Pity the Local Banker

We’ve always looked up to the local banker, pillar of the community, whose loans provide the catalyst for growth in local businesses. No? Well, I guess one needs to be somewhat advanced in age for this to be your image of the bank. Times have changed.

Bank mergers and failures have left us with about 2,300 fewer community banks than in 2000, a decline of 28% in 15 years.

Small bank’s share of deposits has declined from 40% to only 22% of deposits over that time.

Why Regulations Make Us Pity the Local Banker

For an overview, check out the Mercatus Center at George Mason University: http://mercatus.org/publication/small-banks-numbers-2000-2014

From the beginning, Lynx Loan Fund, LLLP, our private loan fund, has worked with local banks to fund a portion of our loan portfolio. In the course of working together, we discuss business and market trends. The banks want to hear what we are doing, so they know whether we’ve been bad or good, and I want to know what’s going on with the banks, so I have an inkling of how willing they will be to support our business further. We both win when we know each other better.

Regulation is killing community banking.

Death by a thousand Regulations Makes Us Pity The Local Banker
  • Regulators use loan guidelines as a cudgel against management. If there is a failure to follow the guidelines, the deviation is grounds for criticism, additional scrutiny, and worse. Prudent deviation from a guideline is good judgment, not grounds for summary execution.
  • Compliance with consumer regulations has become so complicated and convoluted that compliance requires one or more staff people devoted exclusively to making sure that each element is perfect. Absent a compliance department, and individual loan officers are overwhelmed with the intricacy. The moral of the story is that community banks will often avoid making consumer loans due to the risks of a meaningless error in the process. The result is that reduced competition for consumer loans, the variety of consumer loans reduced, and the local banker’s flexibility to “work with” a consumer customer is virtually lost. Big banks don’t keep consumer loans on their books. They are sold and securitized.
  • Regulations have also created a loan review hierarchy. Bank Presidents are not “the man (or woman).” The Chief Credit Officer wields the big stick. Why? Regulators like them. Sadly, however, loans these days all go to the “loan committee” and or the “board.” Well, committees represent the zenith of groupthink. A well-structured loan request can go down in flames due to a single committee member’s comment: “Well, I don’t know. It sounds good, but what if there is nuclear Armageddon?” Bank boards, sadly, are often made up of owners who have never been a banker (Grandpa was an outstanding banker) and a few hangers-on, or golfing buddies, who often also lack the breadth of business judgment or knowledge to evaluate many credits.
  • Banks operate with tremendous leverage. Banks have skinny margins, especially in this era of low-interest rates. These low margins are compounded by overhead demands for compliance staff, support of brick and mortar branches, and the risks of dopey “Community Reinvestment Act” loans, which are generally somewhat sketchy but help them satisfy the regulators.
  • The capital allocation of a particular share of capital allocated to loans that fall within various categories is arbitrarily assigned a higher risk level. This requirement leads banks to limit lending in traditionally lucrative loan categories like construction and other loan types that fit the community banking model. What this means is fewer loans, more regulatory scrutiny, and often whole categories of loans banished from a bank’s offerings.
  • When a bank does have a loss, it’s a big deal, since it takes so long to recover the loss due to the high leverage and skinny margins. Regulators feed on troubled loans like piranha. They pick their teeth with the bones of the loan officer, chief credit officer, and everyone else, too.
  • In case my point isn’t clear, bank regulation has become so extensive and intense that banks are unable to use their judgment and skills as community bankers to make loans to worthy credits. At one time, bankers spoke of the 4C’s of credit. It went something like this: Credit, Collateral, Capacity, and Character. The last C virtually erased from the lexicon of banking due to rigid guidelines, checklist-based regulators, ever-expanding compliance rules, and the ultimate fear of any bank stockholder.

Why Do Lenders Fear Regulation?

The ultimate reason we pity the local banker is the effect on the bank’s stockholders and managers if they get seized by regulators. We have used “regulator” in the generic sense, but remember banks are subject to at least two and sometimes more regulators – FDIC, Federal Reserve Bank, OCC, State Regulators, and others). A bank seizure does two things. It takes overall management and control of the bank from management – permanently. Second, it extinguishes the bank equity completely. The shareholders irrevocably and forever lose their capital in the bank. There is no appeal. Bank stockholders have attempted to legally sue to have seizures undone or modified, but have not succeeded. Of course, this is only supposed to happen when the bank’s in such tight shape that it can’t recover. One problem, the sole judge or arbiter of this decision is the regulator. There is no input, no appeal, and no recourse. When they say it’s over, it’s over. Harsh.

The regulatory environment is bad for community banks, bad for their community, bad for borrowers, bad for depositors, bad for the economy, that’s odd.  Ben Bernanke and Janet Yellen, after him at the Federal Reserve Bank, tell us that banks should be lending more money. The State and Federal legislators keep telling us that all this consumer regulation will make consumer loans easier to obtain and better for consumers. So, folks get mad at the local banker and write their representative, asking for more regulation. I feel sorry for the local banker.