Have a comment on this story? Click here to let us know what you think.

The Obama administration has pledged $30 billion to help community banks boost small-business lending. That has led to a big debate: Should strugglers be eligible?

Industry groups are pushing to allow struggling banks into the program if the capital would improve their fiscal health. Some industry observers, however, say the money would best serve its intended purpose by going to stronger banks that can get it out the door faster to deserving businesses.

Dozens of large, distressed banks received funds through the Treasury's Troubled Asset Relief Program to help keep them afloat last year. But no such program has been available to struggling community banks, said Diane Casey-Landry, senior executive vice president and chief operating officer of the American Bankers Association.

"There are a fair number of community banks, through no fault of their own, that are facing increased challenges, and they should be given the opportunity to succeed, to preserve those jobs and their role in the community," she said.

Capital markets have come back for large banks, yet smaller institutions have generally had a longer recovery period, Casey-Landry said. Government capital will be less attractive to healthy banks that can raise capital on their own, she added, but could be a tremendous help to banks in economically distressed regions where the recovery still has not taken hold.

Paul Merski, senior vice president and chief economist for the Independent Community Bankers of America, said many community banks have plenty of capital, though they lack demand for small-business loans. As the economy turns around, those banks are already well-positioned to make loans, he said. It's the struggling banks that will need the capital, not simply to prop them up but to help them start lending again, Merski added.

Some bankers agreed with that assessment. Arthur Johnson, the chairman of United Bank of Michigan and ABA chairman, said injecting capital into banks that have struggled but survived would ultimately fulfill the administration's goals through the program.

"The fewer banks that fail, the more potential there is for lending to occur in those communities," he said.

Michael Menzies, the president of Easton Bank and Trust in Easton, Md., and chairman of the Independent Community Bankers of America, said it is essential for the program to reach banks that are Camels 3 rated, so-called on-the-fence institutions, in stressed markets where small business lending is crucial. Small business is a "fundamental component of restoring the economy."

Executives from the Conference of State Bank Supervisors said the administration's proposed program represents an important policy shift from the previous Tarp program. Before, the program was intended to stabilize the capital markets, with the focus on the nation's largest banks. Because the new proposed initiative focuses on small business lending, the institutions that participate should be healthy enough to be able to lend, said John Ryan, the conference's executive vice president. "If they can demonstrate the ability to extend credit to credit-worthy borrowers, they ought to be in," he said.

Yet Ryan noted that when the conference sought feedback from commissioners on whether the Treasury Department should extend Tarp, it received a range of responses from bankers in different parts of the country on whether to continue the program.

In regions that are still struggling, help from the Treasury Department might be the only capital available in those markets. But in areas where the economy is turning around, government assistance is interfering with the flow of private capital, commissioners told the conference.

Where private capital is flowing, it's going directly to banks with better management teams, strong capital and the ability to absorb failing banks, said Brian Klock, the senior vice president of equity research at Keefe Bruyette Woods.

"Investors have already started to pick those winners and give capital to the banks that will make those acquisitions, and eventually be the strongest ones to make loans when the market comes back," Klock said. If the government assists a bank that capital markets are unwilling to invest in, it might be encouraging the wrong kind of behavior, he said.

"I'm a believer in capital markets, so I believe capital goes to those who can make the best use of it," Klock added.

The Treasury Department should view the program as an investment on behalf of taxpayers, said Jeffrey Hare, a partner at DLA Piper in Washington and chairman of the firm's financial services regulatory group. The agency will have to consider the likelihood that taxpayers would receive their money back. If that means one criteria is a bank's health, Treasury is likely to consider whether a bank is healthy in advance of giving the institution funds, Hare said.

"If you need the Tarp money in order to get to the threshold of being eligible, then the Tarp money isn't doing what it's supposed to be doing, which is work its way back out into the market," Hare said. "It's being used to build up and support the bank."

Michael Iannaccone, president and managing partner of MDI Investments in Chicago, said that of the approximately 2,000 community banks that have raised a red flag, about 800 are in critical condition. There are a number of criteria that could be used to whittle down the list of eligible banks, including whether institutions are already lending money to small businesses, how well they've used Small Business Administration programs in the past, whether banks are well-capitalized, and which banks have higher Community Reinvestment Act ratings.

Other considerations for eligibility will likely include a bank's location and market conditions, its lending and management history, what kind of support it has from regulators, and what it intends to do with the money, Hare said.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.