The good, the bad and the costly
Community bankers say reforms will bring more regulation
- July 28, 2010
Compared with many banks, Chesapeake Bank weathered the recession well. The financial institution, which has $500 million in deposits and 13 locations in the Northern Neck, the Middle Peninsula and Williamsburg, landed at No. 32 on U.S. Banker magazine’s list of the top 200 community banks in the United States this year — its third consecutive year on the list.
The future isn’t looking promising, though. Jeff Szyperski, the bank’s chairman and CEO, worries that the actions of Congress might hurt his business more than the recession did.
“A recession comes and a recession goes, sometimes not as quickly as we would like,” Szyperski says. “Increased regulatory burden just seems to come and never go away.”
He’s not alone in his worries. Some Virginia bankers are warning that recently approved federal finance reform legislation — the largest financial overhaul since the Great Depression — might do more harm than good. Pledging “there will be no more taxpayer-funded bailouts,” President Obama signed the bill to law in late July.
While the legislation might reduce the chances of another round of bank bailouts, bankers say it fails to address some of the issues that got the industry into a mess in the first place. Plus, they worry that reforms might tie up community banks in costly new regulations, which will mean higher costs for bank customers.
The vast majority of Virginia-based banks are community banks like Chesapeake. These banks are loosely defined as locally owned financial institutions with less than $2 billion in assets, although some are larger. Virginia’s largest community bank, Union First Market Bankshares, has $4 billion in assets.
Community bankers, many of whom support some aspects of financial reform, acknowledge that the legislation addresses some of their biggest concerns. Specifically, it provides a blueprint on how to handle systemic risk and “too big to fail” institutions.
“The ‘too big to fail’ issue creates a moral hazard because it implies the government will bail out those institutions,” Szyperski says. “It creates an uneven playing field.”
The legislation seeks to end bailouts by shifting the focus of troubled banks from conservatorship to receivership.
“Pushing more to the bankruptcy side is good,” says Bruce Whitehurst, president and CEO of the Virginia Bankers Association. “We ought not to have this concept of ‘too big to fail.’ I hope what comes out is enough belief that the government might not bail out large firms in the future.” Likewise, the new systemic risk council “gives government more tools to oversee and manage against undue systemic risk,” he adds.
Many community bankers like the legislation’s attempts to regulate derivatives and credit default swaps, as well as its oversight for investment banks and insurance companies, although the devil will be in the details, Whitehurst says. “For example, many community banks use derivatives to hedge against interest rate risk, allowing them to offer fixed-rate commercial loans they might not otherwise offer. If the derivatives reform is too restrictive, the cost of borrowing could increase as a result.”
The plan to put thrift supervision under the Office of the Comptroller of the Currency is a good idea, too. At least that’s the opinion of Peter Clements, president and CEO of The Bank of Southside Virginia, which has 15 locations throughout Southern and Southeastern Virginia. “The Office of Thrift Supervision didn’t have the expertise that the other regulatory agencies do,” he says. “A lot of the issues that forced the subprime crisis were under its watch.”
Despite these strengths, bankers note that the legislation doesn’t address some of the major issues that contributed to the credit crisis. It is silent about Fannie Mae and Freddie Mac, the mortgage-lending giants now in conservatorship under the Federal Housing Finance Agency, Whitehurst points out. In June, Fannie and Freddie announced plans to delist their stocks from the New York Stock Exchange.
Many community bankers also worry that the legislation reaches beyond its original goal of avoiding another credit crisis. “It’s a Christmas tree full of ornaments that have nothing to do with the crisis,” Whitehurst says. A case in point: the proposed consumer protection bureau. “Ninety-four percent of subprime lending was done outside the traditional banking industry,” he says. Creating a consumer protection bureau to oversee community bank lending — “which already has oversight and wasn’t a real player in the subprime market” — heaps more regulation on banks that are already heavily regulated and does not adequately address the riskier nonbank lending, he says.
Likewise, the regulation of interchange fees charged for consumers’ debit card transactions is unrelated to the credit crisis, and bankers worry that it will hurt the industry. Under the legislation, the Federal Reserve is empowered to establish “reasonable” rates for the fees, and retailers can set minimums and maximums for purchases made with a debit card.
“It was opposed not only by community banks but the credit union industry and several state governments,” says Watts Steger, chairman and CEO of the Bank of Botetourt. He estimates his bank, which has 10 locations primarily in the southern end of the Shenandoah Valley, will lose revenue “well into six figures” each year due to the interchange amendment.
Clements says the change will cost The Bank of Southside Virginia “well in excess of $100,000” in lost revenue annually, while Szyperski says Chesapeake Bank could lose up to $450,000 a year because of the change in interchange fees.
The change was championed by retailers who have complained for years about the fees being too excessive. All told, the country’s banks made about $16 billion on interchange fees last year, according to the Nilson Report.
The industry also stands to lose up to $170 billion in capital with the reform’s elimination of trust-preferred securities as Tier 1 capital. Regulators measure a bank’s Tier 1 capital to help assess whether it’s well capitalized. Banks have historically issued trust-preferred securities to raise capital inexpensively.
“Eliminating it will force banks either to raise capital by other methods, which is unrealistic in this environment, or shrink the balance sheet, which impedes the recovery because loan growth would be restricted,” Steger says. More than 600 medium-size banks will be adversely affected, he adds.
The new regulatory burdens, which include additional monitoring for small business lending, will increase banks’ compliance costs and subject community bankers to what Clements describes as “Chinese water torture.” “We’ll have a full-time federal agency whose job is creating regulation,” he says. “It will be a tremendous burden on banking going forward, and there’s a potential for operating costs to expand dramatically.”
And that means consumers will eventually feel the pinch as well. “When banks have to swallow these big pills, the money has to come from somewhere,” Szyperski says. “Do you get to the point where you have to put service charges on checking accounts? Do you have to raise the cost of borrowing money? It hurts consumers, too.”
Passing costs along to customers might not be enough for banks already weakened by the recession, though. For them, the legislation’s high compliance costs might kick off rounds of mergers, Szyperski says. “You would then have a contraction in the industry. Are we going to look back on this and say traditional banks were road kill?”