Basel III Capital Rules: Undue burden on community banks
In part 1 of this guest column, Edgar Ortiz, President and CEO of Strategic Analytic Solutions LLC, discussed the importance of the U.S. bank regulatory agencies’ delay of the implementation of the new capital rules of the Basel III Accord. In part 2, the potential burdens facing community banks from the proposed rules will be discussed.
The effect of the one-size-fits-all prescription
By Edgar Ortiz
The burden on community banks posed by the proposed rules is twofold: risk weighting and limited access to capital.
Risk Weighting: One of the new rules requires banks to apply a weighting system to the risk on their balance sheets. The banks will have to hold sufficient capital to offset this risk. But commercial real estate, a large portion of many community banks’ business, carries a high risk weighting, meaning the banks will have a high proportion of higher risk weight based on the very same loans that keep them–and their communities–in business. Those same communities are often the bank’s primary source of capital.
Access to Capital: When a large financial institution needs or wants new funds, it can easily tap into capital markets, where brokers and traders are at the ready to get investors to buy in to the bank. But community banks depend on local shareholders and net interest margin for their capital. Local, private shareholders are as directly affected by the economic conditions as the bank asking them for funding, which makes that market a tough one to tap in times of need. And net interest income, the difference between what the bank earns on loans and the interest they pay on deposits, will be severely depressed by increased capital requirements. These banks would start to disappear, creating an oligopoly that would hurt consumers and benefit only the few players left.
The financial crisis of 2008 was a clear demonstration of the tight interconnectedness of the international financial system. Consequently, rules that require the largest international banks that are the columns supporting the world’s financial system to hold more capital are a welcome development. However, applying the same stringent capital and liquidity rules to thousand of community banks that pose no risk to the stability of the international system is a mistake and will lead to the end of many of these institutions.
Regulators have paused the implementation of the rules while they deliberate how to modify them, and this is welcome news. During this pause, it’s imperative the regulators recognize the vital role these smaller banks play in the economies of the smaller communities where they do business. Sparing community banks from the one-size-fits-all capital requirements will mean ensured future banking for all of these communities’ needs.
Edgar Ortiz is President and CEO of Strategic Analytic Solutions LLC, a bank risk management consulting firm. He is the former head of Global Analytics at Dun & Bradstreet, a former McKinsey management consultant and former vice president of credit risk management at GE Capital. He has more than 25 years experience in the financial services sector, risk management and predictive analytics. For more information, visit: www.strategicanalyticsolutions.com.
The advice and views in guest columns are intended for informational and discussion purposes only and do not necessarily reflect the views of Sageworks or its employees.