The Importance of Small Community Banks

August 09, 2010 at 1:24 PM
The passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act coupled with heighted enforcement fervor among the bank supervisory agencies has given rise to concerns that increased regulatory costs, both implicit and explicit, will make it difficult for small community banks to continue operating and may force them to sell or seek strategic mergers.  The regulatory agencies and the bank examiners have an opportunity to address this and help to ensure the viability of small banks going forward.
Small community banks play a critical role in providing banking services in many states. In fact, small community banks, defined as those with $250 million or less in assets, hold over 20% of total deposits in six states.  Unsurprisingly, these states are less densely populated and are located in the Midwest and Great Plains where communities are often located far apart. The demographics and geographic characteristics of these banking markets often make them less attractive to large banks and also suggest that mergers between small community banks aren’t likely to yield significant operating efficiencies.
In light of these considerations, regulatory authorities would be well advised to modify their approaches to implementing certain new policy directives in small community banks. For example:

1.  The prevailing examination approach seems to be to insist on write-downs and reclassifications of commercial real estate loans or other loans whenever there is a doubt about the condition of the loan. This is not always the right course of action. Examiners must give the benefit of the doubt to management when appropriate. Otherwise they risk hindering the ability of small banks to lend monies and remain competitive.

2.  Small community banks should not be required to raise and maintain capital levels significantly above the minimum regulatory levels established for well-capitalized banks. The recent crisis was not caused by excessive leverage among community banks.

3.  Regulators should allow, without penalty, small community banks to use certain types of non-core funding such as FHLB advances and CDARs reciprocal deposits. These are vital forms of funding for institutions that do not have the wherewithal to build expensive retail deposit gathering capabilities.


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