The bipartisan “regulatory relief” bill that was adopted by Congress and signed by President Donald Trump earlier this year is a positive development for the banking industry, and it continues a string of good news for banking (and, by extension, the economy at large) since the passage of the Dodd-Frank Act. Banking is highly regulated, and it should be, because most banks’ balance sheets are funded with federally insured deposits to the tune of 90 percent.
The Economic Growth, Regulatory Relief and Consumer Protection Act is not all that the industry had hoped for in a regulatory relief bill, but it is not a complete giveaway to the big banks as some suggested. For the really big banks in this country, the bill does not change much at all.
One of the best things about the legislation is the House and Senate came together to pass a bill that makes sense. On the other hand, the bill seems to further engrain buckets of banks based on asset sizes that have no meaningful support. So, we should get used to the notion that a bank with assets over $10 billion is somehow a “large” bank and that banks with over $250 billion in assets are “systemically important.”
At a high level, the substantive provisions of the new law are relatively brief, when compared to the expanse of Dodd-Frank. Arguably, the mortgage-related provisions of Dodd-Frank did more harm than good because plenty of smaller lenders got out of the housing finance business rather than risk the penalties of noncompliance.
The recent legislation provides that banks with assets of $10 billion or less can avoid some of the more cumbersome qualified mortgage rules under Dodd-Frank, provided that the loans are originated by the bank and kept in the bank’s loan portfolio. Banks that made fewer than 500 mortgage loans in each of the last two years will be exempt from Dodd-Frank’s expanded reporting under the Home Mortgage Disclosure Act as long as the bank has a satisfactory or better Community Reinvestment Act rating.
The new legislation also directs the federal banking agencies to adopt a “Community Bank Leverage Ratio” that will exempt most banks with assets of less than $10 billion from the risk-based capital rules of Basel III. This safe harbor capital requirement is to be not less than 8 percent and not more than 10 percent, and it is going to require an interagency rule-making process, which can take many months to accomplish. So don’t throw away your Basel III models just yet. Most of these so-called small banks will also be exempt from the Volcker Rule, but that too is going to require promulgating rules. It is just going to take time for to reach consensus on what the regulations should say.
A couple of provisions of the new law beneficial to smaller banking organizations should be implemented fairly quickly and without much controversy. The threshold for a “small” bank holding company for purposes of the Fed’s policy statement on the capital and leverage requirements for such entities has been raised from $1 billion to $3 billion. This means bank holding companies with less than $3 billion of total assets will not be subject to capital requirements on a consolidated basis, and allows those holding companies to borrow money at the holding company level and inject it into their subsidiary banks as equity capital. In addition, the exam cycle for well-managed and well-capitalized banks with assets of $3 billion or less has been extended to 18 months. These two provisions could amount to meaningful relief for the banking organizations that can avail themselves of the flexibility afforded by the new law.
For those of us who appreciate the important role that a properly functioning banking system plays in the U.S., our elected officials deserve credit for making changes to Dodd-Frank. But we should not lose sight of the fact that the new law is merely a drop in the bucket of work to be done around bank regulation in the U.S.
Board members have an important role to play in implementing the latest directives from the Basel Committee on Banking Supervision.
More and more, I find myself to be in [Federal Deposit Insurance Corp. Vice Chairman] Tom Hoenig’s camp. Regulations have become monstrously complex. The Basel III regulations are more than 900 pages. If the question is whether higher minimum capital ratios and liquidity requirements make sense, I would say sure, but 900 pages? Beyond the complexity, there is considerable administrative burden even for community banks. I laugh when I read what amount of time regulators say is needed to comply with new regulations. They must all be masters of Evelyn Wood’s Reading Dynamics. I needed over two weekends just to read the first 280 pages of regulation.
Basel III is good for banking in that it directs the industry back into the more conservative role of a traditional financial intermediary rather than the high growth, boom or bust mentality that was so pervasive in the industry in the early to mid-2000s. The Basel III rules, in a general sense, promote more modest risk-taking by banks. The rules also moderate growth through limiting leverage for those institutions that have more aggressive asset mixes. By doing this, the rules will help curb competition that is strictly based upon which institution is willing to take the most risk. Hopefully, these rules will lead the industry back into an environment in which the most successful institutions are the smartest, not just the most aggressive.
Yes and no. People generally accept that banks should have had more capital prior to the recent financial crisis, but Basel III has clear weaknesses. The problem lies in recognizing that overly complex rules and prohibitively high capital levels can be incompatible with increasing economic activity or at least contribute to driving borrowers to the shadow banking environment. The key is to understand the interrelationship of new requirements in addition to Basel III, both national and international, both imposed by Dodd-Frank and independently by bank regulators, to recognize that the cumulative effect of those rules may be more onerous than at first supposed.
It’s a mixed bag. Since all U.S. banks will be required to hold more capital, especially common equity, than under the existing rules, they will be more likely to absorb significant losses and thus may be less likely to fail. However, in order to raise or maintain additional common equity, banks still have to deliver attractive returns to their shareholders. The cost of additional capital, plus the compliance burden arising from more complex rules, makes it too early to tell whether banks will succeed without cutting back on the availability of credit. The Basel III rules also create disincentives for smaller U.S. banks to expand through M&A transactions instead of organic growth. That could act as a brake on consolidation and affect the competitive landscape between banks of different sizes.
The application and implementation of Basel III to community banks is unnecessary. Community banks were not the cause of the troubles leading up to the Great Recession. Then, as now, most healthy community banks have more capital than will be required in 2015. When deemed necessary for safety and soundness, troubled institutions often have increased capital ratios imposed on them by their regulators. This has not changed, nor should it. Basel III may have the undesired effect of driving more consolidation of healthy community banks because they will not be able to profitably keep up with increased regulatory compliance costs, new CFPB rules, information technology advances, along with maintaining higher capital standards. This will be our loss.
We believe Basel III will be good for banking, so long as the rules are clearly set out. Basel III will require banks to maintain higher capital levels, even though there are changes to what can be included in Tier 1 capital.
Basel III implementation risks pushing banks to pursue similar business strategies to manage their regulatory capital burdens (which contributed to the 2008-2009 systemic crisis as well). Regulators have pushed banks to adopt model risk management practices to ensure that each institution does not slavishly follow underwriting, valuation, or risk management models without routine and independent validation. However, these same model risk management principles have not been built into the Basel III standards themselves, which are static and risk similar effects.
The Basel III final rules recently released make clear one thing: Small, community banks are getting a break. It may not actually feel that way. In fact, community bank CEOs across the country tell me they are very frustrated with new regulation, with Basel III, with the Dodd-Frank Act and with examiners scrutinizing their banks and coming up with problems that never seemed to be a problem before. The overarching theme is that more regulation is coming down the pike, Basel III’s final rules are just one part, and they will be burden to digest and implement.
Recent rule making for expansion of stress testing requirements to new constituencies and Basel III implementation have stirred uncertainty and angst among banks. Stress testing regulation includes significant detail on reporting templates, model management and capital planning guidance. Standards of practice are beginning to form. However, regulatory guidance provided on methodological and modeling approaches to date has created confusion and caused a divergence of practice and a variety of modeling approaches among financial institutions. The appropriateness of each approach is widely debated. 
The entire U.S. banking industry breathed a collective sigh of relief recently when the three federal bank regulatory agencies postponed indefinitely the effective date of the Basel III capital and liquidity rules, which had been set for Jan. 1, 2013. The proposed rules, which would have applied more or less equally to all institutions—from the country’s largest bank, JPMorgan Chase & Co., to very small community banks in out-of-the-way rural locations—set off a firestorm of protest throughout industry.
Basel III is bearing down upon us. The U.S. bank regulators issued their final proposals to adopt Basel III capital standards on August 30, 2012. Numerous members of Congress, the industry and even senior officials at the Federal Deposit Insurance Corp. (FDIC) and the Comptroller of the Currency have expressed concerns about these proposals.On the other hand, the Basel Committee has expressed concerns about timely, consistent implementation of Basel III around the world. The U.S. bank regulators announced on November 9 that they would further consider the Basel III proposals, and that these would not become effective on January 1, 2013, as originally contemplated.