Now that large banks have less interest in serving correspondents, community bankers depend more on the impartial advice of their regulators.

Well, the advice may be impartial, but it comes with teeth. Do something a regulator considers unsafe and you may be looking at meetings with the board and threats of sanctions. So it pays to know what worries regulators have.

Last month, at the Community Bankers of Kentucky convention, I asked Stephen H. Jenkins of the Cleveland Fed what his main concerns are.

"Bad loans," said Mr. Jenkins, who is a vice president in the department of banking supervision and regulation.

"Why do banks make bad loans?" I asked.

Topping Mr. Jenkins' list, of course, were competitive pressures. From large players like GE Capital to small mortgage and consumer finance companies, there are more lenders than ever before competing to make business and consumer loans.

The impact on net interest margins has forced some community banks to go after loans they otherwise might not have sought.

Also, large banks have started cherry-picking small-business loans. They use credit scoring programs to speed up the process.

Again, many community banks are responding with aggressiveness in pricing and terms.

Profit pressure from analysts and shareholders can also tempt banks to take inappropriate risks.

What else do regulators worry about? Here is part of Mr. Jenkins's list:

    Pricing that is not consistent with risk.
  • Overreliance on best-case assumptions in the underwriting process. and on collateral value instead of cash flow.
  • fearless loan officers - fearless because they have never seen an economic downturn.
  • Subprime lending.

Mr. Jenkins also stressed two other basic concerns:

  • Underwriting that relies too much on the borrower's character.
  • Lending outside the territory, where it is hard to monitor the use of the money.

Despite this emphasis on what can go wrong, Mr. Jenkins seemed very different from the stereotypical "The answer is no. Now, what do you want?" regulator.He is anxious that the community banks he serves prosper. He does not think they must operate without risk - but he wants to make sure that they don't take too much, and that they are adequately compensated for the those they do take.
Mr. Nadler, an American Banker contributing editor, is professor of finance at Rutgers University Graduate School of Management.

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