Community banks warn about rates, economy and capital rules

Community bankers say lofty interest rates have curbed loan demand, and they're warning that potential new regulatory burdens could further stunt the flow of credit and harm an already fragile economy. 

"Things are certainly slowing," said Daniel Robb, president and CEO of the $127 million-asset Jonesburg State Bank in Missouri.  

Now that 11 Federal Reserve interest rate hikes since early 2022 have raised borrowing costs substantially, more business owners have started to think twice about taking on new loans or drawing upon lines of credit, he said.

Robb, who also is the outgoing chair of the American Bankers Association, joined several other bankers at the organization's annual convention this week in Nashville, Tennessee. He said business owners are generally positive but the economy is vulnerable to fallout from surging rates. Historically, when loan costs spiked, spending slowed enough to tilt the economy into a recession. 

Other bankers said the Fed's rate hikes have had their intended effect — easing inflation that hit a 40-year high last year — and policymakers could reverse course by 2024. The annual inflation rate in August was about a third of the 2022 peak. Should rates start to come down in 2024 and the economy avert a downturn in the meantime, lending conditions could rebound. 

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With that possibility on the table, Carissa Rodeheaver, chairman and CEO of the $1.9 billion-asset First United Corp. in Oakland, Maryland, said many commercial borrowers remain "pretty optimistic" but cautious as they await the Fed's next moves. 

Kenneth Kelly, chairman and CEO of the $581 million-asset First Independence Bank in Detroit, agreed. He said caution looms large because of the "tremendous amount of pressure" that high rates have put on the cost of credit.  

He also noted that, in the wake of several bank failures earlier this year, the Federal Reserve and other regulators have proposed capital reforms that could prove onerous for small lenders. Such rules could boost overall capital requirements by as much as 20% at the largest banks, officials said, depending on a company's business activities. Kelly and other community bankers railed against the proposed increases for big banks, noting that after the financial crisis of 2008 many rules created to limit risk at megabanks ultimately trickled down to small lenders. This drove up regulatory costs and forced many community banks to sell to larger competitors.  

In a speech Monday at the American Bankers Association convention, Fed Vice Chair for Supervision Michael Barr defended the suggested reforms and noted changes would generally apply only to banks with at least $100 billion of assets. He also emphasized that the proposal only calls for a modest increase in capital to cover loan growth, with the bulk of the increases focused on trading and other nonlending activities largely managed by major financial institutions.  

Bankers, however, were dubious. Robb called the proposal "deeply misguided" and "dangerous" for both community lenders and the economy. He said higher capital requirements could force small banks to scale back lending or pass along increased costs to borrowers. Either could hinder the economy. 

The change could also push lending activity outside of the banking system and increase risk because less-regulated nonbanks could step into the void and account for a larger share of the total credit pie.  

Regional banks, too, voiced concern.  

"I think it will hurt every American. I think it will hurt banks. I think it will hurt the economy," said Scott Anderson, CEO of Zions Bank in Salt Lake City.