WASHINGTON — Community banks should consider agreeing to higher capital standards in return for a simpler capital compliance regime, Federal Reserve Board Gov. Daniel Tarullo suggested Thursday.

During a speech before the Independent Community Bankers of America, Tarullo once again endorsed specific carve-outs from the Volcker Rule and executive compensation rules for small banks from the Dodd-Frank Act. But he went one step further by suggesting small banks might prefer to face higher capital standards closer to the original Basel I rules in return for less complex capital requirements.

"One idea I have heard is to allow smaller community banks to opt into a simpler set of risk-weighted capital requirements in exchange for a higher minimum required ratio than under the more risk-sensitive, but more complicated, standardized risk-weighted requirements finalized in 2013," he said. "I believe the concept of a 'simpler' set of requirements is meant to describe something much closer to Basel I in terms of the detail and number of risk categories."

This idea would solve the problem of maintaining leverage and risk-based standards as required by the Collins Amendment, he said. Tarullo added it might be a good deal for community bankers because many of them hold higher capital than required already.

"Because so many smaller community banks maintain capital levels well above minimum regulatory levels anyway, the tradeoff of higher requirements for a simpler approach may be promising," he said.

Tarullo did not explicitly call on Congress to pass a bill allowing this trade-off, but his comments come as lawmakers in both chambers are debating regulatory relief bills. The Senate Banking Committee is due to vote on a relief bill May 14, but the details of the legislation have not been settled upon.

During his remarks, Tarullo outlined the so-called "tiered approach" that the Fed has taken toward bank regulation since the passage of Dodd-Frank, where larger and more complex banks face more elaborate compliance burdens than smaller and less systemically risky institutions. That approach is based on the financial reform law's mandate but also because "the possible failure of a community bank self-evidently poses no risks to the financial system," Tarullo said.

But he argued that the compliance burden from Dodd-Frank rules poses a risk to community banks and the communities they serve. He argued that the Fed needs to find effective ways to reduce those burdens as much as possible in order to preserve the services that community banks provide to areas that larger banks often fail to reach.

"Just as rural customers would be denied credit if their bank fails, they would also be denied credit if their bank's costs make it an unviable business proposition," Tarullo said.

Among the Dodd-Frank rules that are burdening small banks, he reiterated that the Volcker Rule — which prohibits banks from engaging in proprietary trading on its own account — and the restrictions on incentive compensation for loan officers deserve particular attention.

"There is, in my view, no need to make particularized prudential requirements of this sort applicable on a mandatory basis to thousands of community banks," Tarullo said. "Indeed, the Volcker Rule and the Dodd-Frank Act incentive compensation provisions present almost prototypical cases in which minimal potential safety and soundness benefits are outweighed by the compliance costs faced by those thousands of banks."

The Volcker Rule has already been the subject of several bills, including some that would carve out community banks entirely or seek to blunt its impact in other ways. The Fed late last year effectively extended a deadline for some important provisions for the Volcker Rule from July 2015 to July 2017, which many observers said bought banks time to lobby Congress to change the requirements legislatively.

But Tarullo did not advocate a roll-back of all community bank rules. He pointed to the Fed's treatment of high-volatility commercial real estate in 2013 capital rules that he said should apply to all institutions because it was the cause of failures during the financial crisis. He acknowledged, however, that the process might be made less onerous by assessing the proportion of such loans a bank underwrites rather than assess an institution's portfolio loan-by-loan.

"We do need to take account of HVCRE risks, given that commercial real estate lending accounts for a significant percentage of the assets of many community banks," he said. "But we can look for ways to simplify the specific capital requirements while ensuring that appropriate capital buffers exist."

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