Changes to Call Reports and Capital Among Proposals to Reduce Regulatory Burden

Congress has been hearing testimony for months about tailoring bank supervision to reduce the burden on community banks.  Meanwhile, the prudential regulators have been tasked with reviewing all bank regulations to identify outdated or unnecessary ones, with a report due next year.  The bottom line is that some changes will happen.

But whether there will be wholesale modifications – such as a recent proposal from FDIC Vice-Chairman Thomas Hoenig to boost capital requirements for community banks – remains to be seen. More likely is a push to simplify or improve Call Reports, which has the support of community bank trade groups and has been brought up repeatedly by industry, and longer exam cycles for the healthiest of banks.

Hoenig, a vocal critic of the largest banks and a fierce supporter of the Volcker Rule, wants to provide regulatory relief for community banks that have zero trading assets or liabilities.  Such banks would be eligible for reduced compliance burdens as long as they maintain a ratio of GAAP equity-to-assets of at least 10 percent.

Invictus Consulting Group Chairman Kamal Mustafa says that Hoenig’s proposal is short-sighted and misguided since most community banks rely on earnings as the primary source of capital. In the long-run, requiring banks to maintain such high levels of regulatory capital will reduce earnings and profitability, he says.

“Mr. Hoenig is putting the interests of shareholders way below the interests of depositors. By responding to banks’ complaints about over-regulation, he would be making them pay the price in a higher leverage ratio. This simplifies the regulatory process, but at the same time, he is forgetting the fact that with that cushion, banks’ future earnings will be less and less, and their accumulation of capital will be less and less, and their ability to make loans will be less and less. Hoenig’s approach may make sense on a national scale, but it doesn’t make sense for a community bank business model,” Mustafa said.

Banking attorney Steven Loftchie, a partner at Cadwalader, Wickersham & Taft, and a senior fellow at the Center for Financial Stability noted that banks are already turning away cash deposits because cash adversely affects capital ratios, which suggests “that the ratios are encouraging counterintuitive behaviors.”

Capital levels are not always the main reason why community banks thrive, according to a recent research study by the St. Louis Fed.  The study, which looked at community banks that thrived during the financial crisis, found that while 39 percent of the “thriving banks” had Tier 1 leverage ratios in the highest quarter of distribution, 18 percent of the best banks had ratios in the lowest quarter. Those banks assumed relatively low credit risk. The researchers concluded that community banks that will do well in the future will have “strong commitments to maintaining standards for risk control in all economic environments and business plans that work for their individual markets.’

While regulators may reduce some of the compliance burden, it is doubtful they will scale back on the major risk controls put in place after the financial crisis. Instead, they are scouring rules to find ways to simplify regulation without putting the banking system in danger.

“Guiding our consideration of every proposal to reduce burden on community banks is the need to ensure that fundamental safety and soundness and consumer protection safeguards are not compromised,” said Toney Bland, OCC senior deputy comptroller for mid-size and community bank supervision at an April 23rd House subcommittee hearing on “Examining Regulatory Burdens – Regulator Perspective.”

The FDIC’s Doreen R. Eberley, the director of the Division of Risk Management Supervision, and the Federal Reserve’s Maryann Hunter, Deputy Director of the Division of Supervision and Regulation, also testified. Each mentioned efforts by a regulatory task force to simplify Call Reports for community banks.

One proposal would allow “certain banks” to file a short-form Call Report for two quarters a year, Bland noted.  The task force is looking at every line item of every schedule to see what can be deleted, as well as considering a simplified Call Report for community banks that would eliminate some schedules and data items.

Eberley said regulators “will pursue several actions in the near term” to improve the Call Report process.  She also said that regulators are looking at the length of the community bank exam cycle and whether the $250,000 thresholds on appraisals and limits on currency transaction reports should be changed.

“It is our intention to continue looking for ways to reduce or eliminate outdated or unnecessary requirements as we move forward with this review, rather than wait until the end of the EGRPRA process,” she said.

Bland said the OCC supports “changing current law to allow more well-managed community banks to qualify for a longer, 18-month examination cycle. Raising the threshold from $500 million to $750 million for banks that would qualify for this treatment would cover more than 400 additional community banks.”  The OCC also supports exempting most community banks from the Volcker Rule.

“As the vast majority of banks under $10 billion in asset size do not engage in the proprietary trading or covered funds activities that the statute sought to prohibit, we do not believe they should have to commit resources to determine if any compliance obligations under the rule would apply. We do not believe that this burden is justified by the nominal risk that these institutions could pose to the financial system,” he said.

Hunter said the Fed was working on ways to calibrate exams to make them more commensurate with a bank’s risks. She said the Fed was using “Call Report data and forward-looking risk analytics to identify high-risk community and regional banks, which would allow us to focus our supervisory response on the areas of highest risk and reduce the regulatory burden on low-risk community and regional banks.”