Growth Strategies

Small Business Fights Borrowing Squeeze

"I am convinced that creating a large disparity in capital standards between the large and small banks will lead to increased consolidation, leavin...
Rob GarverSeptember 27, 2006

Unless the playing field is kept level to enable small banks to compete with big ones, corporate borrowers in the United States will face a market where there’s less competition for their business, a former top banking regulator on told Congress on Tuesday.

In testimony before the Senate Committee on Banking, Housing, and Urban Affairs, former Federal Deposit Insurance Corp. chairman William Isaac said he was concerned about a proposal to allow large commercial banks to hold less cash in reserve against bad loans in exchange for implementing sophisticated risk management programs.

Ironically, a representative of the big banks argued at the same hearing that they would be hindered in competing with their counterparts in Europe and Asia if U.S. rule makers fail to loosen proposed capital restrictions on domestic lenders. The possible result for many corporate borrowers here: their future loans might move offshore.

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But Isaac was worried about the current huge wave of consolidation in U.S. banking, noting that the 25 largest banking companies now control about 70 percent of the nation’s banking assets. “I am convinced that creating a large disparity in capital standards between the large and small banks will lead to increased consolidation, leaving fewer banking choices for smaller businesses,” the former FDIC chair said.

The paucity of choices could have serious consequences for small-town America, some say. Indeed, loans from community banks reportedly account for more than a third of all borrowing by small businesses.

While more banking mergers are “inevitable,” said Isaac, now chairman of the Secura Group, a financial services consulting firm, they “ought to be driven by market forces, not by capital rules that favor larger banks.”

His remarks came in a hearing that looked at how U.S. banking regulators plan to install a new international bank capital accord designed to harmonize the regulatory capital requirements for banks that operate across borders. While the accord allows banks to pick from a number of options in how they can set regulatory capital, U.S. regulators announced in 2003 they would limit the choices available to banks in this country.

The ten largest U.S. banks would be required to adopt the most sophisticated risk management programs described in the accord. The remainder of the banks in this country – over 9,000 – would not adopt the new accord at all. Instead, they would be regulated under the old standard.

An outburst of complaints from mid-sized and community banks, which feared that lower capital requirements would leave the largest banks in a position to undercut their smaller competitors on loan pricing, successfully pressured regulators to promise an update to the old standard. The update would offer small-sized and mid-sized banks the potential to lower capital as well.

At Tuesday’s hearing, several participants were intent on making sure that the updated standard would do just that. Kathleen Marinangel, chairman, president, and chief executive officer of McHenry Savings Bank in McHenry, Ill., testified that her bank would be placed at a “serious disadvantage” unless capital requirements were lowered to better reflect the true risk of its loan portfolio.

The banker said that a cut in the capital her company had to hold for risk-based assets would enable the bank to make more small business loans. But more importantly, it would allow McHenry to remain competitive. McHenry, Ill., a town of 24,000, has 28 different banks. McHenry Savings competes not only with national powerhouses like J.P. Morgan Chase and Bank of America, but with foreign-owned banks like Harris National and LaSalle/ABN AMRO.

Regulators insisted that they now recognize the need for competitive equality in the industry and promised to deliver it. “It is fundamental to fairness and capital neutrality that we maintain comparable (not necessarily identical) risk-based-capital requirements for lending activities that have approximately the same risk characteristics, regardless of the lender,” said John Reich, director of the Office of Thrift Supervision.