The Federal Reserve's Regulation F, mandated by the 1991 banking law to reduce interbank credit exposure, poses a threat to the bankers' banks that many community banks rely on for correspondent and related support services.

This raises a question about the effectiveness of the Federal Deposit Insurance Corporation Improvement Act of 1991.

While it set out to address the "too big to fail" problem, it caught in its net 16 bankers' banks, whose aggregate assets and deposits cannot be construed as posing a too-big-to-fail risk.

Dwindling Alternatives

The tragic result would be to leave throngs of community banks with no alternative. They would be obliged to do business with the same large institutions whose lack of competitive ethics drove them to start bankers' banks in the first place.

A respondent bank would have to limit exposure to 25% of its capital in a correspondent deemed "not adequately capitalized."

The exposure could be as great as 50% in the case of an "adequately capitalized" correspondent. And there would be no limit for one that is "well capitalized."

It would be necessary for respondents to monitor their correspondents' conditions on a daily basis. If the upstream correspondent is part of a holding company with four or more banks, the exposure could be apportioned to allow for full compliance in good times and bad. But that is a big "if."

Two Exemptions

As a double whammy against bankers' banks, the Federal Home Loan Bank System and Federal Reserve System are both exempt from the provisions of the law.

Although the regulation could easily have made a distinction between bankers' banks and traditional correspondents, it does not. It plays into the hands of the big banks, which have never abandoned their goal of eliminating bankers' banks.

But the legislative intent was clear and not ambivalent: Bankers' banks were not supposed to be sacrificed to the new law.

Correspondent banking, in its heyday from the end of World War II into the 1970s, was a source of profit and satisfaction for banks of all sizes - until the money-centers and regionals decided to bypass their smaller customers and pirate their business away.

Feisty Contenders

While some smaller respondents were placated by free downtown parking, baseball and football passes, fishing trips and other frivolities, a few unhappy Minnesota bankers decided to fight back.

By 1975 they overcame severe political obstacles to open a bankers' bank in which they were the investors, users, owners, and management.

Today, 16 such banks operate successfully in as many states. Their importance and contributions to the communities they serve are well documented and indisputable. But their future is now in the hands of the regulation-writers at the Federal Reserve Board.

The Fed cannot claim "ignorance of legislative intent," or of the harm their Regulation F could inflict on their smaller competitors. The Fed should know full well how markets will become more concentrated if there is a reduction in the number of competitors.

What is clear is that the Federal Reserve Board members are not in concert with their staff on this question. Regulation F as drafted is a staff position before the Fed, not a board position. When the final decision is rendered, it will show who holds the power at the central bank.

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