The financial crisis of 2007-2009 has produced a playing field increasingly tilted against community banks and a general danger for all banks that regulatory burdens will increase markedly as compared with un- and underregulated financial firms.
This is bad not only for the banking industry but also for the American economy. Regulatory anomalies create economic inefficiencies that translate into less safe and sound financial institutions and less sound credit being made available to the marketplace.
Once the financial crisis was at a full boil, the Treasury, Federal Reserve and financial regulatory agencies rightly, through a variety of mechanisms, kept many larger institutions from failing. They did this by dramatically increasing access to the discount window, making available new discount window products and injecting capital directly into institutions. In addition, the regulators created a more understanding and flexible regulatory climate. To have done otherwise would have risked a meltdown of our financial system with Depression-like consequences.
However, the flexibility the regulatory community has shown vis-à-vis the "too-big-to-fail" banks — roughly defined as those banks subject to the stress test — has not been in evidence for the community banking sector. Even community development banks have been subject to cyclically harsh orders and requirements with a much smaller dollop of the financial largesse available to their larger brethren. This is unwise.
Our community banking sector fulfills an important role in communities all over America, particularly for small and midsize businesses. These institutions did not cause the current financial crisis; their woes are the product of failures triggered by the activities of under- and unregulated entities and entities with more leverage and capital markets expertise.
I am not arguing for forbearance. The fact of the matter is our bank regulatory agencies did a much better job than they are being given credit for in regulating banks. In the past decade regulators have faced a tough environment in which markets were too liquid, underregulated competition too prevalent, interest rates too low and yield curves flat or inverted. But now is not the time to let the regulatory pendulum swing from harsh to harsher. (As an aside, point-in-time regulatory response has many of the same weaknesses as mark-to-market accounting.)
Now is the time for regulators to work with the well-managed community banks wherever possible to raise capital and dispose of troubled assets. Regulators must look for ways to help these institutions rather than find reasons to close them.
Why not, for example, inject community banks with regulatory "rescue capital," the same strategy that is helping to revive much larger financial institutions? Why not ease onerous accounting rules that force banks to write down investments to fair value when there is a strong possibility they will recover in an improving economy? What is the harm in establishing a separate regulatory unit that works with banks that specialize in low-to-moderate lending? Why not take a longer-term view since many of these well-managed community banks have weathered two and three tough cycles and need only one thing to survive — time?
Certainly, we should develop methodologies so that the healthy parts of the banking system, including community and regional banks, would not be required to pay extra FDIC assessments — right in the middle of the crisis — for the sins of less well-run institutions. Right now, the FDIC has little choice but to make these assessments. However, Congress, with the encouragement of the entire regulatory community, should step in and at least temporarily replenish the FDIC fund, giving banks time to fully recover before paying additional assessments.
And indeed, a strong case can be made that the healthy banks should never pay the tab. After all, the strong banks did not cause the fund loss and had no way of causing the weak banks to perform more prudently. Assessing the healthy banks for the weak banks' past sins simply serves to make the whole system weaker.
In sum, the government can and should take a number of steps to help the community banking sector weather the current storm. Doing so will help to restore credit availability more quickly and revive our economy to everyone's benefit.