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Imagine this, says Dennis White, president of First Bancshares of Valley City, North Dakota:
- A bank that serves a small town of 220 people on the plains of North Dakota must create and continuously update a special color-coded map that reflects the income status of people in its market area.
- That small-town bank has just five employees, one of whom works almost exclusively on compliance of bank regulations.
- That same bank is part of a two-bank holding company with 30 employees that dedicates the equivalent of 2.5 full-time workers to regulatory compliance, at a cost of $70,000 per year.
- And now imagine that the worst is yet to come—a new series of regulations that will add even more paperwork to an industry where most banks say that compliance costs total at least 3 percent of their non- interest expense, according to the current fedgazette poll.
That's the story of the Litchville State Bank in Litchville, North Dakota, and its holding company, First Bancshares, headquartered in Valley City. And it's also a story that many banks—particularly small ones—are telling these days, especially since passage last year of the Federal Deposit Insurance Corp. Improvement Act (FDICIA), much of which will go into effect next spring.
Litchville State Bank, with its $13 million in assets, is in good company in the Ninth Federal Reserve District. About 41 percent of the district's banks have under $25 million in assets, and about 71 percent are under $50 million—no larger than some big-city branches.
The reg that may break the banker's back
The above-mentioned map is part of the compliance for a federal regulation (the Community Reinvestment Act of 1977) meant to discourage redlining, or the practice of excluding certain segments of a community from bank loans. That's a perfectly good intention, according to White, but it's misdirected. "I can understand problems with redlining in cities like Chicago and New York, but in a town of 220 people?" says White, the president of the Independent Community Banks of North Dakota.
Misdirected intentions—that's how many bankers and banking association officials interviewed for these stories describe Congress' attempts to regulate financial services. Some say that small banks are penalized because of legislation that was meant to address issues concerning their larger brethren. But all banks—large and small—say that FDICIA, Congress' latest banking law, is an overreaction to the S&L debacle and may actually serve to hinder the banking industry.
FDICIA was born out of the FDIC's need for a $30 billion line of credit from the Treasury Department to assuage its Bank Insurance Fund. The insurance fund was nearly insolvent following about 1,000 bank failures between 1986 and 1990 that drained nearly $20 billion from the fund. Still reeling from the S&L crisis and the resultant loss of taxpayer dollars to prop up the industry, Congress agreed to the FDIC credit, but they also created a bill that expanded regulator powers in the hopes of preventing an S&L-type crisis in the banking industry.
FDICIA, which is intended to limit the cost of bank failures, requires closer bank supervision and gives regulators new tools to close banks before they become insolvent. Some of the bill's provisions include: strict capital standards requiring automatic closure; as well as new powers for regulators' to downgrade ratings of banks, analyze loan management, and to review compensation for officers, employees, directors and stockholders.
The 60 provisions of the bill also include consumer issues, including the Truth-in-Savings Act (TISA), which requires all financial institutions to disclose clearly the terms and conditions of savings and checking accounts. Bankers don't dispute the intent of TISA, but they say the resultant 267-page regulation goes too far, creating needless paperwork for financial institutions that already provide adequate information, and who now must prepare detailed reports for consumers who won't read them anyway. Seventy-two percent of the banking respondents to the fedgazette poll are opposed to TISA, and 90 percent of the non-banking respondents say their banks already provide enough information on deposit accounts.
Bankers have found support in their battle against increasing regulation from those who are required to advance Congress' charges—the regulators themselves. John P. LaWare, a member of the board of governors of the Federal Reserve System and a former banker, told members of Congress at a hearing this summer that regulatory burden has grown so much that he fears for the survival of the banking industry. LaWare and other members of the Board have also been critical of TISA, saying that the additional costs to financial institutions will reduce yields to savers.
In other testimony this summer LaWare said that FDICIA "piled increasing regulatory burdens on virtually all banking institutions, taking a shotgun approach to past problem areas."
Bankers sound off
Regulatory burden has long been a bane of the banking industry, but recently it has become issue number one for banks, overshadowing such perennial topics as interstate banking, branching and banks' attempts to move into new lines of business. Small and large banks are united, and special hearings have also been convened before members of Congress on the matter. Regulatory relief legislation has been proposed, but passage is doubtful during this election year.
"FDICIA is the straw that broke the camel's back," says Terry Jorde, president and CEO of Towner County State Bank of Cando, North Dakota. "Our compliance files are almost as big as our loan files. That's just getting out of hand."
Allen Olson, president of the Independent Bankers of Minnesota, is more blunt in his assessment of FDICIA: "It's stupid and destructive to the economy in the long term. The whole damn thing stinks of irrational conduct on the part of Congress."
Regulatory compliance has become so onerous, according to some in the industry, that there are small bankers who are now planning or considering a sale of their bank because of the cost of regulation. One older banker recently told Arlene Melarvie, executive director of the Independent Community Banks of North Dakota, that "banking isn't any fun anymore." That refrain is becoming more common, Melarvie says. (Sources would not divulge the names of bankers who have been pressed to sell because of regulatory burden, out of deference to those bankers' selling strategies.)
Another older banker once told Truman Jeffers, Minnesota Bankers Association's executive vice president, that there are so many regulations to follow that "I don't know from the time I open the door in the morning till I close it at night, how many rules and regs I've broken." And that was many years ago.
"I'm president, compliance officer, economic development director and I make the coffee in the morning if I'm in first," says Jorde, describing the full schedules of many small-town bankers. Each additional regulation takes more time that she needs to spend on other bank matters, Jorde says.
"Micro-management" is the term John Cadby, executive vice president of the Montana Bankers Association, uses to describe Congress' latest regulations. With regulators keeping a sharper eye on all aspects of a bank's business—from lending practices to employee compensation levels—bankers are not only paying more to comply with regulation, Cadby says, but they are becoming increasingly reluctant to make certain types of loans because they fear the loans will sour and the bankers will face regulatory reprimands. The net effect, according to Cadby, is that bankers are lending less because of regulatory compliance.
"The beauty of our system is that it's based on local bankers and businesses sitting down and making decisions," Cadby says. Too much regulation "stifles initiative and ambition," he says. "It's going to kill community banking."
Jeffers agrees, placing blame for the so-called credit crunch and the nation's stagnant economy largely on the impact of financial regulatory compliance. "Bankers are risk-averse because of Congress and the regulators. I'm absolutely convinced of that. Funds are available, but are loans going to be made? Not likely," says Jeffers, adding that when lenders are unwilling to take risk, the entire economy suffers.
The relationship between banking regulation and the economy is a simple equation, according to James Schlosser, executive vice president of the North Dakota Bankers Association: "When [regulation] hurts the banks it costs the consumers and eventually hurts economic development."
Schlosser sums up the compliance problem with one number: 43. That's how many documents are involved in an FHA guaranteed loan. Likewise, he says some banks simply are not offering the loans anymore. "Has that helped the consumer?"
Susanne Boxer, president and CEO of Houghton National Bank in Houghton, Mich., and member of the Minneapolis Fed's Advisory Council on Small Business, Agriculture and Labor, is also concerned about the impact on small business of bank regulation. Most small banks don't have the in- house legal counsel or the resources to hire outside services to interpret the new laws and regulations, she says. Hence, they must pass that cost to businesses that apply for loans. "Can I pass that cost on to my customer and still keep that customer?"
But Boxer is also concerned about her bank's deposit base. Houghton National usually opens about 1,000 new deposit accounts within one week every fall with the influx of new students and staff at Michigan Technological University. To service those accounts, Boxer must galvanize about eight employees to meet with customers and an additional four workers to process the accounts. But because of the increased time it will take to open an account following TISA, she says she will have to either double her staff or plan for reduced business next year. She says she expects some potential depositors to become frustrated by delays and take their business elsewhere.
The banking business used to be about intermediation between deposited funds and lending requests, says Olson of Minnesota's independent bankers' group. "Now it's filling out forms and investing in government securities. What good is that to anyone?"
Small banks aren't the only ones sounding off about regulatory compliance. In testimony before the House Subcommittee on Financial Institutions this summer, John Grundhofer, chairman, president and CEO of First Bank System Inc. of Minneapolis, related his plea for less regulation to a call for interstate banking and branching. "The present requirement to operate individual unit banks combined with the extensive federal and state regulations placed on banks creates substantial unnecessary costs for the banking industry," he said. He said that First Bank System's 22 banks must file 6,600 regulatory reports per year instead of just one set of 300 for the entire system.
Richard Kovacevich, president and COO of Norwest Corp. of Minneapolis and the Ninth District's other large financial institution, testified this summer to the House Subcommittee on Commerce, Consumer and Monetary Affairs about the cause and effect of regulation. "Regulations did not work for the savings and loans and they will not work for the banks," he said. His prescription for a healthier banking industry includes deposit insurance reform. In recent years, many reform ideas have been promulgated—including one by the Minneapolis Fed—and Kovacevich's is similar in spirit to them all: Limit the amount of deposits that are guaranteed by the government, thereby forcing depositors to shop for the best place to put their money and encouraging financial institutions to compete on the basis of safety and soundness, as well as service.
However, even though the banking industry may have earned some empathy from its regulators, bankers are having a harder time drawing a similar reaction from some quarters in Congress. And the industry's recent bottom- line success hasn't helped the banker's cause in Congress' eyes. Interest rate margins have been a boon to the industry and some large and regional banks are having their most profitable year in some time. At mid-year, Nasdaq's bank index, a collection of mostly regional banks, had risen 26.3 percent in 1992. Also, a survey of community bankers released in September by the American Bankers Association shows that 80 percent posted year-to- year gains in pre-tax earnings in the first half of 1992. But bankers reply that this current interest-rate scenario won't last forever; besides, they say, FDICIA's cost impact won't be felt until future years, after the provisions have gone into effect.
Insurance reform and reg relief given bleak short-term outlook
Deposit insurance reform was part of the Treasury Department's proposed banking bill that eventually became FDICIA. Along the way, major insurance reform (other than capital measures, prompt closure and other regulatory provisions) was removed from the bill and banking officials don't expect the issue to get a serious hearing from Congress in the near future.
That's just fine for small bankers, who say they have the most to lose if deposit insurance is limited, for example, to one $100,000 account per person. Their fear is that depositors will abandon smaller institutions for the perceived safety of larger banks. Even with the provision in FDICIA to restrict prior too-big-to-fail policy, the result will be the same, according to Melarvie of the North Dakota independent banks. "No matter what the rules are, the perception will favor big banks," she says. (Too- big-to-fail refers to the notion that certain large banks should not be allowed to fail because of the potential risk that such a failure could have on the entire financial system.)
Deposit insurance reform was a primary focus of Treasury's initial bill because the issue gets to the heart of the current debate about banking regulation and reform—that deposit insurance carries an implicit price tag for taxpayers, according to James Lyon, vice president of the Minneapolis Fed's Banking Supervision Department.
When considering banking reform, Congress had a choice, Lyon says, either change the scope of deposit insurance to reduce taxpayers' exposure in the event of bank failures, or increase regulation to try to soften the impact of those failures. Congress chose regulation, and now much of the banking industry is at work trying to push through legislation meant to provide regulatory relief.
Small bankers and their representatives are pushing for a "two-tier" system of regulatory compliance that would impose one set of regulations on larger banks (as yet undefined) and another on their smaller counterparts. During testimony this summer before the House Subcommittee on Financial Institutions, a representative of the Consumer Federation of America, Peggy Miller, gave some credence to the two-tier concept as it pertains to the Community Reinvestment Act: "... some of the examiners are requiring virtually the same thing out of small banks as they require out of Citibank, and that was never the intent, at least our intent."
Lyon says the two-tier idea should be investigated, but he anticipates endless debate over such issues as the definition of large and small banks, which regulations would be bifurcated and in what way, how those regulations would be supervised, and other matters. "From a policy standpoint [two-tier regulation] makes sense, but I'm not optimistic that it's an achievable result."
Deposit insurance reform and two-tier legislation aside, then, bankers must place their hopes with other regulatory relief legislation that likely won't be considered by Congress until next year. As of late summer there were various bills supported by the Senate, House and the administration. But Lyon warns bankers of having too much hope. He says there have been other instances in recent years when Congress has passed major banking legislation, there was a firestorm of reaction from the industry and then Congress moved on to other business.
"Congress doesn't appear to particularly enjoy banking legislation anyway," Lyon says.
