A recent court decision to strike down a Federal Reserve regulation called Reg II threatens the ability of South Dakota’s small banks and credit unions to provide the kind of personalized, hometown service that sets them apart from their nationwide counterparts.
Reg II caps the fees they can charge businesses to process debit card transactions. To mitigate the lobbying pressure members of Congress often face from big businesses to lower the fee, the regulation mandates that they cannot pass a law at the behest of big business lobbyists to set card processing fees below our local banks’ operating costs.
It also ensures that small banks with less than $10 billion in assets (like all of South Dakota’s small community banks) are exempt from the fee cap. This is great news for our state because, overall, its small banks and credit unions are much more dependent on fees than are large institutions, which have much more diverse sources of revenue. If Reg II goes away, they can go out of business.
Many of us have friends or relatives in the banking business who began their careers with local community banks and advanced to positions of vice president or higher. They know the people in their communities, their work ethic and their character.
When hard times came and local residents needed financial assistance to help them through a rough patch, their local banker could look beyond a credit score or an income statement to consider intangibles like integrity, persistence and resolve.
Many of those same bankers remained in their positions through mergers or acquisitions resulting in bigger banks with larger branches and centralized services. Unfortunately, these big corporate mergers came with more rules, less latitude, and an impersonal approach to service.
One South Dakota banker whose institution was gobbled up by a corporate bank lamented the changes, telling me, “I used to be able to make a loan based on what I knew about a person. Now, I’m basically just a clerk. I enter their information into a laptop, and whatever it comes back with is what I have to do, no questions asked.”
Personal banking relationships are particularly important in a state like South Dakota, where 81 percent of farms are operated by families or individuals. That includes more than 12,000 “new or beginning farmers,” according to the 2024 Census of Agriculture.
South Dakota’s 90,000 small businesses — which employ nearly 210,000, according to the U.S. Small Business Administration — also rely on banks that can see beyond cold, hard algorithms. They rely on their local bank for lines of credit, short-term loans and, in some cases, seasonal financing depending on the specialty of the product or service.
Local banks support schools, youth sports, civic clubs and other community activities in ways that megabanks do not. They are the financial lifeline of their communities.
While small banks are in a constant battle to maintain their personal touch while navigating a through a sea of regulations, the recent court decision deprecating parts of Reg II could make their existence even more difficult. It may, in fact, represent one more nail in the coffin of local banking.
Smaller banks count on the processing fees associated with debit cards to provide services like free checking to keep more branches in small towns and to provide other specialized services.
The Federal Reserve Board is appealing the district court’s ruling to the Eight Circuit Court of Appeals, which includes South Dakota.
About a decade ago, Regulation II was upheld after a similar challenge. Hopefully, the same thing happens today.
In a nation where small, local financial institutions are under greater pressures than ever, let’s hope the Eighth Circuit Court of Appeals understands the damage that would result by letting the District Court’s ruling stand, and the importance of siding with local banks – where people down the block matter as much as numbers on a spreadsheet.
Dr. Timothy O’Keefe is a Retired Dean and Professor of Information Systems and Entrepreneurship and the former Dean of the Beacon School of Business at the University of South Dakota. He enjoyed a 45-year career in higher education.
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