Illustration by Aisha Franz
Illustration by Aisha Franz

The wave of new banking regulations that Congress created to deter and punish Wall Street’s misdeeds is landing with much greater impact on the U.S.’s almost 7,000 community banks than on the too-big-to-fail lenders.

Community banks didn’t cause the financial crisis; they played by the rules. Because of their time-tested business model, one based on customer relationships rather than transaction volumes, community banks aren’t a threat to the financial system. Yet they are being forced to pay a penalty in regulatory costs -- to comply with rules aimed at preventing the bad behavior on Wall Street from happening again.

Community banks are also disproportionately affected by the new rules. Right now, banks with less than $10 billion in assets control only 20 percent of total U.S. banking assets. Washington lawmakers and regulators are holding back community banks from devoting their full attention and resources to making more loans and fueling a more robust economic recovery.

The effect of these regulations is that Congress has added insult to injury for community banks while rewarding the real villains. The megabanks are benefiting from what Bloomberg View calculated is an $83 billion annual taxpayer subsidy, the value of implicit guarantees by the U.S. Treasury. Bloomberg View was correct to characterize the too-big-to-fail subsidy as “a major driver of the largest banks’ profits.”

Credit Quality

Perversely, Federal Deposit Insurance Corp. data show that large banks have both the lowest credit quality and the lowest cost of funds in the industry. Community banks rank the highest in both categories even though they have had to compete for years against the megabanks’ access to cheaper money in pricing loans. In addition, community banks must compete against the big lenders’ lower comparative costs in handling regulatory paperwork.

This is morally wrong -- and bad economic policy. Community banks should be putting their capital to work in the small towns, rural communities and middle-class urban enclaves they know well. Instead, they are focusing too many of their precious human resources on onerous paperwork and time-consuming compliance measures.

Community banks are the source of almost 60 percent of all small-business loans of less than $1 million, as well as mortgage and consumer loans tailored to the needs of their local communities. Large banking organizations with more than $50 billion in assets hold almost 40 percent of outstanding small loans to businesses, according to the Federal Reserve, but loans to small businesses aren’t a significant portion of large-bank lending. Small-business loans represent less than 5 percent of the large banks’ total domestic lending.

Five Steps

Lawmakers should rethink the regulations aimed at the megabanks. Here are five steps Congress can take now to rebalance the regulatory burden and give Main Street businesses greater access to loans:

-Exempt small banks from certain mortgage rules. Provide “qualified mortgage” safe-harbor status for all home loans originated and held in portfolio by community banks, including balloon mortgages and interest-only loans, and exempt these banks from mandatory requirements to maintain cumbersome escrow accounts for the same class of loans.

-Cut red tape in small-business lending. Waive the new requirement to report information on every new small-business loan application. It falls disproportionately on community banks that lack the back-office expertise and other resources to comply.

-Require cost-benefit analyses by regulators. Prevent regulators from proposing new rules before they have determined that costs won’t exceed benefits. This step must recognize the disproportionately higher cost of compliance on small banks, and ensure new rules are consistent with existing regulations, written in plain English and easy to interpret. More broadly, new rules should reduce the threat to society of future crises, and the resulting economic damage from a recession and high unemployment.

-Waive certain audit rules. Increase to $350 million from $75 million the market-capitalization threshold requiring outside auditing of internal controls. Bank examiners continually monitor these systems at smaller banks. Waiving the audit requirement for small, publicly traded local banks would reduce their expenses substantially without creating more risk for investors, taxpayers or the deposit-insurance system.

-Eliminate the annual requirement on no-change privacy notices. Mailing annual notices on privacy policies serves little purpose when no changes have been made. Keep the notification requirement for those years when changes are made.

None of these changes would alter the already significant regulatory tools that provide appropriate oversight of community banks. But it would be a failure of logic and lawmaking if the new wave of banking regulations that are meant to stop Wall Street excesses instead resulted in cutting off one of Main Street’s economic lifelines.

(Camden R. Fine is president and chief executive officer of the Independent Community Bankers of America. The opinions expressed are his own.)

To contact the writer of this article: Camden R. Fine at camden.r.fine@icba.org

To contact the editor responsible for this article: Paula Dwyer at pdwyer11@bloomberg.net.