Member Article

One of the key provisions of the Dodd-Frank Act rollback law signed by President Trump on May 24, 2018, hasn’t met its early promise for U.S. community banks. Recently proposed rules to implement simplified capital requirements have fallen short of the industry’s expectations when the bank deregulation law was enacted in May.

On November 21, 2018, the Federal Reserve Board, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency jointly announced a proposed rule to simplify capital requirements for qualifying community banking organizations that opt into the community bank leverage ratio framework. The agencies are seeking public comment on a proposal that would simplify regulatory capital requirements for qualifying community banking organizations, as required by the Economic Growth, Regulatory Relief, and Consumer Protection Act (S. 2155 regulatory reform bill).

The proposal would provide some regulatory burden relief to qualifying community banking organizations (defined as those with less than $10 billion in total consolidated assets and limited amounts of certain assets and off-balance sheet exposures) by giving them an option to calculate a simple leverage ratio, rather than the existing risk-based and leverage capital requirements under Basel III. FDIC FIL-77-2018 provides an overview of the proposed regulation amendments—required under Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act—which would allow qualifying organizations to satisfy (i) generally applicable leverage and risk-based capital requirements; (ii) the prompt corrective action framework’s well-capitalized ratio requirements; and (iii) any other generally applicable capital and leverage requirements.

Small community banks had asked and hoped regulators to spare them from the Basel III requirements if they maintained leverage of 8%. Thebanking industrybelieves the proposed 9% community bank leverage ratio is too high and estimates some 600 banks will be left out of the exemption.

Rob Nichols, American Bankers’ Association president and CEO, remarked, as follows:

“Today’s proposal marks an important step forward in implementing the bipartisan regulatory reform law that passed earlier this year, but we believe there is room for regulators to go further. Strong capital requirements don’t need to be complex to calculate, which is why Congress wanted healthy community banks to spend less time filling out paperwork documenting their capital positions and more time serving local communities and small businesses … Unfortunately, the 9 percent leverage ratio proposed by regulators will still leave too many well-capitalized community banks forced to follow capital rules always intended for more complex institutions. We appreciate regulators putting the proposal forward, and we look forward to working with them to improve it.”

Similarly,Independent Community Bankers of America® (ICBA) President and CEO Rebeca Romero Raineystated that:

“As an ardent proponent of strong minimum capital levels for all banks, ICBA supports an 8 percent community bank leverage ratio. This would be well over the 5 percent leverage ratio requirement currently required of all well-capitalized banks and significantly higher than next year’s requirement of 7 percent common equity over total risk-based assets, which includes the capital buffer. Community banks did not cause the financial crisis of 2008-2009. Their simplified balance sheets, conservative lending, and common-sense underwriting shield their regulatory capital from the kinds of losses incurred by the largest and riskiest financial institutions.

The higher the leverage ratio, the more capital banks must set aside for regulators—and the less they have to make loans and expand operations. Failure to maintain those higher leverage demands could lead to regulators tightening supervision on a bank. As capital levels decline, the regulators would become more and more involved in the bank. They’d place greater scrutiny on the bank. Community banks were hoping to have a simple leverage ratio set a little lower to give them room for growth.

A simple leverage ratio makes sense for traditional community bank business models, and regulators could have gone a lot further in helping community banks. The federal bank agencies appear to have missed a golden opportunity to reduce the compliance burden imposed on small banks that, by and large, already have more than enough capital to meet regulatory minimums. Community banks are not clear as to why they should be subjected to the same capital standards as systemically important financial institutions, and have been hit hard by the 2010 passage of the Dodd-Frank Act and the promulgation of an avalanche of new, complex, and onerous implementing regulations.

There is nothing to gain from applying the BASEL III capital rules to community banks, but there is much to lose. The negative consequences that might resonate from applying the global capital standards to community banks could endanger the future of the community banking industry. Community banks do not have and cannot afford the infrastructure necessary to comply with the complex BASEL III rules. There is no reason why they should be required to staff up and invest in the data-processing systems that would be necessary for the community banks to gather and analyze the necessary data to comply with these international capital standards. The simpler banking model of community banks will magnify the impact of the global capital rules on the core banking functions that constitute the only services provided by community banks.

The application of the complex BASEL III rules to community banks is regulatory overkill that could damage otherwise healthy community banks. Applying a “one-size-fits-all” modeling approach to community banks that was meant to apply to global banks poses a threat to many community banks. This is especially true given the relative soundness of the community banking industry. Community banks did not cause the 2018 economic crisis; complex, systemically important financial institutions that engaged in risky behavior did. Unlike the “too-big-to-fail” banks, the community banking industry does not need to be fixed or contained.

FDIC Chairman Jelena McWilliamshas said that regulators will continue working to simplify the existing capital framework for community banks that choose not to adopt the leverage ratio or do not qualify for it. This would include finalizing a capital simplification issued last year that would make changes to the capital treatment for mortgage servicing assets, certain deferred tax assets, and investments in unconsolidated financial institutions. But this is little consolation to community banks who need regulatory relief sooner than later. Banks are holding out hope for revisions as the three agencies collect comments from banks and prepare final rules in the coming months. Regulators are likely to stick with the 9 percent leverage ratio, however, and assess the impacts. Perhaps significant changes are more likely to occur in the far future, once we are further removed from the 2008 financial crisis.

Financial institutions should obtain experienced regulatory counsel to assist them in evaluating and understanding capital requirements and the federal agencies’ community bank leverage ratio once it is finalized.