FDIC Wake-up Call: No More Regulatory Carve-Outs for Community Banks

A special Read Between the Lines report

Community banks have gone too far in asking for special exceptions from bank regulation, according to Federal Deposit Insurance Corp. Vice Chairman Thomas Hoenig. And that signals a tough new stance for community banks going forward.

In a speech earlier this month at the North Carolina Bankers Association convention in Palm Beach, Hoenig told community bankers that their banks “are dying a slow death waiting for regulators to carve them out as special.” He noted that the cost of increased regulation “contributes to the trend toward consolidation as smaller banks work to control costs and to survive within a highly regulated industry.”

It won’t work any longer to argue that rules written after the crisis to stem the misdeeds of large commercial banks weren’t intended for community banks, Hoenig warned. “But in fact they were intended for commercial banks, which you are,” he said. He called on community banks to have “the courage” to stop missteps in the industry, the only solution that would lead to what he termed “regulatory balance.”

“Rather than rely on the hope of a ‘carve out,’ they should insist on discipline across the entire commercial banking industry,” Hoenig told the community bankers. He said commercial banking will never be one industry if the largest banks get subsidies that community banks don’t, such as requirements that allow them to have less capital.

The speech is a game-changer for the community bank world, says Invictus Consulting Group Chairman and founder Kamal Mustafa, and it’s all about capital.

The largest banks that have had to undergo mandated stress testing as part of the CCAR and Dodd-Frank programs have been able to customize and fine-tune their capital ratios, leaving them with less stringent leverage requirements than most community banks. Most community banks have ignored stress testing since it is not yet mandated by regulators for banks of their asset size.

But Hoenig is signaling to smart banks that they should now read carefully the intent of the stress testing, capital and liquidity rules and the methodologies behind them, and begin applying them to their own banks.

Community banks, as commercial banks, “for starters” are already subject to Basel III, QM, QRM, escrow requirements, balloon mortgages and compliance exams, Hoenig said.

The response from trade associations has been muted, probably because groups such as the Independent Community Bankers of America publicly support Hoenig’s prior proposals to restrict banks to core banking activities as a way to prevent extension of the federal safety net and reduce systemic risk. In effect, Hoenig is now telling those groups to get on board with him all the way. He is saying profitable and smart banks will succeed if they adapt to the new rules in the marketplace.

“The community bank business model is viable, but its success relies on a market system that is being undermined,” he said. “To prosper as an industry, commercial banks must be allowed to compete and succeed or fail based on the fundamentals of commercial banking and individual bank performance.”