Who invited Basel III?

Joe Shearin, president and CEO of Eastern Virginia Bankshares, would be happy to hire new employees if the move helped customers or generated new business for his community bank. But bringing more people on board just to keep up with federal regulations is frustrating.

“We have had to hire two to four people just to deal with 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act,” says Shearin, whose bank has 22 locations in Virginia’s Northern Neck, Middle Peninsula and other areas east of Interstate 95.  “Now if Basel III comes into being, we’ll have to hire more. It’s another layer of bureaucracy for small banks, which, after a while will determine they can’t stay in their communities.”

Basel III is the third installment of a set of international bank regulations developed in Basel, Switzerland, in reaction to the global financial crisis in 2008-09. In 616 pages, it sets out new bank capital requirements and regulations dealing with liquidity and leverage. The concept is designed to keep large international banks from making risky investments — but if the regulations go into effect in the U.S., they could hurt community banks disproportionately. In fact, community bankers in Virginia say the new regs could put them out of the mortgage lending business.

Community banks are locally owned and operated banks with a board of directors elected from the community. Patricia G. Satterfield, who retired as president and CEO of the Virginia Association of Community Banks at the end of the year, says that the vast majority of banks chartered in Virginia are community banks. Some of those are larger banks that operate in multiple cities or even states, such as Union First Market and First Community Banks. Megabanks, such as BB&T, Capital One, Wells Fargo and Bank of America, are not considered community banks. “In community banks, the lending decisions are made locally as opposed to sending a loan application to Charlotte, N.C.,” she says. “Another indicator is when you can walk in as a customer and ask to see the president.”

Because of this different scope and mission, Satterfield says that Basel III rules were intended for large international banks. “One size does not fit all. These shouldn’t be applied to banks with under $50 billion in assets who conduct no international activities.”  That’s the threshold outlined in Dodd-Frank and other provisions. In November, the Federal Reserve delayed implementation of Basel III, which was set to take effect Jan. 1. The Virginia Association of Community Banks had written to the Fed in October asking for exemption from the regulations. In January, a committee of regulators and central bankers agreed to ease some   Basel III rules. The change provides more flexibility in determining banks’ liquid assets and delays implementation of the regulations until Jan. 1, 2019.

Steven C. Yeakel, who became the president and CEO of the Virginia Association of Community Banks at the beginning of the year, says that early reaction to the revision is that it falls short of the mark of what community bankers want,  exemption from Basel III.

“The implementation delay is a welcomed change, but I’m still looking for much more significant change in the proposal,” he says.

Community bankers say the regulations could tie their hands in developing creative loans for homebuyers. The Basel III regulations would modify risk weightings, perhaps pushing those loans into the category of unacceptable risk. “If a banking customer buys a house and cannot meet the requirements for a traditional mortgage, the banker might be able to make the loan with a balloon mortgage [a shorter-term loan with a large balance or ‘balloon payment’ due at the end of the term]. The customer stays in the community and sticks with the bank,” Satterfield says. But if banks have to hold more capital on their balance sheets because of Basel III, they will have less money to lend to retail and commercial borrowers.

Part of the challenge community banks face is the fact they cannot adjust their loan portfolios as quickly as larger banks. It’s more difficult for them to raise capital quickly. Community banks typically raise capital from local sources, so they can’t reach out as far and wide as international or even large regional banks.

Ellis Gutshall, president and CEO of Valley Bank, with eight offices in the Roanoke Valley and $800 million in assets, says the real vulnerability for banks lies in their loan portfolios. Community banks tend to hold these loans rather than sell them to others, and they often extend credit through more creative financing. If interest rates rise, banks will be stuck paying rates on deposits while still earning low rates of return on their existing loans.

Gutshall says that when the Basel III regulations first came out, he and others were sure that common sense would prevail, keeping these regulations focused on the largest banks. “No one thought it would come down to banks our size,” he says.

But if the proposals go into effect, it’s going to hit the community bank — where home mortgage loans comprise the bulk of business — the hardest. Balloon loans, for example, are considered riskier, meaning that banks have to have a larger cushion of cash on hand — and meaning they have less to lend. “If we had to do that, we would not have made those loans. If these rules are put in place, it will push community banks out of doing what they do,” Gutshall says.

William H. McFaddin, president and CEO of Community Bankers Bank, agrees that Basel III could put community banks out of the mortgage business. “In Central Virginia, drawing a wide circle around Richmond, there are 15 community banks with an aggregate of $2.5 billion in mortgage loans in their portfolios. In the scheme of things, that’s not a huge amount, but it’s important to the 15 banks,” McFaddin says. “If Basel III were put in place as proposed, most if not all of those loans would not be made because of the new capital requirements.”

Eastern Virginia Bankshares’ Shearin, who is also chairman of the board for the Virginia Association of Community Banks, says that he’s concerned that, even if community banks are exempted from Basel III, the regulations still will trickle down eventually. That already has happened with parts of the Dodd-Frank banking reform law because having two sets of regulations isn’t realistic. “Once a bank examiner gets the rules, he or she doesn’t have two sets of rules — just like any company wouldn’t have two sets of books,” he says.

Initially, bank examiners would focus on larger banks, but after a while, the regulations implemented will be the ones they want to follow — no matter the size of the bank.

Shearin says Basel III wasn’t designed with American community banks in mind. The banking environment in Europe — where a central bank or a few large banking institutions dominate in most countries — is far different from the 22 EVB branches with their $1 billion in assets, he says. “The people who are making the rules don’t understand the makeup of community banks.”