The threat of losing community banks in the home lending space, prompted Federal Reserve Board Governor Elizabeth Duke to propose the creation of a separate regulatory regime for smaller banks this week.
While speaking to the Community Bankers Symposium in Chicago, Duke said one-size-fits-all regulatory structures ignore the unique burdens community banks face when dealing with Dodd-Frank Act rules and Basel III capital requirements.
"Balancing the cost of regulation that is prescriptive with respect to underwriting, loan structure, and operating procedures against the lack of evidence that balance sheet lending by community banks created significant problems, I think an argument can be made that it is appropriate to establish a separate, simpler regulatory structure to cover such lending," Duke said during her speech.
Duke is one of the first Fed Governors to go on the record, saying she believes regulation is starting to reach a point where its benefits are now outweighed by the risks of overburdening community banks and forcing them out of home lending altogether.
For starters, higher-interest rates and balloon payments have become targets of lending regulations tied to Dodd-Frank and the Consumer Financial Protection Bureau. But community banks have successfully used these products time and time again in the past.
Unlike subprime lenders, which abused these tools to drive volume and then sold them through the securitization channel, community banks generally hold the risk on their balance sheets, Duke asserted.
"They use higher interest rates to compensate for the lack of liquidity in these loans or to cover higher processing costs because community banks lack economies of scale, and they use balloon payments as a simple way to limit their interest-rate risk," Duke said.
Concerns over new capital requirements and additional operating procedures could push community banks away altogether, Duke said. This is a problem when considering banks and credit unions together represented 25% of all originations in the U.S. marketplace last year.
Rather than imposing the same regulatory structure on all institutions, Duke proposes the creation of a separate regulatory regime that possesses the skills to evaluate smaller banks on the disclosures they make and through on-site bank supervision.