Regulate Banks by Complexity, Not Size

Financial institutions today operate in a constant state of reevaluation. Banks of all sizes are contemplating mergers, consolidations and divestitures in an effort to adapt to a Darwinian landscape.

At the biggest end of the scale, Citigroup announced that it will be exiting consumer banking in 11 markets. JPMorgan Chase completed the sale of part of its physical commodities unit in October, joining other Wall Street firms that are selling their physical commodities businesses in light of regulatory scrutiny. JPMorgan Chase also announced in July the divestiture of its $1.3 billion loans and securities portfolio. Meanwhile, Goldman Sachs reduced its total assets in the second quarter of 2014 by $56 billion and sold its aluminum business last month.

Much of the impetus for these kinds of structural overhauls stems from postcrisis regulatory pressure for banks to shrink, shed assets and reevaluate noncore businesses. And it's not just the big banks that are placing their businesses under a microscope. Financial institutions of all sizes now face increased regulatory burdens. This has ushered in the need for all banks to increase their staffs in order to keep pace with evolving compliance requirements, risks and opportunities. At the same time, low interest rates and a brand-new tech-driven consumer landscape have further contributed to the paradigm shift we're experiencing in banking.

All of these pressures are creating an environment in which only the fittest banks can survive. As the largest banks continue to prune their non-essential operations and focus on their main lines of business, smaller banks are consolidating in order to better address challenges and meet the demands of today's consumers while continuing to grow. To be clear, small banks aren't becoming extinct -- they're just getting bigger. Institutions with assets between $100 million and $10 billion have increased in both number and in total assets over the past three decades, according to data from the Federal Deposit Insurance Corp.

It makes sense that pairing up has become the norm for smaller banks. The ability to acquire additional capital, increase lending capabilities and expand offerings is central to smaller institutions' ability to evolve and adapt. Having recently completed a merger at ConnectOne Bank, we're experiencing these kinds of benefits firsthand.

As smaller banks seek out compatible partners, the absence of de novo institutions entering the market makes the extent of consolidation seem even greater. While the cost of entry is currently too high for new bank charters, it's plausible that de novo bank activity will eventually resume. With this change would come a new set of rules for survival.

The reality is that the industry is still operating within a one-size-fits-all regulatory model. But many banks no longer fit easily into their previously labeled categories of big, midsize or small, making their path forward more difficult than ever before. A better alternative would be a regulatory model that distinguishes institutions based on their complexity rather than their size, lifting unnecessary regulatory burdens from those banks that operate by a core banking model.

Banks of all sizes are facing the same demands. Consumers want fast access to funds and instant gratification, which means that banks must keep up with changing technology while grappling with limited access to capital and resources necessary to stay compliant. We are all working to mitigate economic concerns and risks.

Only time will tell which banks will be dexterous enough to adapt to the new normal. In the meantime, banks should embrace strategies that allow them to take advantage of opportunities as they arise. Ultimately, our goal should not just be to survive, but to thrive.

Frank Sorrentino is chairman and chief executive of ConnectOne Bank in Englewood Cliffs, N.J. Follow him on Twitter at @FrankSIII.