The recently passed Dodd-Frank relief package will put banks with less than $10 billion in assets under a much simpler capital framework, giving these smaller institutions reprieve from a global regulatory system that many argue was never intended for them.
Under the new law, banks under $10 billion that choose to maintain a leverage ratio of tangible equity to average assets at a yet to be specified minimum between 8 percent and 10 percent will be deemed to satisfy all their regulatory capital requirements.
That means community banks would no longer have to continually calculate and monitor their compliance with certain complex, multi-tiered regulatory capital ratios that one might see on a call report today such as the tier 1 risk-weighted capital ratio.
“The biggest thing is it will streamline the process for smaller institutions,” Jon Skarin, executive vice president at the Massachusetts Bankers Association, told Banker & Tradesman. “It takes community banks out of Basell III, which they never should have been subject to in the first place.”
Under Basel III, an international regulatory framework created after the financial crisis to improve regulation and supervision of the banking industry, banks were required to hold capital equivalent to at least 8 percent of its risk-weighted assets.
The calculation was difficult to determine because different amounts of capital were required for different assets based on their risk, so a commercial loan might require more capital than a residential mortgage. The leverage ratio, on the other hand, is a calculation involving non-risk-weighted assets.
“We’ve always as a bank wanted to stay above [a] 10 percent [leverage ratio],” said James Dunphy, CEO of the roughly $1.35 billion asset South Shore Bank. “We felt that was a good cushion for us, so getting some credit and relief would be a good thing.”
The bank has grown in recent years and regularly reports solid profits, but Dunphy said managing high capital ratios over the years has certainly been a burden. And while he said you can never go wrong with a solid capital cushion, having more latitude to invest in services such as fintech or different types of lending would be helpful.
The new capital framework also relieves community banks from other unintended consequences of Basel III, said Skarin.
For instance, Basel III only allowed depository financial institutions to count 10 percent of their mortgage servicing rights toward tier 1 common equity, forcing many small banks to shed these services to third-party, non-bank entities.
“I am not sure if that was the best thing,” said Skarin.
Small Bank Holding Companies Adjusted
In addition to capital requirements, the new law puts community banks up to $3 billion in assets under the umbrella of the small bank holding company statement – previously, only banks up to $1 billion in assets were eligible. The Federal Reserve’s small bank holding company policy can help community banks grow and serve as a key mechanism in ownership succession.
“Small bank holding companies can be used as financial alchemy devices to convert debt into equity to provide basis for expansion,” said Kevin Handly, a Boston-based banking lawyer and teacher at Boston University Law School’s graduate program in banking and financial law. “It enables bank holding companies to take advantage of double leverage. It can really be an engine for growth for community banks.”
While the Federal Reserve is generally strict about the borrowings of larger bank holding companies, those of banks under $3 billion will be able to go out and raise significant amounts of money they can then use to buy additional stock in their subsidiary banks, Handly said.
That transaction essentially amounts to a direct infusion of money into a bank’s tier 1 capital, adding to the amount of deposits the bank can take in and loans it can make.
The other big advantage of a small bank holding company, said Handly, is for ownership succession purposes such as if the controlling owners of a community bank want to sell their ownership to the bank’s existing management.
Managers of banks under $3 billion can form a new holding company that can borrow money and then use the proceeds to purchase the bank from its retiring owners, he said.
