Regulatory Game Changers and How to Deal with Them

Banks have been struck with an avalanche of new regulations. Derrick Cephas with the law firm of Weil, Gotshal & Manges LLP talks about how banks can approach the new regulations in a constructive manner, and how the new rules have changed the regulatory landscape.

What are the new regulations for mid-sized and smaller banks that are really the game changers, in your view?

Although most of the major provisions of Dodd-Frank have the greatest impact on the very large banks, I think that as a matter of industry practice over time, a number of the Dodd-Frank initiatives will be made applicable to smaller banks. For example, the law provides that the Consumer Financial Protection Bureau will apply to banks with assets of $10 billion or more. I can’t imagine that if the CFPB decides that a practice is abusive or against the public interest, that banks below $10 billion in assets will be allowed to continue to engage in that practice. However the CFPB ends up reshaping consumer banking practices, the result is likely to have applicability to smaller banks as well.

The abolition of the Office of Thrift Supervision will also have broad implications for the thrifts, many of which are relatively small, because they will now be regulated by the Office of the Comptroller of the Currency and the Federal Reserve Board.

One of the changes that regulators have instituted over the last few years, with no change in statute, is to have raised the required minimum capital requirements substantially. Prior to the recession, regulators would find a leverage ratio of 6 to 6.5 percent to be acceptable. Now, through the supervisory enforcement process, regulators have effectively increased the minimum acceptable leverage ratio up to 8 percent, or 9 percent in some cases. That approach now has equal applicability, no matter the size of the bank. 

How should bank officers and board members try to tackle this labyrinth of new rules?

They need to establish a tracking system to identify the regulations and statutes that apply to them and what the bank needs to do to stay in compliance. Then they should appoint a senior person internally to be in charge of regulatory compliance on a day-to-day basis, such as a chief risk officer, chief compliance officer or general counsel. That person’s department should be adequately staffed and he or she should report to a committee of the board, either the risk management committee, compliance committee or a similar committee. That committee should report to the board, maybe monthly, maybe quarterly, depending on the severity of the problems.

At what point should a bank really push back against a regulator’s suggestions and input and at what point should it be more receptive?

A bank should always maintain a constructive dialogue with its regulators. If the bank believes that the regulator is taking an inappropriate approach, it should engage the regulator substantively on that issue. If the bank’s management team thinks there’s a better approach, it should make that suggestion to the regulators. But remember that at the end of the process, the regulator decides the issue and once the issue has been fully considered, the bank will then have to follow the regulators’ guidance on the issue. The banks that get in trouble with regulators are the ones that aren’t responsive to regulatory guidance. If regulators conduct an exam and produce a list of issues to be resolved and they come back the next year for another exam and find that the same issues have not been resolved, the message the bank sends is that it doesn’t take compliance seriously and can’t be relied upon to resolve outstanding regulatory concerns. Having a poor relationship with your regulators is not a good strategy. Very few banks achieve their objectives by having an adversarial relationship with the regulators.

Do you see regulation changing the focus for banks and thrifts, and if so, is that good?

Depending upon how long it takes for the economy to stabilize and then improve, I think you’re going to see an increased emphasis on regulation for the foreseeable future.  There will be a focus on asset quality, capital adequacy, basic risk management, risk reduction and liquidity requirements. Increased regulation has significant cost implications and also has an impact on bank profitability. If the economy stabilizes and starts to improve, the demand for quality loans starts to increase and the unemployment picture improves significantly, all of that will indicate that the economy has turned the corner and we would then expect to see moderation in the regulatory climate. I don’t expect to see that change in the next two or three years or so. The increased regulation that we now have did not occur in a vacuum. It came in response to a problem.

Derrick Cephas