Regulators Must Better Engage Community Banks in Major Rulemakings

The community bank furor over the final Volcker Rule highlights a troubling issue: the banking agencies are failing to effectively consult with the majority of banks in rulemakings.

Bank regulators have the challenging task of building public confidence and preventing a future crisis. To do this, they have issued thousands of pages of proposed rules to meet Dodd-Frank Act requirements and satisfy a steady stream of international standards. While targeted nominally at the largest banks, significant and complex issues that impact community banking are buried within these proposals — issues that few small institutions are aware of until it is too late.

The problem is at least twofold. Community banks are challenged to divine the bits and pieces of the regulation that may affect them, and the focus of the proposals on the largest institutions causes regulators to neglect how they impact community banks and the industry as a whole. Compounding the situation, media attention is more likely to focus on the large bank issues in these major rules.

The Volcker Rule and Basel III rules were nearly 1,000 pages each. The Volcker Rule was designed to curtail certain large bank activities, yet many community banks — to their surprise — are immediately and significantly affected. Even when community banks do comment on proposed rules, they often do so at an informational disadvantage. Many small banks, for example, supported the Volcker Rule proposal based upon its public portrayal by advocates, only to find out later that it had significant negative implications for banks of all sizes.

To make the process better and fairer, there are three critical steps that banking agencies should take:

First, regulators should issue community bank summaries at the proposal stage to assist in their understanding of a rulemaking. On some massive rulemakings, banking agencies have issued community bank summaries with the final rules. While these summaries can be extremely useful in helping community banks understand the impact a final rule may have on their institution, they do nothing to improve the consultation process.

Second, the agencies should engage in presentations and question-and-answer sessions to improve community bank awareness during and even before the formal proposal stage. During the Basel III rulemaking, regulators put forth an extensive outreach effort that included presentations and telephone briefings. This effort was highly effective in raising awareness of the Basel III proposals, and should be standard operating procedure for the agencies.

Third, large and broadly applicable regulatory proposals should have longer comment periods. The average community bank does not have the depth of legal and compliance resources to meaningfully review a massive regulatory proposal and provide comment in a short period of time. The longer the comment period, the greater number of banks that will be able to provide comment and the more informed the banking agencies will be when developing a final rule.

The problem is more acute when a U.S. rulemaking is motivated by an international agreement, such as the Basel III Accord. The banking agencies spend years negotiating an international standard and can become hesitant to have a U.S. rule deviate from the international bargain. During the negotiation process, large banks may be consulted to some extent. The Basel committee also sought specific information from these banks through a process called a Quantitative Impact Study. There is never a study of the impact on community banks.

The Basel Committee's discussions with internationally active banks are reasonable since they are developing international standards. However, in the U.S., international standards are increasingly being pushed down to smaller institutions. Rep. Scott Garrett, R-N.J., recently introduced a bill that would bring more transparency to the international process by requiring the Federal Reserve Board “to publish a notice that details the subject, scope and goals of any international agreements and solicit comments from market participant ahead of negotiations.” His approach recognizes that U.S. regulators need to engage with the public and Congress as a prelude to international discussions to ensure banking agencies make the most informed decisions.

Consultation and effective consultation are two different things. The banking agencies should strive to make community banks more aware and informed of all the ways that proposed regulatory initiatives could affect them. The agencies have an obligation to alert institutions that proposed standards could apply to them, offering critical opportunity to raise important issues publicly. Regulators cannot reasonably assess the impact of new standards on all sectors of the banking industry without first engaging all banks in the process. Quite simply, they can't address concerns that they haven't heard.

Hugh Carney is senior counsel for the American Bankers Association.