Community Bankers Face Regulatory Inequalities

Maryann F. Hunter, Deputy Director, Divisionrnof Banking Supervision and Regulation, Federal Reserve Bank told the U.S. Senate Subcommittee on Financial Institutions and Consumer Protection, Committee on Banking, Housing, and Urban Affairs that the banks that weathered the recent financial crisis most effectivelyrnwere those that adhered to the traditional community banking model. </p

None-the-less, she said, the economic downturn significantly impactedrncommunity banks and many continue to struggle. The banks recorded an aggregate profitrnlast year but one in five reported a loss. While the need to bolster reserves remains a critical task, the pace ofrndeterioration in their loan portfolios continued to slow during the fourth quarter ofrn2010 and nonperforming assets fell for the third straight quarter.  Loans secured by real estate continue to bernthe main contributors behind poor asset quality, particularly loans forrnconstruction and land development. </p

Although community banks have cut their exposure to commercial realrnestate lending, she said, community banks are particularly vulnerable to deteriorationrnin real estate markets because of their emphasis on local lending. Because ofrnreduced revenue in that sector many banks are seeking alternative sources ofrnrevenue. </p

Community banks have actively worked to restructure their problemrnloans though. During the past year, loans restructured and in compliance with modifiedrnterms have increased more than 30 percent to $15.1 billion including $3.5rnbillion in restructured residential mortgages. Although banks have beenrnaggressive in charging off losses and restructuring, reserves may requirernfurther strengthening and loan loss provisions will likely continue to weigh onrnearnings in future quarters at many banks. </p

Outstanding loan balances have declined for nine consecutive quartersrnfor all banks including community banks but Hunter said many healthy communityrnbanks continue to lend to creditworthy borrowers.  A significantly higher proportion of banks withrnassets under $1 billion actually increased their lending during this periodrnthan larger banks. </p

Community banks havernreported a number of possible causes for reduced levels of lending includingrnreduced demand, tighter underwriting standards, fewer creditworthy borrowers,rndeclining collateral values, and high levels of problem loans.  They also cite increased supervisoryrnexpectations of capital, liquidity, and oversight of commercial real estaternloans.  The Fed is working, she said, to ensurernthat its examiners are well-trained and employ a balanced approach to bankrnsupervision. </p

Community bankers and their supervisors have also been increasing theirrnattention to other areas where lending concentrations may exist such asrnmonitoring agricultural lending to ensure that underwriting standards arernconsistent with potential exposures to fluctuations in commodity prices andrnland values. </p

Hunter said that community bankers arernconcerned about the changing regulatory environment.  While recent reforms are aimed at the largestrnand most complex financial institutions, there is a fear that they willrnultimately affect smaller community-based institutions as well.  Of particular concern are some provisions ofrnthe Dodd-Frank Act such as the limit on debit card interchange fees and a rulernto prohibit network exclusivity arrangements and merchant routing restrictions.  Bankers are also concerned about the ultimaternimpact of new prudential standards that the Federal Reserve is required torndevelop as well as the Basel III framework, both of which are aimed are largernand/or globally active banks, and the new Consumer Financial Protection Bureaurn(CFPB).  They feel that the cost ofrncompliance with new regulations may fall disproportionately on smaller banksrnthat do not benefit from the economies of scale of larger institutions and thatrnthis may increase consolidation of the banking sector.  All federal regulators will be publishingrnproposed rulemaking under Dodd-Frank for public comment and the Federal Reservernencourages comments from community banks and others on this and all proposals.</p

Hunter said the Federal Reserve has beenrnworking closing with the Offices of Thrift Supervision, Comptroller of thernCurrency, and the Federal Deposit Insurance Corporation to prepare for therntransfer of supervisory authority of savings and loan holding companies to thernFed.  “Our intent–to the maximumrnextent possible and consistent with the Home Owners’ Loan Act and otherrnlaws–is to create an oversight regime for savings and loan holding companiesrnthat is consistent with our comprehensive consolidated supervision regime forrnbank holding companies.” The Fed appreciates, she said, that savings andrnloan and bank holding companies differ in important ways and will remainrngoverned by different statutes. </p

These regulatory changes will provide a new set of challenges forrncommunity banks.  However, Hunter said theyrnhave faced similar challenges in the past and have performed effectively andrncontinued to meet the needs of their communities. The banks that entered thernfinancial crisis with moderate exposures to commercial real estate, moderaternloan-to-deposit ratios, and ample investment securities tended to operaternsafely, soundly, and profitably despite the most challenging financial climaternsince the Great Depression. </p

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