If you ask a community banker if he’s thinking about selling his institution, he’ll have to consider a lot of variables.

But one of the biggest factors he’s going to be considering is the ongoing cost of compliance.

In Massachusetts, especially, most of our smaller community banks have been surviving this current economic Gotterdammerung. But what they may not survive is the substantial increases in compliance costs they’ve had to take on as a result. Between 2000 and 2006, average compliance costs at banks in the U.S. rose almost 87 percent, according to Deloitte. Since then, they’ve almost doubled again.

Recently, acting Comptroller of the Currency John Walsh spoke to a group of community bank directors. He acknowledged that the “economic meltdown and the resulting recession took a heavy toll on community banks, slowing loan growth and impairing the quality of your portfolios, particularly in the area of commercial real estate. Lending activity, which is the primary revenue source for community banks, continues to be hampered by the overall economic downturn, and net interest margins continue to be strained.”

Then, he effectively said, “tough noogies.”

“No one should be surprised that supervisory expectations have ramped up in the wake of the financial crisis, and there’s no point in belaboring or bemoaning the fact that there are more supervisory eyes on you than ever before,” Walsh said. “… In the wake of a financial crisis, the markets expect more of you; the public expects more of you; politicians expect more of you; and so do we.”

The Bankers Revolt

So, knowing it isn’t likely to be getting a lot of changes passed to the Dodd-Frank Act any time soon the bank lobby is trying another tactic: Tie the hands of bank examiners by limiting their discretion and flexibility.

It’s called the “Financial Institutions Examination Fairness and Reform Act.” Under the bill, examiners wouldn’t be able to construe a commercial real estate loan as non-performing if loan payments are still being made on time. They wouldn’t be able to order a bank that is considered well-capitalized to raise more capital. And there would be a new ombudsman’s office set up for banks to appeal almost anything on an examiner’s report.

The leading national bank associations are cheering for the legislation, as are credit union groups.

But while compliance costs are indeed mounting for small institutions – actually threatening their ability to generate enough profits to survive – tying the hands of examiners isn’t the “fair” solution that’s being presented.

Just because a commercial real estate loan is current now, for example, doesn’t mean it’s going to stay that way. CRE loans are often structured with low periodic payments, leading to a whopper balloon payment. If reasonable people can look at the borrower and conclude there’s not much chance that balloon payment is going to be made, then that’s not a “performing” loan under Generally Accepted Accounting Practices (GAAP).

Under this bill, examiners wouldn’t be able to enforce those GAAP rules. And the last time bank examiners ignored GAAP, we got a little thing called the S&L Crisis.

Bankers leading well-capitalized institutions may chafe at an order to raise more moolah. But if examiners see a problem in the offing – like what happened with Lowell-based Butler Bank, which suddenly found itself with too many residential development loans on its books – they shouldn’t be waiting until the bank falls below capital standards to insist it raise more. That’s when investors are going to be least likely to recapitalize a bank.

Examine This

It’s not surprising that organizations including Americans for Financial Reform decry that “this legislation would tilt the playing field further in the direction of excessive deference to industry interests and tie the hands of regulators attempting to protect the public interest.”

But you’ve got to sit up and take notice when a respected regulatory compliance company speaks out about the issue of compliance overload.

“As long as there is legislation, there will be an effort to circumvent it within financial institutions,” says George Mark, president of internal audit at ICS Risk Advisors. “Risk has always been an inherent part of profit in finance, but that doesn’t mean it can’t be managed properly. There is a belief that regulation is choking progress, when in actuality we’ve found the lack of proper risk preparation to be far more detrimental.”

Bankers may be choking on that statement. But Mark is right.

For years, bankers wanted their examiners to have flexibility. But it appears they only want that when examiners are going to flex their way. And while the industry may have a legitimate gripe about the scope and complexity of compliance rules, taking discretion away from examiners doesn’t seem like the right answer to this problem.

Vincent M. Valvo is president of Agility Resources Group. He can reached at vvalvo@agilityresourcesgroup.com.