Rules meant for big banks could hurt county’s small banks

EVERETT — Banking reforms meant to fix the practices that led to the 2008 financial meltdown could end up doing more harm than good to the Snohomish County economy — and the nation.

Bank capital rules proposed by the Federal Reserve will likely make it more difficult for local businesses and individuals to obtain credit and could even drive community banks out of business, say some financial experts.

That would stifle smaller businesses, the lifeblood of the local economy.

The new federal rules enact an international agreement known as Basel III. International financial regulators conceived Basel III to create a more resilient banking sector by strengthening global capital and liquidity rules.

Regulators sought to put a stop to mega banks’ laissez-faire lending practices that led to the global financial crisis and U.S. recession in 2008. They want banks to rely more on equity than debt to fund themselves.

The international accord and the federal proposal would require banks to maintain capital equal to 7 percent of their risk-bearing assets. That’s about three times what’s required now. The rules would be phased in from 2013 to 2019.

In a comment letter to the Federal Reserve, the Independent Community Bankers of America asked regulators to exempt community banks from the proposed capital standards.

Applying the capital standards to community banks would shift the definition of regulatory capital, minimum capital requirements and risk sensitivities, representatives from the national organization wrote. The standards were “never intended to apply to a domestic community bank.”

They added that the proposals would significantly erode community bank profitability and credit availability and drive community banks out of business.

Requiring banks to have higher levels of minimum capital on hand is a positive change, said Mark Duffy, CEO and president of Mountain Pacific Bank in Everett.

What he objects to is the one-size-fits-all approach to calculating the risk of loans. The rules are needlessly complicated for small banks, which generally don’t offer complex investment and loan products such as collateralized debt obligations.

On some loans, the rules assign higher amounts of risk than before, which means a bank would have to hold more capital. That, in turn, limits the amount of money the bank can loan out.

For example, take a loan with a balloon feature. Mountain Pacific Bank doesn’t handle many mortgages, but when they do, they typically offer a fixed interest rate for the first five years, then adjusts the loan to current market interest rates — hence the balloon. This type of loan receives a much higher risk score under Basel III.

The new rules also change how capital assets are calculated. Some assets that are now considered part of a bank’s capital would not factor into the equation, which means small banks would be on the hook to raise even more capital they couldn’t loan.

Duffy estimates that the new requirements will decrease Mountain Pacific’s lending capacity by $11 million annually. That’s about 10 percent of the bank’s current outstanding loans.

Troy McClelland, president of Economic Alliance Snohomish County, warned in a letter to federal regulators and legislators that Basel III would likely stifle the local economy, “significantly limiting the capital available to small businesses, local developers and even our local governments.”

An analysis by EASC found that the rules could negatively affect more than 200 businesses and potentially harm 6,000 to 10,000 employees in Snohomish County. In an interview, McClelland described those as conservative numbers.

Officials from the state Department of Financial Institutions’ Division of Banks have raised similar concerns about Basel III and the Fed’s proposed rules. So have more than 50 U.S. senators in a letter to federal bank regulators.

So, too, has the Conference of State Bank Supervisors, a national organization of banking regulators. In a prepared statement, that organization called the capital requirements “highly reactionary” and not in the best interests of the U.S. banking system or the national economy.

Duffy supports strengthening capital requirements of community banks. In the past four years he’s watched half of Snohomish County’s community banks disappear, eaten alive by the economic crisis.

His own bank, Mountain Pacific, got stuck with some troubled loans when the economy fell apart, causing the Federal Deposit Insurance Corp. to place a cease-and-desist order on lending. FDIC has since lifted that order, after Mountain Pacific raised $10.5 million in additional capital, increased liquidity and added to its loan-loss reserve.

The solution, Duffy said, is to let the regulators who directly oversee local banks calculate the lending risk formulas, not an international banking committee.

The Conference of State Bank Supervisors recommends strong capital standards for community banks, but insists the framework must be clear and easy to implement and sustain.

“An overly complex capital rule will only increase cost to the industry, curtail credit availability and drive industry consolidation,” according to a prepared statement from the group of banking regulators.

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