Small Banks, Regulators Start to Break Ice Amid Chilly Relations

WASHINGTON — Underlying a much-anticipated conference on regulatory issues facing small banks Thursday was a feeling of hope among executives that Washington may finally be starting to focus on their sector.

The meeting, hosted by the Federal Deposit Insurance Corp., is part of a new agency initiative to better understand the conditions and challenges faced by community banks, and then consider changes to how regulatory policy affects them.

Attendees were not shy about pushing for so-called "two-tiered" regulation, concerned that the agencies were applying the same scrutiny to large and small institutions.

"We don't cause a systemic risk to the FDIC fund and shouldn't be on the same level of examinations" as larger institutions, said John Evans Jr., chief executive of the $938 million-asset D.L. Evans Bank in Burley, Idaho, in an interview.

"I hope there will be some changes happening in the regulatory process. Forty percent of the banks in Idaho are 3-, 4- or 5-rated. They're not lending, they're trying to just survive. It makes it very difficult when only 60% of the community banks are out there lending."

While not promising a revamp of community bank policy, key regulators speaking at the conference — Federal Reserve Board Chairman Ben Bernanke and acting FDIC Chairman Martin Gruenberg — made clear that ensuring regulations and exams are balanced with banks' relative size and risk to the system was a top priority. .

"I don't think we can change the world, but I think on the margin we may be able to do some things that are helpful and still supportive of the supervisory process," Gruenberg said in an interview.

"Smaller institutions do have a different business model than larger institutions, and I think we do quite frankly take that into account in our supervisory process. There would be real value in looking closely at our supervisory process as well as how we issue our rules and guidance to see if there aren't ways on the margin that we can do things better."

The FDIC conference was scheduled amid a highly tense atmosphere between regulators and community bankers in the wake of the financial crisis and the Dodd-Frank Act. Community banks have complained of overly aggressive examinations, and are fearful of getting caught in the reach of Dodd-Frank.

They have been actively promoting new legislation — cosponsored by Rep. Shelley Moore Capito, R-W.Va., who spoke at the conference — that would allow banks to appeal their exam rating to a neutral third party.

Specifics of how regulators could ease policies toward community banks were few. But small bank executives said they appreciate that regulators are taking a deeper look at their issues.

"This is inspirational to community banks. For years we've been trying to get regulators and Congress to recognize the difference in our business models and our risk profile," said Cynthia Blankenship, vice chairman and chief operating officer of the $338 million-asset Bank of the West in Grapevine, Texas, in an interview. "As sad as it is to say that the crisis probably drove us to this point, this is a benefit that came out of it: an awakening and realization that community banks — although they do represent such a small percentage of the assets — make a larger portion of the loans and support small business."

Industry insiders said they want to ensure the new dialogue will produce real reform.

"You can't impose Citicorp kind of regulations on small banks," said Camden Fine, president and chief executive officer of the Independent Community Bankers of America, who called the new interest from policymakers "long overdue."

He expressed hope that the conference "will translate into perhaps a change in attitude and stance by the FDIC and by the other federal regulators toward how community banks should be regulated. … We need a different regulatory regime over community banks if they are going to continue to prosper."

In his speech, Bernanke touted already-existing efforts by the Fed to encourage dialogue between community banks and the central bank through an advisory panel, as well as a new initiative to clarify if and how new rules affect community banks. (The FDIC has a similar process.)

"As a first step in this effort, when issuing supervisory letters, we have begun to state specifically if and how the new guidance will apply to community banks," Bernanke said. "Although this change seems relatively simple, we hope it will help banks avoid allocating precious resources to poring over supervisory guidance that doesn't apply to them. We also hope that it will provide greater clarification to our examiners, who are on the frontline fielding questions from bankers and working closely with their state regulatory counterparts."

But Bernanke also questioned concerns community banks have raised about the effects historically low interest rates have had on net interest margins — saying "accommodative monetary policy" will be "almost certainly positive" in the long run. He also argued that most of the Dodd-Frank Act applies "only, or principally" to the largest firms.

Yet he stressed the need for regulators to understand the challenges facing community banks when setting policy.

"Bank supervision requires a delicate balance — particularly now," Bernanke said. "The weak economy, together with loose standards in the past, has put pressure on the entire banking industry, including community banks. To protect banks from a possible race to the bottom and new problems down the road, and to safeguard the Deposit Insurance Fund, supervisors must insist on high standards for lending, risk management and governance.

"At the same time, it is important for banks, and for their communities, and for the national economy that banks make loans to creditworthy borrowers. Lending to creditworthy borrowers, after all, is how banks earn profits. Getting that balance right is not always easy, but is of utmost importance."

While it is unclear how much farther regulators will go to ease community banks' regulatory load, Gruenberg reiterated next steps by the FDIC to continue the conversation.

He said he will attend upcoming roundtables with bankers in each of the FDIC's six regions. The agency is also doing ongoing research on the evolution and current condition of the community bank sector — research which Gruenberg said has been lacking to date. (Officials at the conference reported what findings the project has revealed so far.) But perhaps most significant is a review of the agency policies to determine if the supervisory process could be more efficient for community banks.

Officials will "review the examination process for both risk management and compliance supervision, as well as to review how we promulgate and release rulemakings and guidance, to see if we can identify ways to improve our processes and communication while maintaining our supervisory standards," Gruenberg said.

For certain businesses, he said community banks are better equipped than larger institutions in providing credit, which makes having a still-vibrant community bank sector necessary.

"Given the labor intensive, highly customized nature of many small business loans, it is not clear that large institutions would easily fill this critical credit need if community banks were not there," Gruenberg said. "Community banks also play a crucial role in extending credit and providing financial services in rural communities, in small towns, and in inner-city neighborhoods. In many of these localities, if not for the community bank there would be no easy access to insured financial institutions."

Yet federal policymakers are not of the same mind about the response to bankers' complaints about the level of aggressiveness in exams.

Not surprisingly, Capito, who opposed Dodd-Frank and chairs the House Financial Services subcommittee on financial institutions, was the most effusive in her praise of the small-bank sector during her remarks.

Her bill, cosponsored with the subcommittee's ranking Democrat, New York's Carolyn Maloney, would significantly ease examination standards and install a central ombudsman to whom banks can appeal their exam findings.

But the lawmaker noted regulators' opposition to the bill, most notably regarding the lighter exam standards proposed by the bill.

Some bankers are "saying, 'What we see on the ground with our examiners differs from what happens when the examiner then reports back to Washington and we get a different report or a changed report or a report that doesn't really jibe with what our exit interview was,'" Capito said in her speech.

She cited "a big difference of opinion with the FDIC" on the examination standards. "But I think it's a conversation we need to have, in our committee and at the highest levels." (In her prepared remarks, Capito called on "all parties to sit down and work through these issues.")

Echoing other bankers attending the conference, Rebeca Romero Rainey, the chairman and chief executive officer of the $169 million-asset Centinel Bank of Taos in Taos, N.M., said two-tiered regulation is the answer to ensuring community bank oversight is fair.

"We can't just apply one rule to fix the sins of the big," she said in an interview. "The unintended consequences for community banks are significant."