Sheila Bair, who led the Federal Deposit Insurance Corp. at a time when nearly 400 community banks failed, believes that smaller banks are getting a raw deal these days.

Bair, now a senior policy adviser to DLA Piper, made that point clear during a Q&A session with Hovde Group on Wednesday. Bair repeatedly emphasized during a conference call that a top-down approach to regulation, which has been "disproportionately affecting" smaller banks, and low interest rates have served as a double-whammy for those institutions.

"The zero interest rate policies have not been a helpful policy for the traditional lenders," Bair said during the more than hour-long discussion. "It is creating distortion and pockets of instability, and it is penalizing the traditional lenders."

Bigger banks have been able to better weather lower rates because of a reliance on fee income, namely trading revenue, Bair said, adding that larger institutions have the ability to fund their balance sheets with cheap debt.

Bair was also asked by Joe Fenech, a Hovde analyst who moderated the event, to share her thoughts on industry consolidation, noting that the operating and regulatory environments are often cited as motivation to sell. Industry experts often point to such factors as the catalyst for the sale of banks with less than $1 billion in assets.

Bair, who frequently displays a preference for market solutions, said she views consolidation spurred by onerous regulation as a "bad thing" for the banking industry. "I like to see acquisition activity driven by the market, not by regulation," she said.

"If you're an insured bank, you have a level of regulation because your liabilities are insured... but it should be smart regulation and I question the value added of some of these rules," she added.

Bair, who said she is "sympathetic to the idea" of creating a regulatory body dedicated to smaller banks, stated that proposals to give existing regulators broad authority to craft exemptions for banks with less than $10 billion could be a good first step.

"One thing I saw as a regulator was that no one wanted to be viewed as the weak regulator," Bair said. "So if you did something to the big bank, you had to do something to the small banks."

Bair said she doesn't believe a new regulator — or existing regulators with broader authority to streamline rules — would be lax with small banks.

Current regulators have "been harsher than they need to be at times," she said. "I think they'd use that authority responsibly."

As for regulatory thresholds, Bair said she thinks $50 billion in assets, where banks are considered to be systemically important, is too low, noting that the FDIC used a $100 billion-asset mark for such institutions.

For Bair, the $10 billion-asset threshold, where interchange fees are capped and stress tests become mandatory, seems appropriate. She provided one caveat: Banks with $10 billion to $50 billion in assets may be better suited by a streamlined stress-testing mechanism.

Though smaller banks have been overburdened, Bair said that the market has been kind to institutions with a "traditional bank model."

Indeed, the KBW Nasdaq Regional Banking Index, which includes 50 small and midsize banks, has outperformed the broader banking index so far this year.

"I hope I'm seeing a trend where banks with simple businesses are being rewarded by the market," Bair said. "The traditional bank model, with a customer focus, was the best and most sustainable in the crisis."

Robert Barba is one of American Banker's community banking reporters.

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