A Single Federal Community Bank Regulator?

It's painful to observe the mega-bank vs. community bank internecine warfare unfolding within the U.S. banking industry.  At a time when unity might collectively advantage the industry more, the dynamics of detrimental fratricide seem to be dominating the banking trade press and Washington politics lately.  Its present incarnation is the Brown-Vitter Terminating Bailouts for Taxpayer Fairness Act (TBTF Act), aimed at hobbling our largest banks with significantly higher capital requirements and assorted other restrictions.

The frustration of community banks is expressed through the Independent Community Bankers of America (ICBA) End Too-Big-to Fail report.  Snippets such as "Community banks are living with the wreckage of the megabanks... their abusive practices have resulted in new consumer and capital regulations... regulatory burden exacerbates consolidation and compounds the problem of too big to fail."   In the report's press release, ICBA President and CEO Cam Fine emphasized the core issue: "But there is perhaps no greater reminder of the too-big-to-fail impact than the constant, oppressive regulatory burdens that community banks face on a daily basis."

Federal regulators and Obama Administration officials have raced to the microphones arguing to let existing Dodd-Frank TBTF powers take hold before layering on additional remedial measures.  To the underlying and core issue of the regulatory burden being imposed on community banks, raised by Cam Fine and the ICBA, they have little that's substantive to show.

While there have been many "Main Street, Mom, and Apple Pie" speeches, showy conferences, glossy economic studies, and high-level banker advisory committees on the topic of community banks and community banking;  the bottom-line is that there have been no visibly significant regulatory simplification or community bank carve-outs coming from the Federal bank regulatory agencies.  

We all know that each Federal bank regulatory agency oversees banks other than community banks.  The core interests of community banks, therefore, are diluted within the milieu of each Federal banking agency's overall responsibilities.  In addition, community banks reside on different islands within the Federal bank regulation and supervision archipelago; most at the Federal Deposit Insurance Corporation (FDIC), many at the Office of the Comptroller of the Currency (OCC), and some at the Federal Reserve System.

Today, in a counter-intuitive way, the Dodd-Frank Act may have opened the door to the possibility of considering a single Federal banking agency devoted solely to the regulation and supervision of community banks.  The powers and responsibilities of state bank regulators could be untouched.

Federal Banking Regulation and Supervision in the United States

In the timeline of federal banking regulation and supervision in the United States, the contours of the regulatory landscape were sculpted by periodic financial crisis, legislative responses, and national priorities.  So we started off Federal regulation with a distinction based on whether a commercial bank was chartered by its home state government or chartered by the Federal government.  Then, with the creation of the Federal Reserve System, and its important lender of last resort function, the reach of Federal banking regulation and supervision was extended to Federal Reserve System member banks, regardless of state or federal charter.  Later, during the Great Depression, the reach of Federal banking regulation and supervision was further extended to all commercial banks and specialized lenders (like thrifts), regardless of charter, that were granted federally-backed deposit insurance.

So Federal banking regulation and supervision literally oozed across the spectrum of depository institutions over time, regardless of size or charter, driven largely by an expanded Federal interest in maintaining a safe, sound, and prosperous banking system.

The Dodd-Frank Act, however, made an important, perhaps watershed, change in the overall nature and focus of Federal bank regulation in the United States.  In Section 165 of the Act, it introduced the concept of increasing the stringency of prudential standards based on the size of the financial institution:

(a) IN GENERAL.— 

(1) PURPOSE.—In order to prevent or mitigate risks to the financial stability of the United States that could arise from the material financial distress or failure, or ongoing activities, of large, interconnected financial institutions, the Board of Governors shall, on its own or pursuant to recommendations by the Council under section 115, establish prudential standards for nonbank financial companies supervised by the Board of Governors and bank holding companies with total consolidated assets equal to or greater than $50,000,000,000 that— 

(A) are more stringent than the standards and requirements applicable to nonbank financial companies and bank holding companies that do not present similar risks to the financial stability of the United States; and 

(B) increase in stringency, based on the considerations identified in subsection (b)(3).

(2) TAILORED APPLICATION.— 

(A) IN GENERAL.—In prescribing more stringent prudential standards under this section, the Board of Governors may, on its own or pursuant to a recommendation by the Council in accordance with section 115, differentiate among companies on an individual basis or by category, taking into consideration their capital structure, riskiness, complexity, financial activities (including the financial activities of their subsidiaries), size, and any other risk-related factors that the Board of Governors deems appropriate

So the path of the history of Federal banking supervision pivoted and now includes, not only horizontal slicing, based on charter and membership,  but also vertical dicing, based on asset size and other factors enumerated above, with regulatory authority for the largest financial institutions vested in the Board of Governors of the Federal Reserve System largely through their bank holding company structures.  It is within this revised framework that the opportunity arises to create a federal community bank regulator solely devoted to community bank regulation and supervision.

How It Could Look

A Federal Community Banking Commission (FCBC) could be formed by (1) acknowledging and granting the Board of Governors of the Federal Reserve primary Federal regulator status over the regulation and supervision over large banks, large nonbanks, and their subsidiaries regardless of charter or membership.  Then, (2) by leaving the ministerial national bank chartering and licensing authority as a separate office within the U.S. Treasury Department; moving agency staff involved in the supervision and regulation of community banks from the OCC, the Federal Reserve, and the FDIC into the new entity.  The FCBC would be the primary Federal regulator and supervisor for community banks.  The Board of Governors of the Federal Reserve System would be the primary Federal regulator and supervisor of all of the rest.  This is only one option for an institutional arrangement. 

One caveat, however, is that, for checks and balances purposes, the FDIC should retain back-up examination authority, as the deposit insurer, over the Federal Reserve System and the FCBC; and it would also be wise for the FDIC to have Ombudsman and independent examination quality assurance authority over both agencies.

For perspective, according to statistics gathered by the Federal Reserve Bank of Dallas, as of  9/30/ 2012, 12 banks had total assets between $250 billion - $2.3 trillion, and with a 69% market share.  An additional 70 had total assets between $10 billion - $250 billion, and represented a 19% market share.  5,500 banks had total assets less than $10 billion, and collectively represented a 12% market share.  How one decides the jurisdictional cutoff for a Federal Community Banking Commission is part of the negotiation interplay.

The concept deserves serious consideration by community bankers and their spokespeople.  Never underestimate the power of community bankers when they are united.  Community bankers are influential members of the business community in all 435 congressional districts and are collectively influential in all 50 states.  Despite the inevitable push-back that might come from those invested in the established Federal institutional arrangement, community bankers can get something like this if they really want something like this.

...and I suppose no invitations to the OCC Alumni Association dinners for me anymore.