Community banks did not cause the 2008 housing and economic crisis. However, due to the regulatory creation of the Dodd-Frank Wall Street Reform Act — Washington’s response to the crisis — small community financial institutions have borne the brunt of its effects. They have been unfairly punished with burdensome regulations that have increased paperwork and reduced productivity and services in too many of our communities.
As a former chief executive of a locally owned community bank in Little Rock that existed before and after the implementation of Dodd-Frank, I saw firsthand how regulatory requirements for smaller financial institutions created an unreasonable burden that makes it exceptionally difficult for them to fulfill their roles in providing consumers, small businesses and entrepreneurs with competitive services and access to credit and capital.
This is an Opinion
The number of banks chartered in Arkansas has gone from more than 250 in the mid-1990s to around 100 today. A large contributor to this has been increased regulatory burden from the federal government. These institutions have remained well-capitalized and should never have been unfairly punished for the mistakes of the federal government and larger financial institutions.
Before the expansion of the federal safety net, first with the formation of the Federal Reserve System in 1913, followed by the creation of the Federal Deposit Insurance Corp. during the Great Depression, bank shareholders held substantially higher ratios of capital to assets. While there was a slight uptick during the early 1990s following the passage of the FDIC Improvement Act of 1991, over the past century, ratios of shareholder equity capital to assets for commercial banks have fallen.
Unfortunately for taxpayers, capital ratios at some of the largest financial institutions remained low even after the new Prompt Corrective Action penalties and new capital expectations of the FDIC Improvement Act. For example, at the time of the 2008 housing crisis, Citicorp had a capital ratio of only 4.03 percent for its Tier 1 leverage ratio.
The Dodd-Frank Act of 2010 has only worsened this issue, layering more “macroprudential” regulation and more regulatory expense, while not substantially reducing the moral hazard underlying our “too big to fail” banks. In fact, some argue that the moral hazard actually has been enhanced by the institutionalization of the “too big to fail” doctrine emphasized in the Dodd-Frank Act.
The centerpiece of the House Financial Services Committee bill, known as the Financial CHOICE Act (Creating Hope & Opportunity for Investors, Consumers & Entrepreneurs), is a significant change in approach. To reduce the moral hazard and increase the “microprudential” attention of bank managers, directors and shareholders, the Financial CHOICE Act offers a voluntary capital election.
This is being termed as a “regulatory off-ramp” for financial institutions with high capital. Generally, for a bank or credit union to be considered well-capitalized by the FDIC today, the institution must have a Tier 1 leverage ratio of 5 percent or higher. In Title VI of the Financial CHOICE Act, we double that level to 10 percent or higher.
The 10 percent level was arrived at by reviewing bank failures over time at various levels of Tier 1 capital. Additionally, in April 2015, FDIC Vice Chairman Tom Hoenig proposed a similar off-ramp concept and also established a 10 percent Tier 1 capital leverage ratio as a good working number for his proposal.
This voluntary off-ramp concept is available to all banks that would avail themselves of its provisions. However, it is unlikely that the nation’s largest, most complex institutions will be able to justify the dramatic increase in equity capital to achieve the regulatory benefits.
A recent Congressional Budget Office report confirms this: “CBO expects that most of the financial institutions that chose to maintain a leverage ratio at 10 percent would be those with assets below $10 billion, commonly known as community banks.” And that “the eight large banks headquartered in the United States that are characterized as globally systemic important banks would not make the election because they would have to raise much more capital.”
However, we estimate that about 75 percent of community banks and credit unions scattered across the main streets and avenues of our cities already hold Tier 1 capital at the 10 percent threshold. By availing themselves of this voluntary mechanism, community banks will have more options when it comes to product innovation and services for small businesses, consumers, families, farmers and our entrepreneurs across the nation.
Alexander Hamilton said that banks are the “nurseries of our national wealth.” Those of us on the House Financial Services Committee who worked on this bill believe that the centerpiece of our Financial CHOICE Act will encourage more equity capital to be maintained by banks, making our banks safer and therefore giving them the flexibility to serve the public in good times and bad.
French Hill represents the 2nd Congressional District of Arkansas in the U.S. House of Representatives. Email him online at Hill.House.gov.