April 22, 2015
Authored by: Dan Wheeler
Right now, the federal banking agencies (not including the CFPB) are engaging in a legally-required review process to examine what regulations are outdated, outmoded or unduly burdensome. Accordingly, the time is especially right for community banks to voice their concerns about their regulatory environment. Because of their lingering political unpopularity, many banks believe they have little or no leverage to seek reform of counterproductive regulations and improper regulatory enforcement tactics. But, by speaking with a consistent and united voice and by dealing with facts (in stark contrast to partisan attacks on banks), community banks can achieve real reform.
Here are suggestions for areas in which we can focus our reform efforts, beginning with the most urgent.
1. Seek genuine “right-sized” bank regulation. Community banks’ efficiency ratios severely lag those of large banks because the cost of regulation disproportionately burdens community banks. There is no serious dispute about this by scholars and industry insiders. Despite many carveouts in Dodd-Frank for sub-$10 billion banks, there still is not a genuine tiering or “right-sizing” of regulation. Without it, we will see the continued and inevitable disappearance of community banks (over 1,300 so far since 2010) without de novos to replace them. We will continue to see declines in assets held by community banks (at least 12% decline since Dodd-Frank’s enactment). There are several workable solutions, including the proposal from former FDIC Chairman Sheila Bair to simply give regulators discretion to exempt community banks from unsuitable regulations. And, many regulators and industry advocates favor defining community bank in terms of its complexity instead of size, which is an eminently sensible proposal. No one on any point of the political spectrum truly prefers a world dominated by a handful of extremely large banks. This issue is an urgent matter of survival for the entire community bank industry.
2. Preserve leadership of prudential banking regulators. The leading example of abdication by prudential regulators to politically-motivated enforcement is the notorious Operation Choke Point led by the Department of Justice. That Department has no institutional expertise in banking and makes no pretense of being a prudential regulator, particularly compared to the FDIC, which has decades of cradle-to-grave experience with banks and thoroughly understands the business and regulatory environment in which banks operate. Even the FDIC appears to have belatedly realized that it was a mistake to concede leadership to the Department of Justice when deciding what sorts of legal bank customers should be denied banking relationships. It is entirely appropriate for the banking industry to forcefully express its collective expectation that its prudential regulators must always exert leadership over banking. This leadership role is best documented by clear, written and published guidance that the prudential banking regulators direct at themselves. Not only must the banking regulators definitively end Operation Choke Point, banks and their regulators must ensure that they do not abdicate leadership in the future on other banking issues. Critically important to that goal is ensuring that prudential supervision and compliance enforcement remain at the same agency. Separating these functions, as is being urged by some, would hardwire the philosophy behind Operation Choke Point into our financial regulatory structure. Enforcement without the deep understanding acquired over decades by the prudential regulators will lead to banks and their customers being battered by enforcement crusades motivated by political considerations rather than careful analysis. Bankers and their regulators should unite against any effort to split these functions into separate agencies. Enforcement unhinged from supervision will dramatically raise compliance and litigation costs for community banks, something a challenged industry cannot afford.
3. Comprehensive reform of counterproductive lending restrictions. Community banks are struggling against severe headwinds in the area of loan regulation. The evidence so far indicates that commercial loans that community banks could and should make from a credit perspective are instead being driven into the non-bank sector. Insurance companies are increasing their market share in commercial real estate. Banks have been cut off from making small dollar consumer loans. Leveraged lending is effectively off limits for community banks. Swaps regulation makes these basic interest rate risk mitigation measures too risky from a regulatory enforcement perspective for all but the bravest banks and many worthy bank customers are barred by regulation from entering into a swap at all. Finally, residential mortgage lending, something that community banks are well positioned to do but for the regulatory risk, is an artificial oligopoly of the largest banks and the government-sponsored enterprises (Freddie, Fannie, etc.). In almost every case, when loans are driven out of the banking sector, the cost for the borrower rises because of the non-bank’s higher cost of funds. These regulations are a burden to consumers and a drag on the economy. In short, regulatory risk, not credit risk, is significant and pervasive in every aspect of lending by community banks and this is bad for banks and their customers.
4. Reform abuses of disparate impact theory. Few areas of regulation are as offensive as the regulators’ use of disparate impact theory to publicly accuse banks of racist lending practices and then collect millions of dollars in settlements. Banks find this offensive because there is never any proof (or even a belief by the regulators) that banks had any intention or motivation to act in a way that had a disparate impact on minority groups. And, the regulators themselves fail miserably to meet this standard when their own employment and personnel practices are subjected to the same statistical analysis. HUD and the regulators decided to enact and enforce disparate impact theory despite nonexistent statutory authority to do so. Enforcing this theory allows the regulators to do subtle statistical analyses, claim a disparate impact and use the resulting adverse publicity to regularly extract large fines from unwary banks. Knowing that the courts will eventually recognize the lack of statutory basis for this regulation and fearing the loss of significant revenue, the Department of Justice has used extraordinary tactics to prevent a challenge from reaching the courts. Whether or not the Supreme Court eventually strikes down this “regulation,” banks should insist on reforming what is now a statistics-driven “gocha” regulation into something that instead polices actual misconduct. Failing to do so will further discredit an otherwise worthy public policy goal.
5. Bring at least modest accountability to the CFPB. Even though community banks under $10 billion in size are not directly regulated by the CFPB, that agency’s regulations and enforcement tactics adversely affect community banks. One way in which this has occurred has been to make the bank regulators so concerned that the CFPB will be the first to identify “consumer abuse” that they are piling on in their own way. Community banks should support basic reforms of the CFPB, including replacing the single director with the same governing body that all other Federal agencies have, i.e. a multiple-member board or commission. Also, the CFPB must be subject to annual Congressional approval for its budget instead of receiving enormous and automatic funding each year from the Federal Reserve. Overall, banks should work with Congress to bring meaningful accountability to what is arguably the most powerful agency in the Federal government.
6. Prohibit enforcement of anything not a law or a true “review and comment” regulation. A proliferating problem in banking is the regulators’ enforcement of informal guidance, commentary and other written and unwritten expectations with the same force that they enforce actual laws and regulations that go through the mandatory “review and comment” process. Banks, like any citizen, are correctly expected to comply with the law and regulations that are expressly authorized by the law and that go through the rigorous review and comment process. It is unfair indeed for banks to be fined and castigated for not complying with extra-legal guidance, best practices expectations, etc. that did not go through that process. It really should not be controversial to require regulators to do what they are required to do anyway, which is strictly comply with the Administrative Procedures Act. Further, the banking regulators typically do little in the way of economic impact analysis before promulgating regulations. Requiring them to do so would improve the quality of the regulations, but so far this reform appears to face strong partisan opposition.
7. Support reform of the Orderly Liquidation Authority. Dodd-Frank imposed the Orderly Liquidation Authority on the nation’s largest banks, which subjects those banks to sudden takeover by the government with very little in the way of due process of law. This sets dangerous precedent and its effects will be felt eventually by smaller banks. It is very difficult to challenge the Orderly Liquidation Authority in court because no test case has yet occurred and it is unlikely that a timely legal challenge could be brought when a liquidation process is initiated. Thus, banks should work together to ensure that the affected banks, their shareholders and their counterparties have basic legal protections against sudden and forced extinction.
The case for concerted action has never been stronger. Progress in any of these area will pay lasting dividends for America’s community banks.
A version of this post previously appeared in the April 2015 issue of the Western Independent Bankers’ Directors Digest.