Context
As many of you know, I spent six years as a bank regulator in the Securities Disclosure Division of the OCC. Since moving out to the Northwest, I have had the privilege of being involved with several hundred community banks ranging from de novos to capital raises and from enforcement actions to mergers and acquisitions. I think it is fair to say that I have seen both sides of the regulatory equation in banks throughout the U.S. and heavily in the West.

I have worked on the Bert Lance investigation, the Change in Bank Control Act, SEC Guide 3, and participated in meetings with the full SEC commission and its senior enforcement staff, as well as all of the federal banking agencies and many state banking agencies. I have witnessed the ebb and flow of the economy and regulatory environment. Recent events have compelled me to write this article about my observations regarding community banking and its future. No one has a crystal ball, but reading the tea leaves isn’t that challenging, so here we go.

Recent Events
Just last week I attended the combined OBA, IBA, NBA conference in Idaho. The combining of these three state groups, which has occurred over the last several years, is symbolic of the massive consolidation in the industry. We are fast approaching 6,000 banks, down from 14,000 thirty years ago. I would guess that among Oregon, Idaho, and Nevada, there are fewer than 50 banks combined. At the OBA conference, FDIC Vice Chairman Tom Hoenig, a lifelong economist, gave a straight-talk speech that included his attempt at rolling back Dodd-Frank for community banks (which he defines as under $10 billion).

What impressed me most about Vice Chairman Hoenig was his honesty. In response to questions about the fate of community banks, he candidly stated that the real problem was that Washington, D.C. was split, with half of the powers favoring the “European banking model,” i.e., five mega banks with many branches. These are not exactly encouraging words for the community banking industry.

In a recent American Banker, I saw two articles along these lines, one discussing whether Dodd-Frank was to blame for the scarcity of de novo banks and the other from my old distinguished colleague Tom Vartanian, saying banks must fight for regulatory balance. Just prior to that, Comptroller Tom Curry was quoted as saying that community banks should essentially “stick to their knitting” and not take undue risks to make a buck in today’s brutally competitive low-interest-rate environment.

Well, let’s take the gloves off and explore where we really are.

Historically Low Interest Rates
There is no way to ignore the fact that the protracted low interest rate environment has savaged banks’ margins and negatively impacted earnings. Combined with keen competition for good loans, this is not a good recipe for growing earnings. Hence, many banks buy or sell to address this ongoing challenge.

Regulatory Burden
Dodd-Frank surely was the icing on the cake. The cost of regulatory compliance has escalated particularly for the smaller community banks as a disproportionate amount of their revenues are now spent on compliance. Clearly, as loan problems have mitigated, the regulators have refocused their attention on compliance, which has become something of a passion. Very little tolerance is being shown these days, particularly anything remotely smelling of BSA reporting or compliance.

De Novo Banks
Chairman Gruenberg blamed the lack of new bank formations since the recession on the economy and he is, in part, correct. Low interest rates have made it very challenging since margins are so skinny for growing banks. But let’s be honest, the FDIC’s recently suspended ad hoc “seven year rule” was a huge impediment to de novo formations. Add to that excessive capital requirements and obscene compliance costs and investors don’t see a good opportunity.

The irony is the FDIC, in trying to protect the insurance fund, has asked for huge capital in relatively small markets. This creates inordinate pressure on those banks to grow into their capital to satisfy investors and sets higher than necessary or prudent legal lending limits.

If the FDIC truly wants more new banks, then it needs to strike a healthy balance with appropriate, but not excessive, capital requirements and proportionate compliance costs. The problem is, as Vice Chair Hoenig candidly admitted, D.C. is split down the middle on community banks, so why encourage more new ones?

Community Banks–The Heart and Soul of Communities
As I have said before, community banks are part of the fabric of our country. While accounting for less than 10% of the lending in this country, they fund 40% of the small business lending in the United States. Many rural communities would be lost without their hometown community banks. So, fundamentally, we better have an honest conversation as to whether the powers that be really want community banks. I certainly have my doubts.

Where Do We Go from Here?
Well, we need open and honest conversation with the bank regulators and Congress about where we are and what we really want going forward and no more lip service or political pablum. Collectively, the risk to the FDIC insurance fund or the banking system as whole by community banks pales in comparison to the “too big to fail” mega banks. Let’s put the issues on the table and deal with them. If we are all serious about community banking, we collectively need to take steps to remedy this situation.