Small banks battle regulators on capital requirements

November 13, 2012

Community banks say they may be pushed out of the residential mortgage market, leaving it in the hands of a few lending giants, because of an effort by global regulators to make banks hold more in their reserves in the event of a crisis.

The move will hit smaller banks harder than big ones, lessening their ability to provide mortgages and other loans to consumers, community bank advocates say.

Their complaints, which will be aired during a hearing on Capitol Hill Wednesday afternoon, follow long-standing concerns that out of the crisis a few behemoths, such as JPMorgan Chase and Wells Fargo, are dominating banking.

In the mortgage market, the collapse of several big players have allowed smaller ones to grab greater market share. But these gains could be threatened once a set of international banking rules, known as Basel III, start to take effect next year. Those measures would force banks to hold larger buffers against losses.

So far, their arguments are gaining traction with federal banking regulators. Despite a global deadline to implement proposed rules by the first of the year, U.S. regulators have decided to delay.


Markets share mortgage lenders in 2004 and 2011. (The Washington Post/Source: Inside Mortgage Finance magazine)

In attempting to address industry concerns, policymakers are facing a vexing dilemma: Should the United States force its banks to create reserves that could enhance their safety? Or should officials ease up on stricter rules that could stymie lending and further stall the sputtering economy?

Critics of the lobbying effort by community banks say they are helping the industry get around rules meant to protect the financial system from collapse.

Community banks and credit unions together held one-quarter of the home loan originations in 2011, up from a combined market share of roughly 16 percent in 2004, according to the most recent data gathered under the Home Mortgage Disclosure Act.

Federal Reserve governor Elizabeth Duke presented this data in a speech Friday advocating for smaller banks to have separate rules for mortgages. She noted that the Basel rules take aim at some products, such as balloon mortgages, that are key elements of traditional community bank lending.

Balloon mortgages, in which the borrower faces a massive principal payment after a set number of years, helped contribute to the surge in delinquencies and defaults when house prices collapsed. Duke contended that community banks suffered fewer losses on those kinds of mortgages compared with subprime lenders, and therefore should not face the same restrictions.

“Basel treats balloon mortgages like battery acid,” said Cam Fine, president of the Independent Community Bankers of America, an industry trade group. “It would force three-quarters of all community banks to either totally shut down their mortgage lending or sharply curtail lending.”

The association is leading a revolt against Basel, rallying nearly 15,000 small banks to protest what Fine considers a one-size-fits-all approach. The outcry from institutions, which filed more than 2,000 comment letters on the proposal issued by regulators in June, took hold at the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp.

In a joint announcement Friday, the three banking regulators said, “In light of the volume of comments received and the wide range of views expressed during the comment period, the agencies do not expect that any of the proposed rules would become effective on January 1, 2013.”

Banking groups cheered the decision, but some consumer advocates are imploring regulators not to lose sight of the importance of improving safety and soundness at banks of all sizes.

“It’s important to make sure that community banks have adequate capital; we’ve seen 400 community bank failures since the crisis began,” said Marcus Stanley, policy director at Americans for Financial Reform.

At the same time, Stanley agrees that some exemptions for smaller banks may be necessary to keep the mortgage market competitive. “There are serious problems with antitrust issues and market power held by the largest banks,” he said.

JPMorgan and Wells Fargo, the nation’s largest mortgage lenders, have said they do not intend to make home loans much cheaper for borrowers. They are enjoying sharply higher profits in mortgage lending, helped in part by the Fed’s continued efforts to push down the costs of issuing loans.

Banking regulators, which declined to comment ahead of the hearing, have worked closely with institutions to address the concerns of smaller banks. Over the summer, regulators released a calculator that enabled banks to estimate the amount of capital they would need to hold under the proposal.

The financial reform law of 2010 “eliminated the ability to do a whole plethora of risky mortgage products,” said David Stevens, president of the Mortgage Bankers Association. “Basel is extreme and can cause an extraordinary structural shift in the mortgage market at a time when the housing market is in recovery.”

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