Small lenders back in regulatory crosshairs
But bankers resist Basel III rules, say they played no role in '08 financial crisis
New Jersey community banks view the federal governments' proposed Basel III bank capital rules as a costly headache that's likely to curtail lending and push some smaller banks to surrender their independence and merge with other banks.
After getting a flood of complaints, U.S. banking regulators announced earlier this month they will delay implementation of Basel III, originally set to be phased in beginning Jan. 1. Regulators didn't set a new date, but they said they remained committed to the new rules.
Basel III is a global response to the 2008 financial crisis — the idea is to shore up the banking industry's capital fortress to weather the next financial crisis. But New Jersey's community banks say they weren't to blame for the last crisis, which was ignited by reckless subprime mortgage loans that were packaged by Wall Street into securities sold around the world. Those community bankers say they kept cash flowing to businesses in 2008 and during the subsequent recession — and contend their record proves the nation needs a vibrant community banking system that's ready to step up and lend to businesses in the event of a future financial crisis.
Frank Sorrentino III, CEO of North Jersey Community Bank in Englewood Cliffs, said Basel III requires banks to have more capital overall, while increasing the capital required for specific types of loans, based on the risk. The regulations would impose an "added level of complexity that takes time, effort and money," he said. The result is a vicious cycle: banks will be forced to spend more money on compliance "which is going to reduce bank profitability, which in turn reduces capital, which in turn reduces lending — all this at a time in our economy when everyone wants banks to lend more."
"I don't want to be making decisions about what type of borrowers we should be doing business with based on Basel III," Sorrentino said. By increasing bank operating costs and pinching profits, Basel III could hurt banks by "making it harder for us to attract investment, and therefore harder to grow in the future."
Banks will have to hold more capital — and thus, charge higher interest rates — on loans to borrowers "who don't have the squeakiest, cleanest, strongest balance sheets," Sorrentino said. "Those loans are going to be more expensive and there are going to be fewer banks willing to make them." One of his customers is a homebuilder who uses his home equity credit line to finance his construction business; "we've already told him that that type of credit is going to be more expensive for him."
Somerset Hills Bank CEO Stewart E. McClure Jr. said construction lending will require more capital under Basel III, and "if you make it too challenging for banks to make certain loans, they just won't do them." Somerset Hills is a $350 million asset, six-branch bank with a commercial loan portfolio of about $165 million.
Right now, McClure and his fellow New Jersey bankers say they're eager to make loans to rebuild the devastation of Hurricane Sandy, but Basel III "will make it more difficult and more challenging for banks to provide construction loans for people to rebuild."
Valley National Bank, in Wayne, is one of the largest New Jersey-based banks, with $16 billion in assets, and CEO Gerald H. Lipkin said Basel III "is a lot of expense being laid on banks that don't need this expense." He blames regulators for not halting risky mortgage lending by banks like Countrywide and Washington Mutual, which failed and were absorbed by other banks.
Lipkin said there were about 20,000 U.S. banks when he started his banking career in 1963; now there are about 7,000.
"I'm of the strong belief that the regulators would like to get the number of banks in this country down to about 500 banks, and they are going to make life so miserable for banks that they are going to put their hands up and surrender," he said.
Basel III requires banks to "break down your loan portfolio and allocate capital against different types of loans — there is computer programming that has to take place," Lipkin said. "They are trying to slice and dice and make a major undertaking" out of analyzing capital adequacy: "They are trying to make a science out of an art."
Darius Palia, professor of banking at the Rutgers Business School, said businesses "absolutely" will be affected by Basel III.
"If your relationship is with a community bank, and they have to hold more capital for certain types of (loans), then they are going to move away from some sorts of loans" or else merge, possibly into a larger bank. That, he said, will reduce the number of community banks for businesses to deal with, "so either way the borrowers are going to be affected."
Thomas W. Killian, a banking analyst with Sandler O'Neill Partners, said, "The challenge for the smaller banks is, given higher cost of regulation and documentation associated with some of these rules, can they continue to generate an attractive return on equity." If not, "that could lead to more consolidation among some of the smaller banks."
Kevin Cummings, chief executive of Investors Bank, in Millburn, and chairman of the New Jersey Bankers Association, said, "The community banks headquartered in New Jersey can service the small businesses here much better than the larger banks, because they are closer to the community." And he said it's good to have numerous banks because "competition is beautiful."
Investors has nearly doubled in size in recent years, to $12.5 billion in assets, through acquisitions and by increasing its share of the market. But Cummings said the future is dicey for the small, $200 million-asset community bank that now must hire two or three people just to deal with the government.
"The board of directors might say, 'We're not getting an adequate return here: should we sell?' " he said.
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