Recent changes and discussions regarding increasing bank capital standards suggest that community banks could be required to add additional capital to their operations. Any change could seriously impact their ability in maintaining historical service to small businesses and the banking needs in local communities.
Banking regulators have jointly adopted a change to establish a standard minimum capital floor for all banks. This change moves the larger banks off the Basel II risk weighted approach for minimum capital determination to the same level expected for smaller banks.
All banks want a level playing field, however it is broadly recognized that minimum standards are only a base determinant and additional capital is nearly always mandated for specific bank weaknesses and higher risk activities. The expectations for total bank capital standards remain uncertain as the Fed openly considers the level of additional capital that will be required in response to Dodd-Frank.
By the end of 2011 the Fed must establish special capital standards for banking institutions determined to be "systemically" important. This requirement will include mandating additional capital for about 30 banks and financial institution larger than $50 billion and is intended to provide greater protection and economic well being in the event of any future systemic financial crisis.
Many are speculating that this change will require a capital ratio increase of at least 3% for the included institutions. The Basel III committee recently established a similar systemic international standard of from 1 to 2 1/2%. Fed Governor Tarullo spoke of the possible need to double the 7% Basel III minimum capital standard to meet this objective. A 3% increase for the five largest U.S. banks alone could require an additional $250 billion of capital and most likely twice that amount when all the largest institutions are included.
These largest companies operate in markets worldwide including traditional commercial banking, investment banking, trading, arbitrage, market-making, underwriting, distribution, insurance and derivatives. These companies conduct these activities under varying capital standards, regulations and complex multiple supervisory authorities.
It is easy to accept that greater capital cushions could provide increased comfort to the risks associated with financial institutions. However, this collection of multi-market and multi-industry based institutions are so large, move so fast and are so intertwined that additional capital could never fully protect the system from unexpected financial chaos. What should be recognized is that capital alone, while comforting, will not prevent governments from being the final backstop to financial calamity as most of these largest companies are still "too big to fail."
Interestingly the possible failure of the complex securities, insurance and mega-loan activities of the largest companies underlie the fears of Washington. In this group there is no comparability to the business activities or the traditional small business and consumer loan markets that are the mainstay of the nearly 7,000 community banks.
Nothing sounds wrong with greater protection from the unknown impact of financial disruption provided there are no unintended consequences. In an environment of equalizing capital standards, demands for more capital and continuing public apathy toward banks and bankers it's hard to imagine that new systemic capital requirements will not increase the capital expectations for community banks. Consciously or subconsciously the community banks will most likely be dragged by Washington and banking regulators to higher capital standards. Neither has offered community banks any words of comfort or assurance in this regard.
It's also hard to imagine that regulators will permit community banks to operate with capital levels less than the largest financial companies. To do so would be a reversal of historical patterns. Increasing capital standards seem evident even though the community banks offer only basic banking products, are not a threat to the financial system and business models are dissimilar from the largest financial institutions.
A level playing field has always been supported by community banks, but the anticipated capital standard changes for the largest institutions could lead to higher requirements for community banks. The general mantra of Washington is they have never seen a new dollar of capital that they don't like.
Any changed capital standards impacting community banks should be considered with deep concern for the impact on their ability to facilitate the credit needs and economies of their local markets. At a time when economic and job considerations are so important, any unintended consequences of the new systemic standards on community banks should be avoided.
Robert H. Smith, former chairman and chief executive of Security Pacific Corp., is a founder and director of Commerce National Bank in Newport Beach, Calif.
