It must be the regulator in me but even during seemingly prosperous times when economic indicators paint a picture of growth, my mind drifts toward
The question is not whether there will be
This issue preyed on my mind as I addressed the Community Development Bankers Association Peer Forum last week. Neither these banks nor other smaller banks cause economic downturns. Indeed, banks in general do not cause economic downturns but are often swept into a downturn caused by non-bank institutions and/or market forces. On the contrary, banks, but particularly community banks, including importantly minority depository institutions, work tirelessly in their communities, day in and day out, to build opportunity and lasting value. However, when downturns come, people lose jobs, businesses struggle and banks must work with their customers to preserve value.
If the past is prologue and nothing is done, one should expect regulators to react aggressively when a downturn occurs. But let me suggest a different trajectory, one that benefits the regulatory community, the overall national economy, Americans (particularly low- and moderate-income, or LMI, citizens), and the banking industry alike. Through no fault of their own, LMI individuals caught in an economic downturn, particularly a steep one, tend to lose their homes, small businesses and any chance to build wealth in their lifetime. Black Americans are particularly vulnerable, experiencing high job losses during downturns and often facing last-in, first-out hiring practices. And community banks, and especially community development banks and minority depository institutions, too often are rent asunder at the same time.
Banks and regulators should strive for ways to work collaboratively to bridge downturns in a way that minimizes unnecessary loss without sacrificing safety, soundness and accurate reporting. What is the difference between pursuing a collaborative approach and an unnecessarily confrontational one?
Knowledgeable bankers with a history of sound management and willingness to collaborate with regulators should be given leeway to address problem loans and preserve value (for customers and themselves) notwithstanding temporary risk increases. Ideally, banker-regulator collaboration would determine a reasonable timeframe (such as maximum recovery period) to avoid unnecessary harm to families and businesses.
Forbearance isn't for permanently impaired loans, banks lacking sufficient capital, liquidity, or adequate provisioning, or those lacking recovery plans if needed. But for financially sound banks where loans or other investments are likely to recover their value in a reasonable period, time should be granted to work with borrowers, including terms changes if needed, to minimize downturn loss and disruption.
It's a question of discretion and restraint in cases where examiners view management as capable of resolving transient problems on their own. A supervisory approach without such discretion and restraint will perpetuate what has too often happened: banks write down loans and sell the loans and/or the underlying collateral, only to see buyers make a fortune on the "distressed" assets just a few years later. However, if management does not achieve suitable and timely progress under this period of observation, the regulator can trigger sterner action without delay.
This same approach should also be pursued in calmer times. This often means that when times are reasonably good, as is the case now, bankers and supervisors must create meaningful dialogue. Supervisors should be sufficiently self-confident and knowledgeable about bank matters such that they can successfully persuade banks to act — and be persuaded themselves that perhaps certain demands are of less importance than they seemed at first blush. Ultimately, supervisors have the final say, but listening first can create better outcomes.
Supervisors should not issue "matters requiring attention" (MRA) and "matters requiring immediate attention" (MRIA) orders at every turn where the bank is productively fixing problems the examiners believe are critical.
Too often examiners do not discuss concerns persuasively with management, or allow enough time to make changes where changes make sense. Rather today, there is a hair trigger concerning MRAs, MRIAs and even supervisory orders. It should not be necessary to take such confrontational steps where management is vigorously taking steps to deal with safety and soundness or compliance matters.
Ideally, a collaborative approach would address not just critical safety, soundness and compliance concerns but also tail risk matters — less-common threats that can, if not identified and resolved, give rise to severe problems or bank failure. Too often today, banks and supervisors spend so much time on processes and procedures they lose focus on the most dangerous issues.
Discussions with experienced and highly regarded supervisors informing this op-ed highlight opportunities to improve today's supervisory framework. This includes enhanced examiner education, collaboration and consistency within agencies, and thoughtful industry approaches to generally strengthen safety and soundness.
My notion of more circumspect, collaborative supervision can increase bank safety and soundness and better meet CRA and other necessary compliance and civic goals. Top bank examiners and supervisors do have the talent and experience to work with bank management to assist in working through crises. I saw this from time to time during my own days as a regulator. I have very often been impressed by bank examiners' ingenuity and good judgment when they have worked with banks to get through tough times. Strengthening these collaborative skills now, before there is a crisis, will pay dividends.
Of course, there will be some institutions and bank managers who violate the law or otherwise act recklessly, as we have seen over the decades. I am certainly not suggesting any weakening of enforcement in such cases.
Finally, Dodd-Frank and prior rules created a tough framework for bank operations. It is hard to imagine how further regulation, implemented before or after the next downturn, will net the country greater safety and soundness. On the contrary, I am worried we are reaching, or have reached, a point of serious diminishing returns with respect to more rules.
Indeed, a proliferation of rules and distractions could actually degrade safety and soundness as we cause bankers and examiners to lose focus on the core issues and skills that make for safe and sound operation. My greatest concern lies with a lack of focus on rare, catastrophic events that can devastate the financial system on the one hand, while we dwell on an overemphasis on process and procedure on the other hand. This excessive focus, akin to the Maginot Line, is likely to prove too rigid and to blind us to the true sources of future danger.
In sum, now is the time to look ahead and try to make the next downturn less destructive than has been the case in the past. Increased collaboration and focus, increased focus on core safety and soundness and compliance matters, should be vigorously explored now before it is too late.
