The Federal Reserve Board's plan to limit the amount of nonvoting stock that banks may count as Tier 1 capital would weaken the specialized ownership of minority-owned and family-owned banks, critics of the plan say.
The Fed's May 19 proposal to relegate some nonvoting stock to Tier 2 capital is part of a wider effort, one that has gotten much more attention, to continue including trust-preferred securities in Tier 1 capital calculations despite adjustments to generally accepted accounting principles that threw regulatory treatment of the instrument into doubt.
The proposal is not specific. Rather it states that a banking company relying excessively on nonvoting stock (including nonvoting common stock) may be required to allocate a portion of its nonvoting stock to Tier 2 capital.
Norma A. Hart, the president of the National Bankers Association, said the group's members, minority- and women-owned banks, tend to serve poorer communities and can have a hard time raising capital within their markets. So, to retain their minority ownership, they sell nonvoting stock to individuals and entities outside their communities, including Fannie Mae and larger companies like Citigroup Inc.
In a comment letter to the Fed, Ms. Hart wrote, "Our banks might just decide not to issue any nonvoting common or perpetual preferred stock in the future, but then they would be eliminating a fertile source of capital for which there may not be any substitute."
Likewise, family-owned banks, wanting to retain their ownership while still raising additional capital to grow, could face similar problems, said David Baris, a lawyer with Kennedy, Baris & Lundy LLP in Baltimore.
In an interview last week, Norah Barger, an associate director in the Fed's division of banking supervision and regulation, said that the proposed rule tracks what the agency has spelled out in bank examination manuals since 1996. "This is not breaking any new ground," Ms. Barger said.
Mr. Baris disagreed. The examination manuals state that it may be appropriate to reallocate some of the nonvoting equity elements from Tier 1 capital to Tier 2 capital, he said, but under the proposed rule the Fed says that nonvoting stock generally will not be considered Tier 1 capital.
"For an examiner in the field, the change from 'may' to 'generally will not' would be a big difference," Mr. Baris said.
Examiners may also be more inclined to force banks to reallocate portions of nonvoting stock as Tier 2 capital after the Fed "elevates" this stance from a policy guideline to a rule, Mr. Baris said.
"But the more important question is, whether this rule change makes sense," he said. "I don't think the Fed properly aired all of the issues why they are treating nonvoting stock differently than voting stock - it's still permanent capital."
Ms. Barger said that the Fed is concerned about situations where management may have very little of their own money at risk and are more inclined to take unwarranted risks.
"In 1989 the thrift industry had widespread problems," she said. "You often saw decisions based on a double-or-nothing strategy. For those who didn't have much at stake, the upside potential was great, since the risk would be held by the FDIC, whose insurance fund would pick up the pieces if needed. It was quite common."
Corporate governance issues are a legitimate concern, but it is not appropriate to address them within the context of capital regulations, Mr. Baris said.
"It's the people that regulators should deal with - the capital structure is neutral," he said. "There are plenty of techniques that the agency has to address those who are abusing their positions. This is a broad sweep approach, which would also affect banks that use two classes of stock for a number of legitimate reasons."
Ms. Barger said examiners would have discretion to work with banks, making their determinations based on the circumstances of each case.
"For example, some small family-run institutions have had problems meeting the requirement when they grow over $150 million in assets - the threshold over which the rules apply - and we have allowed them time to transition to a solution that we have worked out with them," she said.
Ms. Hart said that after she submitted her comment letter, Fed officials called to say that her group's members should not be alarmed, and that the Fed would try to be flexible.
"My gut feeling is to trust them and not be too concerned, but I really need more information," Ms. Hart said. "I still stand by my comment letter."
