The Future of Community Banks
As a consequence of the 2008 economic crisis, banking regulators have sought to implement measures to strengthen the global financial system. After several rounds of negotiations, regulators agreed to the Basel III Accord, a framework that includes increased capital requirements, higher risk assessment criteria, and improved stress test evaluation schemes. As proposed, these new rules and regulations will have a far reaching impact across a broad spectrum of banks and financial institutions.
The implementation of higher capital reserves and the imposition of higher risk weight averages under Basel III are key components of the overall framework aimed at insulating financial institutions from the ripple effects of an economic crisis. Originally slated to be implemented in the United States on January 1, 2013, banking regulators have postponed implementation for a later date. The Office of the Comptroller of the Currency has attributed the delay to the lengthy process of evaluating the large volume of comments submitted by stakeholders in response to the regulatory proposal.
In the months leading up to the original implementation date, community banks had been vocal in expressing their opposition to the application of the Basel III framework to their operations. More specifically, community banks have expressed concerns that the implementation of the new Basel III risk weight averages and capital requirements will have an adverse effect not only on the banks themselves, but also on the housing market and the overall economy. Fears that high capital requirements will reduce the amount of capital banks will have available to lend, that new standards will curtail the ability of banks to make multifamily, residential, or commercial real estate loans, and that regulatory compliance will be both costly and time consuming underscore community bank apprehension to the new regulations.
In deciding how Basel III regulations will be implemented, regulators have three options. Bank regulators could choose to impose Basel III requirements on all financial institutions regardless of size. This would mean that the same capital requirements and risk weight averages imposed on banks with $50 billion in assets would also be required for smaller banks. Conversely, community banks, or banks with $50 billion in assets or less could be exempted from applying Basel III requirements to their operations. Instead, regulators may choose to maintain the status quo and continue to apply Basel I standards which exempt community banks. Finally, bank regulators could opt to re-evaluate Basel III formulas and reduce capital requirements and recalculate weighted averages that apply to real estate transactions.
In delaying the application of Basel III, bank regulators have signaled a willingness to take into account the viewpoints of stakeholders that will be affected by the implementation of new rules. Nevertheless, upon assessing all available information, bank regulators must make a decision which reconciles the importance of strengthening the financial system and the views of stakeholders with U.S. international obligations. Regardless of the outcome, it is clear that any decision by regulators will have consequential implications on how community banks conduct business in the future.
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