Community Banks: Basel III Will Put Us Out of Business

WASHINGTON — Hundreds of community bankers on Monday filed letters to regulators expressing despair over the hardships they will face under a proposal to implement Basel III capital and liquidity requirements.

In detailed letters to regulators, banks warned that the new rules, if unchanged, will effectively put them out of business.

"It seems that the proposed Basel III capital rules would unjustly penalize smaller banks for problems caused by the business practices of the very large banks," wrote Greg Krider, senior vice president and chief financial officer of the $378.7 million-asset First State Bank of Middlebury in Indiana. "We feel very strongly that the proposed rules could have dire consequences for community banks across the country, and would be detrimental to the economic recovery of our nation."

Community banks across the country have mounted a near revolt over a June proposal issued by the three banking agencies, enlisting state regulators and a majority of the Senate in an effort to force the regulators to change the plan.

The proposal has elicited an energetic response from bankers. A petition first circulated in July by the Independent Community Bankers of America calling for an exemption for smaller institutions has garnered nearly 15,000 signatures representing nearly 4,200 banks nationwide.

"This shows you that Basel III not only hit a nerve, it is seen as a real threat by community bankers to their ongoing viability," said Camden Fine, president and chief executive of the ICBA.

The proposal would require banks to hold higher capital levels, but more important, changes how capital is calculated. Among other things, it would change the risk-weighting for certain assets, which could have a significant impact on a bank's capital ratio.

Fine and others have been pushing bankers to also file individual comment letters detailing how their institution will be affected by the Basel III requirements. Letters were due Oct. 22.

As a result, the comment letters go well beyond the typical form letters that institutions often submit to weigh in on a plan. Instead, they provide more depth on how bankers will be affected.

James Smith, chairman emeritus of the $1.1 billion-asset Hawthorn Bank in Clinton, Mo., told regulators if Basel III is applied to his bank it would place the firm in jeopardy since it would require him to eliminate his bank's holdings of trust-preferred securities, which is currently included as part of the bank's core capital ratio.

"We have trust-preferred securities and if you proceed with Basel III as written you will probably put us on a list to be sold," Smith wrote in his Oct. 11 letter to regulators. "Eliminating trust-preferred takes capital out of our bank and therefore we will not be able to loan money and serve our communities."

Banks also expressed concern about a provision of the plan that would require unrealized gains and losses of available for sale securities to be accounted for when calculating capital requirements.

Ronald Bowden, the chairman and CEO of Iowa-Nebraska State Bank, wrote that once interest rates start to rise again, it could significantly hurt his capital position.

"Since our current interest rate environment is planted at all-time lows, most community banks show available for sale gains but the risk of an inevitable increase in interest rates, the risk of reduced capital by Basel III far exceeds any perceived benefits," Bowden wrote in the Sept. 25 letter. "As an example, if interest rates were to increase by 300 basis points, my bank's investment portfolio would swing from a current paper gain of $1 million to a paper loss of $5 million. This would drop my bank's Tier 1 ratio by 30% and place the bank in a stressed capital position."

Another major concern for community bankers is the higher risk-weighting that would be applied to mortgage loans, which they say will require additional capital and reduce credit availability to customers looking to buy homes.

"This is punitive for my bank and we would be forced to increase the cost of the credit to customers," William David Lacy, president and CEO of the $405.5 million-asset Community Bank and Trust in Waco, Texas, wrote in an Oct. 9 letter. "This situation would be just another small step in stifling mortgage lending nationwide. It does not help a community bank like mine, nor the United States as it tries to come out of one of the worst economic periods in our history."

The $112.7 million-asset First National Bank in Park Falls, Wis., pressed for an exemption to the proposed rule, especially when it comes to higher risk weights on the balloon mortgage loans they provide to their customers.

"At a time when we need the housing market to pick up, do we really want community banks to stop doing mortgage loans due to compliance issues and the difficulty in processing a mortgage loan?" the bank stated in a letter signed by its directors, loan officers and tellers.

Others joined the call for an exemption, saying large banks should be subject to more stringent rules.

"You cannot regulate Bank of America and the First State Bank of Sauk Centre the same way," wrote Scott Beuning, in an undated letter.

Beuning is vice president and director of First State, in Sauk Centre, Minn. The bank carries a large investment portfolio. Higher risk weights on government-sponsored enterprise securities and municipal bonds would have "an immediate negative impact" on the bank's capital position and "would probably force us to sell our securities portfolio," he wrote.

In its comment letter, the ICBA said regulators should not apply the so-called standardized approach to any institutions with $50 billion of assets or less since they are not considered systemically important institutions.

"Basel III and the standardized approach are regulatory overkill for community banks and go much further than is necessary to make capital standards more robust for all banks," wrote James Kendrick, vice president of accounting and capital policy for the trade group.

Rather, they argued that regulators should make "widespread modifications" and "wholesale exemptions," for community banks to reflect the actual risks to the community banking business model without undermining firms' strong capital positions.

Absent an exemption for community banks, the ICBA provided a list of necessary changes to regulators proposal.

For example, banks with $50 billion or less of assets should be excluded from proposed changes in how banks will calculate their risk weights for residential mortgages. They also argue that higher risk weights for balloon mortgages and second mortgages should not be applied and be kept at current Basel I levels. Banks should also be allowed to exclude unrealized gains and losses of available for sale securities in calculating their regulatory capital. Firms should also be allowed to keep their trust-preferred securities as part of their Tier 1 capital ratio.

"The negative consequences of adopting Basel III and the standardized approach for community banks are abundantly clear," Kendrick wrote. "The regulators have not fully assessed the impact of these proposals on community banks and should first conduct a thorough analysis of the expected, best, and worst-case scenarios for the U.S. economy if the proposals are finalized as currently drafted."

The Basel III plan is taking withering fire from all directions, including lawmakers from both political parties and fellow regulators.

A bipartisan majority of 53 senators has urged the agencies to move cautiously in applying Basel III rules to small banks. Sen. Richard Shelby, R-Ala., ranking member of the Senate Banking Committee, sent a letter to the heads of three banking agencies on Oct. 15, for further information on how the proposed Basel III standards would impact the U.S. banking system and the economy.

"While it is possible that the Basel III capital accords are appropriate for the U.S. banking system, the notice of proposed rulemakings do not adequately explain how the agencies determined that Basel III is calibrated correctly for U.S. institutions," wrote Shelby.

The Conference of State Bank Supervisors also filed a letter to regulators objecting to the plan and calling for a more balanced approach.

"The appropriate level of capital should enhance the resiliency of the banking sector, allowing institutions to remain solvent through the economic cycle," John Ryan, president and CEO of the bank supervisor group. "Too much capital can have the effect of increasing management's tolerance for risks as they strive to provide a return for stockholders."

In a separate comment letter, the New York State Department of Financial Services said regulators' efforts to comply with regulations under Dodd-Frank have made the new guidelines too complex.

"This complexity creates enormous burdens and frustrations for community banks and DFS believes that the agencies should amend or replace the proposal to address these concerns," wrote Benjamin Lawsky, superintendent of financial services.

For example, Lawsky wrote that banks with an asset threshold of $10 billion or less should be allowed to keep their same risk-weighting calculation under Basel I, but still adhere to the new capital requirements under Basel III.

Even before the release of the proposal, which has sparked outrage among bankers, the Federal Reserve has tried to work closely with institutions to hear out their concerns, including holding four teleconference calls with more than 3,200 bankers as well as in-person meetings in Chicago and Kansas City, Mo., over the summer.

Members of the Board of Governors from Fed Chairman Ben Bernanke to Fed Gov. Elizabeth Duke have met with roughly 150 bankers from June through September on the proposal. Most recently, regulators released a calculator to bankers to estimate the amount of capital they may need to hold under the new requirements.

"The Federal Reserve has reached out to hundreds of bankers from smaller institutions throughout the country through meetings and conference calls since the proposal was issued for comment in June," said Barbara Hagenbaugh, a Fed spokeswoman. "These meetings have given us an opportunity to engage and hear perspectives directly from community bankers. Their views and concerns help inform our policy making process and will continue to be carefully considered as we move forward."

For now, bankers mostly agree that regulators are listening to their concerns. Recent comments made by Comptroller of the Currency Thomas Curry, who outlined specific areas where regulators could potentially make adjustments for community banks, along with other public statements by key policymakers on lessening the burden on smaller institution, have also driven that message home.

"We're being heard," Fine said. "I've had several policymakers in my private meetings with me they are looking at ways perhaps modify the Basel III proposals so they don't fall so hard on the community banks."