive for these resource-strapped businesses.

Banks are a significant source of capital to small businesses, with over $500 billion worth of outstanding small business loans in the third quarter of 2023. The cumulative impact of uncoordinated regulatory initiatives, while well-intentioned, can significantly disrupt banking in ways that will negatively impact the economy and the small business customers banks serve.

These regulations may lead to increased bank consolidation, further reducing the options small businesses have when applying for a loan. The federal government is rushing forward with these new rules without having studied the full impact of these complex regulatory interactions on either lenders or the small businesses they serve. And any regulatory changes that affect small businesses to this degree will be felt throughout the economy, since America’s 33.2 million small businesses employ 46 percent of private-sector employees, account for 44 percent of U.S. GDP and have created more than six in 10 new jobs since 2022.

Section 1071’s excessive and intrusive reporting requirements

This is the second article in a series examining the cumulative impact of multiple regulations on the U.S. economy and businesses. Read other entries in the series on credit card users and mortgage borrowers.
Section 1071 of the Dodd-Frank Act requires financial institutions to compile, maintain and submit to the Consumer Financial Protection Bureau detailed data on credit applications by women-owned, minority-owned, and other small businesses. Collecting this data is intended to promote access to capital for minority- and women-owned small businesses by facilitating enforcement of fair lending laws and identification of community development opportunities. In total, should the CFPB’s final rule go into effect as written, banks will have to collect and report 81 different data points (significantly more than the 13 that were statutorily required) for every small business transaction, which would add significant compliance costs to the industry. The CFPB will publish 1071 loan-level data annually, subject to yet-to-be-determined redactions for privacy. Costs associated with 1071 could simultaneously increase borrowing costs for existing small businesses, inhibit the ability of small businesses to expand and deter new business formation.

As previous ABA analysis has discussed, higher borrowing costs and the privacy concerns associated with this rule are likely to force lenders to standardize their lending to small businesses, taking away the customization that is so crucial for the success of our diverse small businesses. The rule will also result in higher costs for small business lending products and tighter underwriting standards.

The CFPB, however, failed to estimate key costs to small businesses. While conceding higher borrowing costs would occur, the bureau did not quantify this impact on small businesses against the purported benefits of the final rule. This goes against the recommendation of the Small Business Administration Office of Advocacy, which stated, “An agency should examine the reasonably foreseeable effects on small entities that purchase products or services from, sell products or services to, or otherwise conduct business with entities directly regulated by the rule.” To understand the true impact of a rule, banking regulators should heed the SBA’s advice and incorporate these foreseeable costs into their analysis.

The CRA regulatory overhaul: Disincentivizing lending to small businesses

In addition to 1071 implementation, banks must prepare to comply with a new 1,500-page rule that overhauls the regulations implementing the Community Reinvestment Act. For roughly 50 years, CRA has required the banking agencies to evaluate bank lending to and investment in low- and moderate-income individuals and communities. While modernization is important, the regulators disregarded key comments from practitioners, resulting in a final rule that, perversely, could dissuade banks from making small business loans in some markets—the opposite of what the CRA statute was intended to achieve.

Under the new rule, regulators would evaluate bank CRA performance in new Retail Lending Assessment Areas, or RLAAs, or the Outside Retail Lending Area, or ORLA, where a bank lends but does not have a physical location. In addition to being inconsistent with the CRA statute, these new assessment areas may be triggered in geographies where a bank does not have a meaningful market presence and may not be central to the bank’s business strategy. In fact, banks that do not have a physical presence in an RLAA or the ORLA would be compared to banks that do have branches or their main office there. This may disincentivize banks from lending outside of their key geographies, which could adversely impact small businesses looking for capital. Unable to grow organically, banks could be forced to consolidate—an outcome clearly inconsistent with the Biden administration’s policy goals.

Furthermore, based on an analysis of 2018-2020 data, the banking agencies estimate that 22.4 percent of RLAAs and 28.8 percent of ORLAs would receive a CRA rating of “needs to improve” or “substantial noncompliance” under the new framework, which bolsters the notion that banks may choose to limit lending in areas where they do not have a physical presence in order to avoid triggering an RLAA or the ORLA and receiving an unsatisfactory evaluation in that area. Unfortunately, the agencies did not analyze whether the rule would result in these types of unintended consequences that work at cross purposes with expanding financial opportunity for small businesses.

Basel III endgame: More capital, less small business lending

The economic fallout caused by uncoordinated regulations does not stop with the federal government’s fair lending and community reinvestment initiatives. Regulators have proposed new capital requirements that would also chill small business lending. The Basel III “endgame” would require larger banks to hold more capital and represents an additional, explicit obstacle to small business lending. For example, this rule would require the largest eight banks to hold roughly 20 percent more capital, which would have downstream consequences for small businesses. Previous regulatory changes in capital requirements impacted bank investment in small businesses. A recent NBER working paper provided evidence that higher capital requirements following the Great Financial Crisis was associated with a decrease in small business investment. Yet regulators seem intent on repeating previous mistakes without understanding the consequences of such changes.

While community banks proportionately lend more to small businesses, these eight global systemically important banks were responsible for about 35 percent of all outstanding small commercial and industrial loans in the third quarter of 2023. Also, a provision within the proposal would give higher risk weights on loans to companies that are not publicly listed, which is yet another deterrent for these banks to lend to smaller businesses.

The proposal is also coming at a time when regulators fully acknowledge the industry is well capitalized. For example, in a November 2023 Senate hearing, FDIC chair Martin Gruenberg noted that “key banking industry measures of performance remained favorable. Net income remained high by historical measures, asset quality measures were stable, and the industry remained well capitalized.” Although key regulators see banks as well capitalized today, if adopted, these higher capital requirements would create clear disincentives for banks to lend to small businesses.


The regulatory tsunami now forming will translate into increased costs for small business customers. Other organizations have also voiced concern about the impact of these regulations on small businesses. A recent Chamber of Commerce survey found that 87 percent of U.S. businesses reported negative effects from regulatory-related cost increases. The House Small Business Committee also recently noted that “new regulations, and the cumulative effect of existing regulations, will have a disproportionate, negative impact on small businesses.” Additionally, higher interest rates are adversely impacting small businesses. An August 2023 National Federation of Independent Businesses survey found that 58 percent of small business owners who borrowed or tried to borrow reported high interest rates as their largest complaint in accessing financing.

Therefore, it is vital that regulators coordinate new regulatory initiatives and assess their cumulative impact—not only to ensure the success of the banking industry—but to avoid unintentional harm to the 33.2 million small businesses and their 61.7 million employees that drive Main Street America and the broader U.S. economy.

Our next viewpoint in this series will examine how new regulatory proposals could worsen housing affordability.

Dan Brown is senior director, economist, banking and financial services at ABA. Krista Shonk is VP and senior counsel, regulatory compliance and policy at ABA.

ABA Viewpoint is the source for analysis, commentary and perspective from the American Bankers Association on the policy issues shaping banking today and into the future. Click here to view all posts in this series.