While many Americans spent the holidays unwrapping presents with loved ones, their local economies were jeopardized by a new federal rule affecting financial institutions large and small. Issued by financial regulatory agencies shortly before Washington went dark for the holidays, a Dodd-Frank provision designed to rein in abuses on Wall Street instead threatens the well-being of the Main Street community banks that did not contribute to the recent financial crisis.
Regulators finalized the Volcker Rule, which bars depository institutions from engaging in risky trading activities for their own benefit. While many community banks generally support the concept as a way to mitigate risks to the financial system, the final version of the rule includes a serious flaw that represents a dealbreaker and a significant threat to Main Street institutions.
The rule would require all banks to sell off their holdings of an obscure type of security that banks issue to raise capital, known as collateralized debt obligations backed by trust-preferred securities. It's bad enough that community banks would have to sell their holdings of these securities in relatively short order by July 2015 instead of holding them until their value recuperates. Even worse, in many cases, they would have to recognize the loss on their balance sheets immediately. This would force Main Street community banks to write down these investments at yearend fire sale prices that would result in a permanent loss of capital weakening institutions devoted to promoting local economic growth.
Regulators have recognized the problem, though they have not yet taken concrete steps to fully address it. On Dec. 19, they released frequently asked questions that community banks should consider in determining whether they will be forced to divest their Trups CDOs under the Volcker Rule. On Dec. 27 the agencies said they are reviewing the rule and will determine by Jan. 15 whether it's appropriate not to cover Trups CDOs under the Volcker Rule. In the meantime, many community bankers worry they will wind up in violation of yearend accounting and auditing standards.
If regulators want to limit the damage in Main Street communities, they should completely exempt these Trups CDOs from the Volcker Rule. This would avoid needless writedowns without putting Main Street communities at financial risk.
Much damage has already been done, as financial markets have devalued the securities and several institutions have offloaded their holdings at considerable losses. The regulators should act now to prevent further damage.
Regulators left many community bankers a lump of coal for the holidays. A cup of kindness, and a little common sense, will help ensure community bankers and the local economies they serve have a happy and successful new year.
Camden R. Fine is president and CEO of the Independent Community Bankers of America.