The three primary bank regulators are closely watching how community banks expand into commercial and industrial lending.
"You always need to be cautious on the latest and greatest … and everybody seems to want commercial lending now," said Darrin Benhart, deputy comptroller for credit and market risk for the Office of the Comptroller of the Currency, at the Risk Management Association's annual conference in Washington Tuesday.
"That's an area we're keeping an eye on."
Speaking on a different panel Monday, a Fed representative voiced similar concerns.
As banks expand existing businesses or add new products and markets, "our main concern is how effective of a job are you doing from a risk management perspective," said Robert Walker, a senior supervisory financial analyst at the Fed.
Walker cautioned banks about moving unskilled loan officers into commercial lending. He gave an example of a bank that received a case-and-desist order because of two loans that were underwritten by unqualified officers. "We want to make sure you have the people in place who understand the industry and understand the risk of the industry," he said.
Walker said regulators are looking for three things in new loans: the degree of upfront due diligence, how the bank controlled risk and whether the loan ended up performing in line with original expectations.
Another key concern for regulators at the conference: how smaller banks will navigate through the plethora of changes outlined in the Dodd-Frank Act.
"The reality is that even though it [Dodd-Frank] is focused on larger banks primarily, there are aspects you will want to monitor," Benhart said.
At the forefront of all the regulators' concerns were loan workouts and monitoring exposure to new loans, and not just C&I loans.
For example, on Monday, Richard Buczynski, the chief economist at IBISWorld, shared a study showing that agriculture had the most growth potential in the next five years for loans. Even that raised flags with some of regulators.
While regulators encourage diversification for smaller banks to move away from an over-concentration in real estate, "there are concerns about agriculture lending and commodity prices," said Jack P. Jennings 2d, a senior associate director in the Fed's Division of Banking Supervision and Regulation, during a panel discussion Tuesday. "That is something we will watch closely as the global economy rises and falls."
Jennings differed from Walker, his associate at the Fed, saying that banks' inability to make new loans could contribute to another recession.
"We're not trying to throw caution under the bus about concentrations," Jennings said. "But we could throw ourselves under the bus in a second dip here with a do-nothing strategy."
Regulators acknowledged complaints coming from banks of all sizes about disadvantages in competition and regulation from Dodd-Frank.
"The large bankers complain to us that the smaller banks are giving up on structure or are not as diligent about the financials or guarantors" on a loan, Benhart said.
"The small guys say the large banks are pricing [loans] at a point they can't compete with," Benhart added. "We acknowledge and recognize there isn't the same level of robustness and complex monitoring and controls necessary for community banks as there is for large banks."
Benhart told attendees that the OCC has the structure and capacity to handle big and small banks.
"Sometimes we get tagged with the moniker of being a large bank regulator," Benhart said. Due to the OCC's absorption of the Office of Thrift Supervision in July, "we will have an even larger emphasis with community banks and the issues they face."
Overall, the Dodd-Frank Act could reduce earnings per share at small to midsize banks by 10-20%, according to KBW Inc. The hit could be 11-25% for bigger banks, according to KBW.
"So how do bankers digest all of it? I don't know if I have a great answer," Jennings said. Still, the Fed is working on ways to "articulate up-front to whom exactly these things apply and what is the impact," Jennings said.
"To the extent we can make clear what does and doesn't apply, from our standpoint at this point in time, that is the best approach," Jennings added.
Regulators also advised community bankers to get more pro-active monitoring and stress testing credits and new loan options, while watching capital levels and tying executive pay with risk.
"Compensation practices at smaller firms were not atop the list of things we saw contributing to the crisis," said Jennings. But "the alignment of incentive pay practices of all firms related to their time horizons with risk of certain activities is likely to show itself" in examinations.
Benhart said that formal capital ratio guidance is "very old and very general" but he was cautious to discuss any changes. "We're not looking to establish a new capital regime for community bank in this forum," he said in response to an audience question. There are "proactive things that we're trying to get many of you to think about as a 'lessons learned.'"