Obama vs. Regulators: Easing the Grip on Community Banks

Obama meets with executives of community banks.President Barack Obama surprised some in the regulatory arena when he said that community banks may be mired in too much “red tape,” and that may be hindering their ability to increase loans in the vital sector of small businesses.
Obama made that observation this week after conferring with several community bank executives at the White House in a meeting that was friendlier than the one with the big bank CEOs the previous week. After his time with the heads of the smaller banks, the president told reporters that these executives had little or nothing to do with the financial crisis.
The president then said the following – in effect, throwing a challenge to bank regulators who do not report to him:
“We are looking to see if there are possibilities to cut some of the red tape,” Obama said. “We don’t have direct influence over our independent regulators, but we think that the more we can highlight that…the pendulum may have swung too far in the direction of not lending…that if we can get that balance right that there are businesses and communities out there that are ready to grow again, and we just need to help make that happen.”
Federal Reserve officials and other bank regulators are keenly aware of the balancing act mentioned by the president.
But in the current regulatory scheme of things, the smaller banks are in the same mix as the larger banks. And it is unclear whether financial oversight reform that has already passed in the U.S. House, and another set of reform laws brewing in the Senate, addresses the dichotomy that exists between the banking giants and the community banks.
The country’s small banks, which number about 8,000, may not have had a large role in the sub-prime loan meltdown, but they are key to helping the economy sustain a sound recovery. Despite accounting for only 12 percent of all bank assets, community banks make nearly one-third of all loans of less than $1 million to small businesses, the Independent Community Bankers of America said.
The biggest challenge of many community banks is not so much regulatory restrictions, but current credit market realities.
And regulators have said in recent weeks that their examiner teams are working with these banks to guide them through the current crisis – a concentration in commercial real estate loans that are failing at a concerning rate.
“Federal Reserve examiners are reporting a sharp deterioration in the credit performance of loans in banks’ portfolios and loans in commercial mortgage-backed securities,” said Jon D. Greenlee, associate director, Division of Banking Supervision and Regulation at the Federal Reserve, during a Congressional hearing last month. “At the end of the econd quarter of 2009, approximately $3.5 trillion of outstanding debt was associated with commercial real estate, including loans for multifamily housing developments.”
Greenlee also said the Federal Reserve has “directed examiners to be mindful of the effects of excessive credit tightening in the broader economy” and increased examiner training and industry outreach “to underscore these intentions.”
“We are aware that bankers may become overly conservative in an attempt to ameliorate past weaknesses in lending practices, and we are working to emphasize that it is in all parties’ best interests to continue making loans to creditworthy borrowers,” Greenlee said.
But community banks remain under pressure to preserve capital in light of underperforming loans and as a hedge against future defaults.
This reality was a focus of a speech by Daniel K. Tarullo, governor of the Federal Reserve Board, in June.
“Changes in competitive environments require banks to respond with changes in their business strategies,” Tarullo said. “But the financial crisis has also revealed the importance of banks adopting risk-management strategies appropriate to these strategic changes, and of bank regulatory agencies adapting their supervisory models to both these kinds of changes in financial institutions.”
Community banks have responded well to regulatory guidance on monitoring concentration of loans in high risk areas, Fed officials say. But they can only advise these banks that lending to credit-worthy small businesses is crucial to economic recovery. 
“Many banks have reinforced their contingency funding plans and developed sophisticated systems to more closely track their sources and uses of funds,” Tarullo said. “These steps are particularly important for banks facing weaker asset quality.”
What remains unclear is whether financial oversight reform, backed by Obama, will loosen regulatory grip on community bank lending. Under reform legislation approved by the House this month, a new financial oversight panel would monitor “systemic risk” among financial institutions, and report to Congress with recommendations. But the group of laws is directed at larger financial institutions, the ones labeled “too big to fail” in the past.
No specific language in the reform laws addresses the regulatory requirements of community banks, and whether those policies contribute to a “systemic risk” to the U.S. economy by hindering lending to small businesses.

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