Introduction

Square-Off: Are Financial Institutions Overregulated?

We ask this question because it matters, not just to banks but to the entire U.S. economy. We need a healthy banking system for the economy to thrive. But banks are in a bind. On the one hand, we have the "fintech" upstarts who are making inroads into consumer lending and wealth management, to name two areas. They are disrupting traditional business models. On the other hand, we have banking regulators, who, in the wake of the financial crisis, have really clamped down on banks. What has that ..

Regulation is essential to ensuring safety, soundness, resiliency, and consumer protection within the banking system. And, since banks occupy a special place in our economy as financial intermediaries that receive the benefits of what is essentially a government subsidiary in the form of deposit insurance, some degree of regulation is needed to guard against the possibility of overly risky behavior that may jeopardize taxpayer dollars.

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William Stern

That being said, there’s a sense among community bankers that the current model of “one size fits all” regulation simply doesn’t work. Given their smaller size and more limited resources, it’s no surprise that smaller institutions disproportionately shoulder the effects of regulation. With a few notable exceptions for institutions that reach $10 billion or $50 billion in assets, most bank regulatory requirements in the United States apply to all banks and make no distinctions based on the riskiness of an institution’s activities or the markets in which it operates.

As an example, banks of all types are required under guidance issued by the federal banking regulators to implement a robust third-party vendor management program that is commensurate with the operational, compliance, reputational, and other risks arising out of relationships with third parties.

The guidance directs banks to apply more comprehensive and rigorous oversight, both initially and on an ongoing basis, to third-party relationships that involve critical activities, including vendors that process transactions or have access to sensitive customer information. Needless to say, banks devote considerable resources to complying with these requirements.

However, for community banks, the most critical third party relationship typically involves core processing, often with a national provider that serves banks across the country. So the emphasis on vendor management means that community banks across the United States are duplicating each other’s efforts to oversee the same vendors that in many cases are already subject to examination by the federal banking agencies.

Another example relates to capital requirements. Banks of all types are subject to the Basel III capital standards, including the capital conservation buffer and requirements related to calculation of capital and risk-weighted assets. These requirements were adopted following the financial crisis to better match the amount of capital a depository institution must hold with the exposures that it faces; the impact of Basel III has been to significantly increase the amount of capital required in the banking system.

FDIC Vice Chairman Thomas Hoenig has proposed regulatory relief from a number of requirements, including the Basel III capital standards and associated capital amount calculations and risk-weighted asset calculations for traditional banks that engage primarily in deposit taking and lending and do not engage in riskier activities. Only institutions that do not hold trading assets and liabilities and do not hold derivatives positions other than interest rate swaps and foreign exchange derivatives, whose total derivatives exposure does not exceed $3 billion of notional value and that have a GAAP equity-to-assets ratio of at least 10%, would qualify for relief. While some in the banking industry may question whether the last requirement is properly calibrated, this proposal would break with the current model of applying most bank regulatory requirements to all institutions across the board.

There’s no question that we need a strong regulatory regime to keep our banking system safe, but we can and should look for opportunities to more closely align the degree of regulatory burden to which an institution is subject to the riskiness of its business.

William Stern is a partner in the firm’s financial industry, banking, consumer financial services, and fintech practices.

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