The U.S. government may have the ability to prevent the nation's community banks from going the way of the corner drug store. If legislators and federal agencies want to stop bank consolidation from diminishing the ranks of small lenders, they must relax the government's iron-clad grip over 6,046 community banks that today control less than 10% of the country's banking assets.
As my last BankThink piece explained, smaller community banks are having an increasingly difficult time competing against larger rivals that enjoy the advantage of scale. The growing profitability gap between banks with under $1 billion in assets and banks with over $1 billion in assets is likely to lead to a spurt in mergers between 2014 and the end of this decade.
Two public policy changes could help give smaller community banks the opportunity to survive independently. Both actions have the potential to fuel local and national economies. If implemented correctly, they could do so without heightening safety and soundness concerns.
First, Congress needs to assign just one regulator to banks with under $1 billion in assets. Former FDIC chairman Irvine Sprague was on the mark when he wrote in 1986 that "confusion is rampant" in a U.S. regulatory system burdened by "the incredibly complex mix of overlapping and sometimes conflicting supervisory jurisdictions."
Former FDIC chairs Sprague, L. William Seidman and Sheila Bair have all identified regulatory turf-fighting as an obstacle to good supervision. Today, Dodd-Frank legislation and shell-shock in the aftermath of the financial crisis have only heightened the accountability various bank regulatory agencies feel for supervising banks. And with greater accountability comes greater supervision.
The problem of having too many regulatory cooks in the kitchen is perhaps best illustrated by a conversation I had not long ago with the chief executive of a profitable community bank. The CEO told me that a double-digit number of federal and state bank supervisors had just exited the bank's exam. This number struck me as high. Doing the math, I calculated that based on comparable asset size, it would take something like 115,000 supervisors to examine JPMorgan Chase. More supervisors means more things to fix, which can be okay as long as minor issues don't distract bank management from issues that matter most.
Second, smaller community banks should be relieved of unnecessary and "nice to have" regulations, especially those with dubious cost-benefit value. Micro-supervision designed to reduce risk in the banking system is not without direct cost to community banks. Expect bank CEOs and directors of some banks with under $1 billion in assets to conclude that a return on equity target of 8% to 12% is impossible to achieve in the current environment. When that occurs, consolidation is the inevitable and unintended consequence.
A more useful model of supervision for community banks would focus on monitoring loan growth rates and asset concentrationsthe two root causes of over 3,000 bank failures since the early '80s. By focusing on these two critical risk factors, the regulatory community not only relieves community banks of marginally beneficial oversight, but also provides the exact kind of supervision that history proves community banks warrant.
Congress, in its capacity as maker of laws, should ask federal and state bank supervisors to conduct a full accounting of all bank regulations borne by small community banks, with the intention of eliminating everything that is not critical to the safety and soundness of the U.S. banking system and the long-term vitality of community banks.
Congress should examine the findings to weigh public policy priorities. If it seeks a risk-free banking system for social-engineering and quasi-policing purposes, legislators must recognize that such a system comes at the expense of another presumed public policy goal: The preservation of a banking system with healthy, profitable community banks.
If the FDIC wants to stall consolidation, it must help Congress understand that smaller community banks need meaningful improvement in their profitability picture. Together with the Office of the Comptroller of the Currency, the Federal Reserve and the Conference of State Bank Supervisors, the FDIC has the opportunity to build a coherent plan that relieves community bankers from burdensome compliance programs and onerous supervision. This would offer smaller lenders a significant opportunity to cut expenses while freeing them to spend more time with clients and customers and thus build revenue.
Richard J. Parsons is the author of "Broke: America's Banking System Common Sense Ideas to Fix Banking in America," published in 2013 by the Risk Management Association. He worked for 31 years at Bank of America.