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Tougher regulation on large banks will 'trickle down' to community banks


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Tougher regulation on large banks will 'trickle down' to community banks

Regulators are expected to crack down harder on the largest banks after the recent failures, and that scrutiny will trickle down to community banks during exams.

Top regulators have made it clear they plan to subject banks with $100 billion to $250 billion in assets to heightened regulation of capital, liquidity and other metrics. While that impending rulemaking will only impact banks of that size, community banks can expect increased regulatory scrutiny on those topics too during their exams, experts said at S&P Global Market Intelligence's 2023 Community Bankers Conference.

"There will be regulatory trickle down ... where some of those restrictions and guidance that apply to the $100 billion to $250 billion organizations will come down," said John Geiringer, a partner in the Financial Institutions Group at Barack Ferrazzano Kirschbaum & Nagelberg LLP.

Scott Hildenbrand, chief balance sheet strategist and head of the financial strategies group at Piper Sandler & Co., also believes community banks face a tougher regulatory road ahead.

"The regulatory world and others are going to come down harder on the rest of the 98% of the banks that don't look like" the banks that failed, Hildenbrand said during a panel discussing funding and liquidity pressures. "We got to fight that battle."

Speaking on a regulatory panel, industry experts, including current regulators, detailed what examiners will focus on in upcoming exams and how community banks can prepare.

Exam focuses

As their exams approach, banks need to "be aware of the complexity of what's going on externally and how does that impact your bank and how are you prepared to withstand whatever storm may come," said Rafael Valle, the Federal Deposit Insurance Corp.'s assistant regional director of the division of depositor and consumer protection for Arkansas, Colorado, the Western part of Texas, New Mexico and Oklahoma. "The risks are more complex because they are intertwined and one could trigger the other."

One major focus among the agencies will be capital levels, especially given banks' underwater bond portfolios and the outlook for a decline in asset quality, both Valle and Colette Fried, the assistant vice president of banking supervision and regulation for the Federal Reserve Bank of Chicago, said.

"It all boils down to capital. Not so much of what's the notional number of [accumulated other comprehensive income], but what is that relative to capital? And how much loss can an institution withstand? That's really what they're going to focus on," Fried said.

Geiringer suggested banks should be keenly aware of their classified asset ratio, which measures classified assets as a percentage of Tier 1 capital.

"In many ways, at least in the last crisis, that basically determined your life or death and if you were heading in that direction," Geiringer said. "That really provides you the broader surveillance tool to let you know what those loans are going to do, which could help create those capital issues."

Liquidity is also a major focus among regulators right now. Coastal Financial Corp. just finished its safety and soundness exam "and liquidity was mentioned every other sentence," CEO Eric Sprink said on a separate panel.

Both Fried and Valle also named commercial real estate as an area of importance.

"Because of the vacancy rates going up now that more people are working from home and also there's a volume of commercial real estate loans that are maturing so they are going to be renewed at higher interest rates that's going to put some pressure on your portfolio, especially if you have a concentration," Valle said. "We will be looking at your risk assessments internally, your reserves, your capital position and so forth."

While regulators plan to zero in on these areas, ultimately, how tough an exam is will be determined by each individual bank's operating model.

"We need to be aware that we can't have the same expectations of a smaller community bank versus a large bank," Valle said. "It depends on your risk profile, your risk appetite and the fundamentals of your CAMELS."

The CAMELS rating measures capital adequacy, asset quality, management, earnings, liquidity and sensitivity on a scale of one to five, with five being the worst.

Tips and tricks

Given the outlook for more thorough exams, the experts provided advice for helping to ensure exams go smoothly.

Fried suggested community banks should reach out to their regulators now, ahead of exams, and have a conversation about what will be their focus during exams.

"If you haven't spoken to your primary federal or state regulator in the last six months, I would reach out to them," she said. "Having a conversation a month before the exam is not the time to do it."

Geiringer reiterated that "ongoing dialogue with regulators is key."

Open communication is also important during the exam itself, the panelists said. For example, providing more detail about a sector in which a bank appears to have concentration could provide examiners solace.

"It might look like a concentration, but ... maybe you've been really conservative and just put something that is secured by commercial real estate out of an abundance of caution in that category," Fried said. "Trying to define that better for the exam team that's going to be coming on your exam is also really important."

It's also important to have open discussions about remediation timelines if regulators uncover an issue, especially since "given how the external factors are changing, that remediation may need to be quicker than we had during peacetime economy when things were stable," Valle said.

Faster remediation timelines could be an issue for community banks who have to "do a lot with a little," Geiringer said. However, "being able to tell your story with the regulators to say, 'Here's why we can't do something in 30, 60, 90 days,' generally gets a favorable response so long as you're very specific," he said.