INDEPENDENT COMMUNITY BANKERS OF AMERICA
"Consideration of Regulatory Reform Proposals"
United States Senate
Committee on Banking, Housing and Urban Affairs
June 22, 2004
President and Chairman
First National Bank of Las Animas
Las Animas, Colorado
Independent Community Bankers of America
Mr. Chairman, Ranking member Sarbanes, and members of the Committee, my name is Dale Leighty. I am Chairman of the Independent Community Bankers of America (ICBA)1 and President and Chairman of First National Bank of Las Animas, a $140 million-in-assets community bank located in Las Animas, Colorado.
I would like to thank you for examining the important issue of regulatory burden relief. This is one of ICBA's top priorities, and I am pleased to testify today on behalf of our nearly 5,000 community bank members to share with you their views and concerns.
Regulation Disproportionately Burdens Community Banks and Impacts Their Communities
ICBA supports a bank regulatory system that fosters the safety and soundness of our nation's banking system. However, statutory and regulatory changes continually increase the cumulative regulatory burden for community banks. In the last few years alone, community banks have been saddled with the privacy rules of the Gramm-Leach-Bliley Act; the customer identification rules and anti-money laundering/anti-terrorist financing provisions of the USA-PATRIOT Act; and the accounting, auditing and corporate governance reforms of the Sarbanes-Oxley Act.
Yet relief from any regulatory or compliance obligation comes all too infrequently. New ones just keep being added. There is not any one regulation that community banks are unable to comply with-it is the cumulative effect of all the regulations that is so burdensome. As ICBA President and CEO, Cam Fine recently stated, "Regulations are like snowflakes. Each one by itself may not be much but when you add it all up, it could crush the building."
Regulatory and paperwork requirements impose a disproportionate burden on community banks because of our small size and limited resources. We have had to devote so much of our resources and attention to regulatory compliance that our ability to serve our communities, attract capital and support the credit needs of our customers is diminished. Moreover, the time and resources community banks spend on regulatory compliance has also resulted in increased costs to our consumer and small business customers. Credit unions and other non-bank institutions that perform "bank-like" functions and offer comparable bank products and services are not subject to the same laws and regulations as community banks, thus placing community banks at a competitive disadvantage.
Perennial Problem. Regulatory burden is a perennial problem for community banks. In 1992, Grant Thornton, LLP conducted a study for ICBA on the cost of regulatory burden for community banks-the first to focus solely on compliance costs for community banks. At that time, the study showed the cost of complying with just 13 bank regulations (deemed the most burdensome in the eyes of community bankers), both in terms of time and money, was overwhelming. The annual cost for community for the 13 regulations-just a fraction of the rules that govern the industry-was $3.2 billion, which represented a whopping 24 percent of net income before taxes. In addition, 48 million staff hours were spent annually complying with the 13 regulatory areas.
Impact on Community Banks and Their Customers. Since that time, the market share of community banks with less than $1 billion in assets has dropped from about 20 percent of banking assets to 13 percent. And the share of large banks with more than $25 billion in assets has grown from about 50 percent to 70 percent. Community bank profitability also lags large banks.
At the same time credit unions, with an unfair tax-exempt advantage and favorable legislation loosening membership restrictions, have made inroads into small banks' market segments. Credit union assets have more than tripled since 1984, from $194 billion to $611 billion, whereas small bank (less than $1 billion) assets have decreased in value.
An analysis of these trends conducted by two economists at the Federal Reserve Bank of Dallas concluded that the competitive position and future viability of small banks is questionable.2 The authors suggest the regulatory environment has evolved to the point placing small banks at an artificial disadvantage to the detriment of their primary customers-small business, consumers and farmers.3
ICBA Strongly Supports EGRPRA Review
ICBA is pleased that, at the direction of Congress, the federal bank regulators are currently reviewing all 129 federal bank regulations, with an eye to eliminating rules that are outdated, unnecessary or unduly burdensome. The review is required by the Economic Growth and Regulatory Paperwork Reduction Act of 1996 (EGRPRA). Community banks wholly applaud the EGRPRA effort and fervently hope that it bears fruit.
However, it is important for Congress to recognize there is only so much that the regulators can do to provide relief. Many regulatory requirements are hard-wired in federal statute. Therefore, effective reduction of regulatory burden will require congressional action.
ICBA strongly urges the Congress to be bold and open-minded when considering recommendations offered by the regulators or the industry for regulatory relief.
The Most Burdensome Regulations
The litany of burdensome regulations is long. Here is a partial list:
- A myriad of consumer disclosures-that unfortunately are rarely read by consumers: Truth in Savings, Truth in Lending, Real Estate Settlement Procedures Act, Electronic Funds Transfer, Fair Lending, privacy notices, insurance disclosures, Funds Availability notices;
- Many reporting requirements: Home Mortgage Disclosure Act, Currency Transaction Reports, Suspicious Activity Reports, Call Reports, Regulation O (insider lending) reports, Regulation D (reserve requirements) reports;
- Requirements for written policies and procedures, including annual staff training for: information security, customer identification programs, Bank Secrecy Act, Community Reinvestment Act, and all other aspects of banking including procedures for operations, lending, deposit-taking, investments, advertising, collection, etc. And examiners often ask banks to develop policies and procedures that do not apply to that bank's individual operations!
These regulations are overwhelming to the 37 employees of my bank who must grapple with them everyday.
Feedback from ICBA members indicates that consumer lending and disclosure regulations (including the Truth in Lending right of rescission) are among the most burdensome. Others include: Bank Secrecy Act and anti-money laundering compliance, Community Reinvestment Act, and privacy notices. Many of these concerns apply to banks of all sizes, while others may be of special concern to community banks.
Appendices Attached. Appended to this written statement are a number of specific legislative recommendations to help relieve regulatory burden (Appendix A). Also appended is a discussion of regulatory burden presented by a number of specific regulations that has been take from comments ICBA has provided to regulators as part of the ongoing EGRPRA review and otherwise (Appendix B). The comments do not cover the full book of bank regulations.
Community Reinvestment Act. The Community Reinvestment Act deserves special mention since regulators have pending a proposal to reduce the regulatory and examination burden it poses on community banks. CRA is a clear example of regulatory overkill. At a time when banking monoliths stretch from coast-to-coast, evaluating the CRA performance of large complex banking organizations and small locally owned and operated community banks on the same examination standards simply does not make sense.
Increased Size Limit for Streamlined CRA Examination. ICBA strongly supports an increase in the asset size limit for eligibility for the small bank streamlined CRA examination process. Although we believe that a preferable threshold would be $2 billion in assets, we applaud the regulators' proposal to increase the limit to $500 million in assets and eliminate the separate holding company qualification.
ICBA also strongly supports legislation introduced in the House, H.R. 3952, calling for an increase in the CRA small bank size limit to $1 billion, although we would support amending the bill to raise the threshold to $2 billion. We also strongly support the inflation adjustment in the bill to ensure that inflation pressures do not diminish the bill's effect.
Under either the regulatory or legislative proposal, while community banks will still be subject to CRA, many will be free from the more onerous compliance burdens associated with the large bank CRA examination and able to concentrate efforts and resources on serving their communities. The bulk of CRA examination resources should be focused on truly large banks whose hundreds or thousands of local branches never see a CRA examiner, not on community banks that cannot survive unless they serve their communities.
Community activists have suggested that the proposal will "gut" the CRA. This is simply not so. All banks will still be subject to the requirements of the statute and continue to meet the credit needs of their communities. Increasing the small bank size limit will not undermine the purposes of CRA. Instead it will free community banks in the $250 million to $500 million asset range from unnecessary costs, improving their productivity and enhancing their ability to meet the credit needs of their communities.
CRA examination costs place an unfair burden on community banks. If the agencies' proposal is adopted, the regulatory paperwork and examination burden will be eased for 1,350 community banks between $250 million and $500 million of assets. These banks will no longer be subject to the investment and service tests, nor to CRA loan data collection and reporting requirements. Even so, the percentage of industry assets examined under the large bank tests will decrease only slightly from a little more than 90% to a little less than 90%.
In today's market, an institution with $500 million in assets is not a large bank. When the small bank streamlined examination was first considered, 17 percent of the banking industry's total assets were subject to the small bank exam using a $250 million asset limit. Due to consolidation and changes in industry demographics since then, if the asset limit were increased to $1 billion today, only slightly more than 15 percent of industry assets would be subject to the small bank exam-still less than the percentage of assets covered when the streamlined examination was first adopted nearly ten years ago.
ICBA/Grant Thornton CRA Cost Study. A 2002 ICBA/Grant Thornton study entitled The High Cost of Community Bank CRA Compliance: Comparison of 'Large' and 'Small' Community Banks reveals that CRA compliance costs can more than double when community banks exceed $250 million in assets and are no longer subject to streamlined examinations. A survey of community banks showed the mean employee cost attributable to CRA is 36.5 percent higher at large community banks than at small community banks. In each of two case studies-one contrasting costs for a bank that grew from "small" to "large" bank status, and one contrasting costs for a "small" and "large" bank owned by the same holding company-CRA compliance costs were four or more times greater for large community banks than for small ones.
The study further showed that the large bank CRA investment test also represents a cost burden for large community banks, with 92 percent finding the market for CRA investment opportunities "competitive" or "highly competitive" and 69 percent saying such investments are "not readily available." Half reported giving yield concessions to make CRA-qualified investments. Opponents of the proposal contend that community investments will disappear if smaller institutions are no longer subject to the investment test of the large bank CRA examination. We disagree. Community bankers report that they would be involved in the local community and make investments in community development because their success and survival depends on the success and the survival of the community and because they are integral parts of those communities.
It is ironic that community activists complain when larger institutions they consider less responsive to community needs merge with our-of-area banks. Yet the activists oppose critical steps to reduce the burden that is driving community banks to sell to their larger counterparts and, in fact, driving the community bank out of the community. Nevertheless, the cumulative effect of this one-size-fits-all regulation is driving away many of the small banks that have been serving their communities for decades. The ultimate result is that our local communities are losing not only their banks, but their community leaders.
Negative Cumulative Effect of Regulations on Community Banks
Even though each new requirement may be designed to address a particular problem, over time it all adds up to an unwieldy burden. A new rule is not just a new requirement for the bank. There's a lot more to it. First, the rule has to be understood and interpreted. Procedures have to be changed and adapted. Forms and software systems have to be updated to reflect the change. Bank employees have to be trained in the new requirement and given refresher courses from time to time. New audit programs have to be created and implemented to be sure that the new procedures for the new rule are properly followed.
How does the average community bank keep up? It's getting more and more difficult. The typical community bank has $75 million in assets and about 25 employees. During consumer compliance examinations alone, federal regulators review 26 separate consumer compliance rules. That's more rules than the average number of employees! And the time spent on compliance is time the bank is not using to serve its customers.
Moreover, the rules aren't segregated into product types. For example, a banker can't just look in one place for all the regulations applicable to a home equity loan. They have to consider a whole series of rules and regulations, such as Regulation B (Equal Credit Opportunity Act), Regulation C (HMDA), Fair Credit Reporting Act, RESPA, Truth-in-Lending. To make matters worse, the rules don't always match. If a customer wants to apply for a mortgage loan, RESPA and the Truth-in-Lending Act both require early disclosures to provide an applicant with information - but the requirements don't always mesh. After all, they're written by two different federal agencies.
Each rule has certain fixed costs associated with it. A mega bank with thousands of employees can more easily absorb those costs and devote the resources to addressing the new rule. For a small, community bank, the requirements are snowing them under. Unfortunately, many community bankers are seriously considering getting out of the business. When banks lose their local community focus, small businesses - the engines that help drive the economy - no longer have access to the kind of one-on-one relationship with a banker that can make or break the business.
State Law Also Adds Burden. Unfortunately, the Congress and federal regulators do not have a monopoly on regulatory burden. State laws and state regulations also can pose undue burden on community banks. ICBA strongly supports the dual banking system and the strengths it has brought to our economic and financial system. Many of our members are state-chartered and like it that way. But a growing number of state laws and regulations, including those that conflict with federal laws on the same topic, compound regulatory burden.
Tiered Regulation and Proper Allocation of Regulatory Resources
Community banks and large, national or regional banks pose different levels of risk to the banking system, and have different abilities to absorb the costs of regulatory burden For these reasons, the ICBA strongly urges Congress and the agencies to continue to refine a tiered regulatory and supervisory system that recognizes the differences between community banks and larger, more complex institutions.
Just as banks are urged to focus resources to address the greatest risks, regulators and examiners should reallocate resources to the largest banks that pose the greatest systemic risk. ICBA strongly supports better allocation of supervisory and regulatory resources away from community banks and towards larger institutions that present systemic risk.
A tiered regulatory system allocates the costs of regulatory/paperwork burden relative to the risk of the institution and helps restore equity in regulation, leveling the playing field and enhancing customer service. Less burdensome rules and/or appropriate exemptions for community banks are the hallmark of a tiered regulatory system.
From time to time, Congress and the agencies have instituted welcomed regulatory and supervisory policies that lighten the regulatory and paperwork burden for community banks. Examples include: less frequent safety and soundness exams for small, healthy banks; streamlined, risk-focused exam procedures for noncomplex banks; streamlined CRA exams for small banks; and less frequent CRA exams for small, well-rated banks.
Nonetheless, bank regulators devote disproportionate resources to examination and supervision of community banks. For example, one agency, the Federal Reserve, devotes 75% of supervision time to banks with less than $10 billion in assets, yet these banks only hold 30% of aggregate assets and are unlikely to pose systemic risk. Legislators and regulators should address these disparities to better allocate examiner resources and reduce unnecessary burden for community banks.
Maintain Separation of Banking and Commerce
The House-passed regulatory relief legislation, H.R. 1375, includes two provisions - de novo interstate branching and interest on business checking - that have serious implications for the long-standing doctrine providing for the separation of banking and commerce. Congress wisely reaffirmed this doctrine in the Gramm-Leach-Bliley Act of 1999.
The long tradition of keeping banking and commerce separate is based on solid grounds. First, it guards against the excessive concentration of economic power that would be created by the merger of corporate and financial conglomerates. Second, it insures the impartial allocation of credit, protecting our economy from conflicts of interest that might arise under the common ownership of a bank and commercial firm. And third, it safeguards against the improper extension of the Federal safety net, which could put taxpayer dollars at risk if a financial firm is weakened by the transfer of bank capital to a troubled corporate affiliate.
Industrial Loan Companies and Branching
The Financial Services Regulatory Relief Act, H.R. 1375, includes a crucial compromise authored by Representatives Paul Gillmor (R-OH) and Barney Frank (D-MA) limiting the ability of commercial companies to acquire and open new branches of banks by using a loophole in the Bank Holding Company Act. We urge the Senate to, at minimum, protect the Gillmor-Frank compromise, and ideally, to close the loophole in the law once and for all.
The loophole applies to industrial loan companies (ILCs). ILCs are special purpose charters available in only five states (CA, NV, UT, CO and MN) that operate under a special exemption from the Bank Holding Company Act (granted in 1987 because they were not considered "banks"). To maintain this exemption, ILCs must either remain under $100 million in assets, or not offer demand deposits.
This loophole creates significant risks to the banking system, competitive imbalances in the banking world, threatens small businesses, including community banks, and violates long-standing principles of U.S. banking law. The risks posed by ILCs are created because parent companies of ILCs (unlike any other banks) are not regulated at the holding company level by the Federal Reserve Board and are not subject to the same prudent ownership limitations and activities restrictions as bank holding companies.
Without the Gillmor-Frank compromise, H.R. 1375 would have allowed commercial conglomerates, including supercenter retail companies like Wal-Mart, to acquire an ILC charter and open new branches throughout the United States without any effective regulatory review of the process and the conglomerate's use of the ILC. In fact, states would have been powerless to stop these conglomerates from opening new branches of ILCs.
In testimony before the House, Federal Reserve Governor Mark Olson stated, "The bill as currently drafted would allow large retail companies to establish an ILC and then open a branch of the bank in each of the company's retail stores nationwide." Gov. Olson added that this ". . . raises significant safety and soundness concerns and creates an unlevel competitive playing field. . . ."
The ICBA-backed Gillmor-Frank compromise:
- Defines "commercial firm" as any firm that derives at least 15% of its consolidated revenues form sources that are not financial in nature or incidental to a financial activity.
- Has a grandfather date of October 1, 2003, meaning any ILC owned by a commercial firm, or whose ownership application was pending, before that date would get the interstate de novo branching powers.
- Requires both the home state and host state bank supervisors to rule on the commercial basket test, giving either state a veto power.
- And includes a provision called "Prevention of Evasion Through Acquisition" that would require commercial companies that acquire ILCs in the future that have interstate branches to divest all branches located outside the ILC's home state.
Mr. Chairman, this compromise, which ICBA strongly supports, represents the minimum standard that the Senate Banking Committee should adopt if it includes liberalized interstate branching language in its regulatory relief bill. However, we would encourage you to go even farther and close the loophole entirely by bringing ILCs under the Bank Holding Company Act.
ILCs and Interest on Business Checking
H.R. 1375 also includes an amendment that incorporates the substance of H.R. 758, which allows banks - and ILCs - to pay interest on business checking accounts. ICBA has not taken a position on the underlying measure, advocating instead a compromise that would allow financial institutions to conduct daily sweeps into and out of interest-bearing accounts. ICBA-member banks are split on whether or not to allow banks to pay interest directly on commercial checking accounts.
The amendment to H.R. 1375 adopted by the House would allow ILCs to offer business NOW accounts and would make ILCs virtually indistinguishable from banks. Federal Reserve Board Chairman Alan Greenspan wrote to House Financial Services Committee Chairman Mike Oxley (R-OH) on March 11 that giving ILCs this new power ". . . would alter the structure of banking in the United States. . ." and bestow a ". . . significant competitive advantage for the corporate owners of ILCs, such as large retail and commercial firms. . . ."
Mr. Chairman, this provision - like the original language in H.R. 1375 dealing with interstate branching - would breach the wall separating banking and commerce, and violate a long-standing principle in U.S. law.
Again, we urge the Committee to apply a Gillmor-Frank standard if you include the business checking provisions in your regulatory relief bill, stipulating that ILCs owned by commercial firms would not be eligible for the new business NOW account powers under this legislation.
ICBA member banks are integral to their communities. Their close proximity to their customers and their communities enables them to provide a more responsive level of service. However, regulatory burden and compliance requirements are consuming more and more resources, especially for community banks. The time and effort taken by regulatory compliance divert resources away from customer service. Even more significant, the community banking industry is slowly being crushed under the cumulative weight of regulatory burden, causing many community bankers to seriously consider selling or merging with larger institutions, taking the community bank out of the community.
The ICBA urges the Congress and the regulatory agencies to address these issues before it is too late. This is especially true for consumer lending rules, which, though well intentioned, too often merely increase costs for consumers and prevent banks from serving customers. The fact that banks and thrifts are closely examined and supervised should be taken into account in the regulatory scheme, and depository institutions should be distinguished from non-depository lenders.
The ICBA strongly supports the current efforts of the agencies and Congress to reduce regulatory burden. We look forward to working to ameliorate these burdens and to the enactment of statutory changes to help ensure that the community banking industry in the United States remains vibrant and able to serve our customers and communities.
1 ICBA represents the largest constituency of community banks in the nation and is dedicated exclusively to protecting the interests of the community banking industry. We aggregate the power of our members to provide a voice for community banking interests in Washington, resources to enhance community bank education and marketability, and profitability options to help community banks compete in an ever-changing marketplace.
2 Gunther and Moore, "Small Banks' Competitors Loom Large," Southwest Economy, Federal Reserve Bank of Dallas, Jan./Feb. 2004.
3 Community banks are responsible for a disproportionate amount of bank lending to small business, the primary job-creating engine of our economy. Banks with less than $1 billion in assets, make 37 percent of bank small business loans, though they account for only 13 percent of bank industry assets. And they account for 64 percent of total bank lending to farms.