In this issue, Banking Perspective unveils “My Banking Perspective”, a forum that will highlight the opinions of key thought leaders on issues of critical importance to the banking system.
The Importance of Regional Banks in the U.S. Banking System
Regional banks look a lot like their smaller community bank brethren in terms of their Main Street lending and deposit-taking business models. Because of their moderately larger size, regional banks are uniquely positioned to make positive impacts on the geographic regions they serve and in their local communities without generating the systemic risk or resolution challenges often associated with their larger bank competitors. This unique position in the banking system warrants important consideration in the ongoing conversation within the regulatory community and in Congress regarding the continued shaping of bank regulation.
The Regional Bank Segment
Regional banks are generally considered to be banks with business models centered on domestic retail and commercial lending and deposit taking and that range in size from $50 billion to $375 billion in total assets – a group of twenty-some odd banks. While the emphasis on any particular line of business may vary, most regional banks typically engage in residential mortgage, home equity, automobile, and installment lending on the retail side and loans to customers that range from small businesses to middle market companies on the commercial side. Regional banks are also important lenders in commercial real estate. Regionals provide important deposit, cash management and other products and services to their customers, allowing them to save and manage their finances in ways that enable them to achieve their financial aspirations.
Through these activities, regional banks play a vital role in local and regional economies across the country. While no single regional bank is systemically significant, their collective positive impact on the U.S. economy is substantial. According to an American Bankers Association survey, America’s regional banks operate in all 50 states and were responsible for more than $50 billion in lending to American small businesses in 2012 and more than $1.7 trillion in lending to the local communities in which they operated. They employ more than 430,000 people in more than 23,000 banking offices throughout the country and have account or credit relationships with more than half of America’s households.
With their local and regional focus, regional banks build strong ties to their communities that transcend just the business they conduct in the marketplace and sustain the strong commitments they have to their regions. America’s regional bankers invested more than 1.3 million hours in 2012 to volunteering in their communities and the banks they work for contributed to more than 43,000 different charitable organizations.
What makes regional banks unique, though, is the fact that their local and regional focus gives them the appropriate scale to deliver a multitude of products and services to a broad range of customers. Regionals can meet the needs of the smallest customers in their communities and, at the same time, serve many of the largest businesses in their geographies in an effective and efficient way. They are small enough to truly understand the objectives of the local small business owner and large enough to support the financing and deposit needs of the largest customers in the region. Regionals can do this with the appropriate scale that can deliver products and services to a broad set of customers in a cost effective, efficient way.
Risk Profiles of Regional Banks
Though regional banks enjoy a degree of scale that enables them to serve larger commercial customers, the balance sheets of America’s regional banks look incredibly similar to those of community banks and therefore far different from the largest, globally systemic banks. As a consequence, the risk profile of regional banks from just about every perspective – liquidity, capital, market, and operational – is much closer to that of community banks and quite removed from that of global systemically important banks. For example, like community banks, regional banks are predominantly funded by deposits and not wholesale borrowings. The average core deposits to total assets for regional banks is approximately 70% versus only 29% for G-SIBs. Like community banks, regionals have little in the way of risky capital markets activities. The percentage of total trading assets to total assets is less than 1% for regional banks versus 16% for G-SIBs. Similarly, broker dealer assets to total assets is less than 1% for regional banks compared to 19% for G-SIBs. Collectively, unlike G-SIBs, regionals have less than 1% of the banking industry’s total credit default swap exposure and on average derive only 2% of total revenue from trading activities.
As a result of their focus on traditional lending and deposit taking, regional banks do not create systemic exposure through market making or through complex networks of interconnected transactions with other financial firms. The percentage of the notional value of derivatives contracts to total assets is 46% for regional banks versus a staggering 2,549% for G-SIBs. In fact, if you added up all of the derivatives contracts traded by the regional banks, that number would still represent well less than 1% of the total number of derivatives contracts traded by the banking industry.
Almost by definition, regional banks also lack significant global exposure. Though some regionals have small international operations – for example, Capital One has relatively small credit card operations in Canada and the United Kingdom – regional banks are predominately domestic institutions. Approximately 99% of all of their loans are to American consumers and businesses, and 98% of their deposits come from U.S. customers. This contrasts sharply with G-SIBs whose foreign loans and deposits are 18% and 28%, respectively. And you won’t find regionals with affiliates that have large trading desks in Hong Kong or any meaningful exposure to swings in foreign sovereign debt.
While no one would minimize the significance of a bank with $50 billion in total assets, in the context of systemic risk, it is interesting to note that you could fit the total assets of the fourteen largest regional banks inside the largest U.S. G-SIB. And plain vanilla, domestic-based business models don’t require enormous, complicated legal structures, either. In fact, if you were to add up the legal entities of all of America’s regional banks, the total would still be less than the number of legal entities under America’s single largest bank holding company. These observations are, at a minimum, valuable pieces of circumstantial evidence that would suggest that regional banks are likely not systemically important and therefore the potential failure of a regional bank would not require the kind of extraordinary government intervention we saw in the last crisis.
The Future of Policy Rulemaking for Regional Banks
It is clear that in writing the Dodd-Frank Act, Congress intended that there be varying degrees of intensity of prudential regulation among the 6,000 commercial banks that make up the U.S. banking industry. The criteria used to determine the level of regulation under the Act is primarily based on the size of a bank’s total assets. Size is also the predominant criterion used by regulators in honing their rulemaking. While the size, business model and relative systemic riskiness of banks are generally correlated, the breakpoints of legislative and regulatory-designated size thresholds of $50 billion and $250 billion, which trigger massive increases in prudential supervision levels, are perhaps out of step with where risk really exists within the industry. To some degree, this is understandable since these size thresholds have been admitted to be, to a large degree, determined arbitrarily, and the $250 billion threshold derived from the Basel II Accords reflected a very different marketplace in 2004 when it was first adopted. Unfortunately, these arbitrary thresholds are bridged by the size range of the regional banks and, as a consequence, regionals are perhaps subjected to more intense prudential regulation than their business models would suggest is warranted.
For example, it should be pretty clear that the regional bank business model, the simplicity of the legal entity structure, and the lack of interconnectedness should lend itself to straightforward resolution processes in the event of a failure situation. For these reasons, it’s hard to envision regulators having to use Dodd-Frank’s Title II resolution authority to resolve even the largest of the regional banks. Indeed, the living wills filed by each of the regional banks and accepted by the regulators point to the ability to resolve failure without the need for Title II, which was created specifically for systemically important institution failures. It stands to reason that the various resolution methods successfully employed by the FDIC for decades (and by its 1990’s-era sister agency, the Resolution Trust Corporation) can be used to effectively resolve any of the regional banks in an expeditious, orderly manner with minimal impact to the financial system. If the measure of systemic risk is the potential for a bank’s failure to create contagion within the financial system, it stands to reason that regional banks, which would be resolved under the FDIC’s long-standing, traditional resolution process, do not pose a systemic risk to the banking system.
Indeed, there have been indications recently that regulators are beginning to change their thinking around the thresholds used for designating various levels of prudential regulation intensity. In his remarks before the Federal Reserve Bank Structure Conference in Chicago in May, Federal Reserve Governor Daniel Tarullo publicly acknowledged that the thresholds might need to be reconsidered. Noting that “[regional banks] bridge the $50 billion threshold for enhanced prudential standards established by Dodd-Frank,” Governor Tarullo acknowledged that regional banks are “overwhelmingly recognizable as traditional commercial banks,” and called for a calibrated regulatory structure that recognizes business model differences, not just varying asset thresholds, in setting macroprudential regulatory standards.
Governor Tarullo’s remarks followed similar statements from one of his most distinguished former colleagues, former Federal Reserve Chairman Ben Bernanke. Just days before Governor Tarullo’s speech, Mr. Bernanke remarked during a speech at the Brookings Institution that “it’s not just size” that determines a bank’s potential systemic risk. Bernanke suggested, consistent with what America’s regional banks have been arguing for years, that “opacity, complexity, interconnectedness, and a variety of other things” are the true metrics of the risk profile of a financial institution. He concluded that “it’s harder than just saying put a size limit [on it] or something like that.”
Policymakers on Capitol Hill are also weighing in. The House Financial Services Committee held a hearing in May to examine the Financial Stability Oversight Council’s process for designating institutions as systemically important. Several members of the committee offered their view that relying on an arbitrary asset threshold to designate systemically important financial institutions doesn’t account for the relative risk inherent in regional banks’ business models. Michael Barr, the former Treasury Department official who helped to draft much of Dodd-Frank, appearing as a witness at the hearing, called in his testimony for “a graduated approach [to regulation] and a nuanced approach that’s consistent with not just [an institution’s] size, but their risk profile.”
Amidst this growing dialogue over tailored regulation that recognizes the different risk profiles within the banking industry’s tiers, a bipartisan group of members of the House Financial Services Committee have introduced legislation that would require the regulators to do exactly what Dr. Barr called for in his testimony. The Systemic Risk Designation Improvement Act, introduced by Rep. Blaine Luetkemeyer, would amend Dodd-Frank to give regulators the flexibility to take a more tailored approach to macroprudential regulation by requiring that they consider a bank’s risk profile and not just its size before designating that bank as a systemically important financial institution.
Conclusion
Although the Dodd-Frank Act created an arbitrary asset threshold above which institutions are deemed systemically important, there is growing recognition within the regulatory community and Congress that there at least be stronger consideration of business models in determining the intensity of prudential regulation and supervision. This is especially warranted in the case of regional banks, which play such a vital role in our nation’s regional and local communities through their ability to effectively meet the needs of both community businesses and consumers in effective and cost efficient ways without posing systemic risk. Calibrating prudential regulation and supervision commensurate with regional bank business models and risk profiles will better enable both the ability of regional banks to help drive economic growth and the ability of regulators to ensure the safety and soundness of these vital financial institutions.
It is against this backdrop that several of my regional banker colleagues have authored articles for this edition of Banking Perspective. Each of these pieces shed further light on specific public policy issues of importance to America’s regional banks. •