Elizabeth Warren, Champion of Small Banks

WASHINGTON — Sen. Elizabeth Warren may have a reputation as the banking industry's toughest foe, but behind the scenes she's formed a growing alliance with community banks, a widespread and politically powerful group.

Just six months into her term in office, the Massachusetts Democrat has already raised concerns about the need for a two-tiered regulatory system and pressed regulators to pull back on applying Basel III standards to smaller banks — all the while continuing her attacks on "too big to fail" and the country's largest institutions.

"A rule that can be facially neutral can end up slamming community banks, and that's part of what I worry about," Warren said in an interview, adding that her interest in small banks dates to the 1990s. "I became increasingly concerned about the business model of the largest financial institutions — too many of them built their profit model around tricking their customers. Community banks didn't do that. So right from the beginning I saw the key differences among their practices."

So far the positive feelings have proven mutual, said Camden Fine, president and chief executive of the Independent Community Bankers of America.

"There are probably more community bankers that at least appreciate that she reached out and listened to them at so many meetings, and didn't just sit in Washington, but actually traveled and met them in their hometowns," Fine said, though he noted the two don't see eye to eye on every policy issue. "I would say that most of the angst and fear and the negative feelings about Senator Warren emanate mainly, not totally, but mainly, from the Wall Street side of the financial services industry."

To be sure, Warren's strategy to knock the big banks and side with smaller institutions isn't unique — it's one employed by many of her colleagues in Washington. But it's also a way for the freshman lawmaker to further refine how the industry and the public view her, broadening her appeal in Massachusetts and across the country.

"It's a way for her to rebut the argument that she's anti-banking industry, because her retort is, 'no, I'm not anti-banking, I'm pro-small business,' and that's a very smart place to be politically," said Brian Gardner, an analyst with Keefe, Bruyette & Woods.

Support for community banks also helps to round out and even bolster her criticism of the big banks and her concerns that "too big to fail" isn't over.

"It's not enough to just be in opposition to something — there needs to be a better way. So by linking her position to the community bank model and how it operates, I think strengthens her fight against the nation's largest financial institutions," said Isaac Boltansky, a policy analyst at Compass Point Research & Trading. "The senator's work so far is a broader tapestry that illustrates her belief that 'too big to fail' banks are a distortion in the broader economy."

The effort has proven effective at home in Massachusetts, as well as in Washington.

"She's an excellent listener," said Richard Holbrook, chairman and chief executive of Boston-based Eastern Bank and treasurer of the Massachusetts Bankers Association. "She's been supportive of looking at opportunities for regulations to be appropriate to the institution, based on size — we're very pleased with that."

Daniel Forte, president of the Massachusetts Bankers Association, added that Warren has worked with the state bankers group for years, including during her tenure at the Consumer Financial Protection Bureau, when she held meetings with community bankers in all 50 states — a campaign that has made a lasting impression on the industry.

"Even during the campaign and at the CFPB, she really has articulated a strong interest in preserving and improving the community banking sector. She's been very willing to work with us," said Forte, pointing to discussions she's had with the bankers group about the safe harbor provisions under the CFPB's ability-to-repay rule, a privacy notice bill that's in play in the Senate and the Basel III provisions.

"When the first announcement came through that [Basel III] would be applied to small financial institutions, I was shocked, just shocked," Warren said during the interview. "That was never the intent of Basel III. It was about risk in the overall financial system, and it's just not community banks that caused our financial crisis or that pose risk now."

Regulators released a final rule last week that eased several requirements for small banks, although it did not exempt them completely. Whether that's enough for Warren is unclear, but the Massachusetts Democrat has also signaled she might embrace a more radical solution — a two-tiered regulatory system for small banks.

Many community bankers have long backed such an idea, arguing that they should not be subject to the same onerous rules that larger institutions must comply with.

During a hearing last month, Warren voiced support for the concept.

"The question I want to ask is … whether or not we are reaching a point where we should really be thinking about a two-tiered system?" Warren asked regulatory witnesses.

During the interview, Warren said it's important that small banks don't get punished for the crimes larger institutions committed during the financial crisis.

"What concerns me is as we see more and more community banks squeezed out, that's a problem, and we need to see why that's happening," she said. "They're offering a good product to their customers, they serve their customers well and I want to make sure they can stay in business."

She emphasized that she does not think community bankers are seeking to escape regulation, but that some rules are so vague they are hard to follow for smaller institutions.

"I really want to underline that these are banks that want to play by the rules," she said. "This is not that they're saying, 'I don't like having the supervisors around because they keep me from doing something that's really profitable, that we made a couple of billion dollars off last year.' This is about community banks — they're trying to follow the rules, want to follow the rules. But the rules are sometimes complicated. Sometimes there are ambiguities on how to interpret something, and the community banks are concerned that the supervisory process absorbs so much of their time and energy that they can't get out there and serve their customers. And that's just backwards from what we're trying to accomplish."