Economics

Community Banks Face a Regulatory Cliff

New Basel III banking rules will increase the cost of mortgages and small business loans -- which is bad news for Main Street.

By 11.21.12

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As if the "fiscal cliff" and the prospect of looming tax hikes were not enough, banks of all sizes -- and in turn consumers and businesses who rely on their credit -- also face the "Basel cliff."

The term doesn't refer to a mountain in Switzerland, the beautiful country which surrounds the city of Basel. Rather, it refers to meetings in Basel and elsewhere by international banking bureaucrats to develop the Basel III agreement for harmonizing international capital requirements. If implemented as planned, it will dramatically increase the cost of mortgages and small business loans while, according to many experts, actually making the banking system less stable.

The Basel Cliff is part of what Sen. Rob Portman (R-Ohio) and others have called the "regulatory cliff." In the year leading up to the election, the Obama administration put hundreds of regulations on hold.

As I wrote in Forbes a couple weeks before the election, these regulatory delays "may have given employers just enough breathing room," spurring some slightly improved growth measures in 2012. And this slight retreat from stagnation may have been just enough to carry President Obama to his election victory.  But now that Obama has won, my Competitive Enterprise Institute colleague Ryan Young reminds us that "in short run, it means a midnight rush of new rules is coming."

Yet even among the many burdensome regulations entrepreneurs face, the Basel rules are unusual for a number of reasons: their extreme stringency, complexity, lack of accountability, and -- one a sign of hope -- their unpopularity with many members of both parties. The entire Maryland congressional delegation, mostly consisting of liberal Democrats such as House Majority Whip Steny Hoyer and House Budget Committee Ranking Member Chris Van Hollen, recently wrote of their concerns in a letter addressed to regulators from the Federal Reserve Board, Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency.

The lawmakers stated, "[W]e strongly encourage you to avoid needless complexity and consider the impact any new framework will have on traditional depository institutions that provide credit to consumers and small businesses in our communities."

CEI also joined in a letter, sent to the Senate Banking Committee, that was signed by groups representing many sectors of industry, including the U.S. Chamber of Commerce, the Property Casualty Insurers Association of American, and the National Association of Home Builders. We wrote that the Fed, FDIC, and Comptroller "have failed to consider the impact of Basel III upon Main Street businesses."

Given that we now know where the financial problems are located, Basell III's logic is extremely unsound. Under the accord, a U.S. community bank would have to put up much less capital to buy a teetering European bond than to make a mortgage or business loan to a customer it has dealt with for years. As the Wall Street Journal noted in a recent editorial (subscription required):

"Their new rules encourage banks to load up on sovereign debt. This makes perfect bureaucratic sense, since the world's governments have proven to be handsdown the issuers with the most dishonest accounting. The FDIC's own Director Thomas Hoenig sees in Basel III the same complicated system for judging risk that failed in Basel II 'but with more complexity'"

Basel III also imposes one-size-fits-all standards without accounting for underwriting standards and the quality of borrower. A bank offering a mortgage with any type of balloon payment -- or adjustable interest rate -- may be required to carry 200 percent extra capital to cover the loan. Yes, some of those low capitalization requirements were utilized by subprime operators, but they are also the same kind of loans that community banks give to borrowers with stellar credit.

Community banker Jim Purcell, head of the State National Bank of Big Spring, Texas (and co-plaintiff, along with the conservative seniors group 60 Plus, in CEI's lawsuit against the Dodd-Frank bank regulatory overhaul), has already testified that Dodd-Frank has made it impossible to offer the stable mortgages he previously made for decades. However they feel about Dodd-Frank, both Maryland Democrats and Louisiana Republicans seem to recognize that this dash of Basel added to the already potent regulatory mix makes for a poisonous recipe for community banks.

One of the many lessons of the 2012 elections is that while conservatives should look for ways to limit government with bipartisan support, they should never let the Left dictate the main agenda or issues on the table. Since Hoyer and Van Hollen have -- to their credit -- expressed doubt about the Basel regime, the House majority party should give them the opportunity to put those doubts to a vote as soon as possible.

In short, there's no reason that during the "lame duck" session, Congress can't fix the Basel cliff and avert the biggest chunks of the regulatory avalanche.

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About the Author
John Berlau is Senior Fellow for Finance and Access to Capital at the Competitive Enterprise Institute and blogs at OpenMarket.org.