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Industry Needs: Trust and Simple Capital Standards

By: Bill Poquette

Rebuilding trust in banking institutions is a top item on the agenda of FDIC Director Thomas M. Hoenig, he told members of the Missouri Independent Bankers Association at their annual convention last month in Lake Ozark. Everybody talks about the fiscal “cliff” and other dire financial challenges, but he doesn’t think anyone trusts the institutions through which these things have to be solved.

As part of this process, he advocates breaking up the largest banks, not by size but by separating their broker-dealer and trading activities from commercial banking. He has testified before Congress on this issue, and both parties seem sympathetic to his view, according to the former president of the Federal Reserve Bank of Kansas City. “It would bring renewed vigor into the banking system,” he said. High-risk trading is a needed function, in his view, but it should be done outside of commercial banking.

Also high on his agenda are the Basel III proposals, which he warned impose a highly complex set of capital standards industry-wide. “In 99 percent of the cases they are impossible to understand unless you are a mathematician,” Hoenig said. “What we need are capital standards that are simple, understandable and enforceable.”

From 1914 until the mid-1930s, when the FDIC safety net was established, the capital standard for the industry was 10-plus percent, whereas under Basel I and II it is 2.8 percent. “How much capital is enough is the issue, not the formula,” he argued. In a question and answer session following his remarks, he suggested that the debate “should start around10 percent of equity capital.” Higher capital requirements sustain growth rather than stifling it, in his view.

In wrapping up his remarks, which drew a standing room only crowd, Hoenig emphasized that commercial banking needs to be commercial banking, providing financial intermediary services between depositors and borrowers and payment services. “We have a system that can serve the largest businesses and the smallest business,” he said. “It is a better system than five big banks.”

Click here to view photos from this convention.

Also commenting on Basel III, Bill Loving Jr., chairman-elect of the Independent Community Bankers of America, warned that it applies to every community bank. He advised doing some assumptions about what the effects might be, as they did in his bank, Pendleton Community Bank in Franklin, W.Va., where he is president and CEO. “Our risk-weighted assets go up from $180 million to $208 million,” he reported. “Do an analysis, send it to your regulator,” he said. “And your members of Congress need to be contacted by your employees, your board and your customers.”

A report from Rich Weaver, Missouri finance commissioner, showed the majority of Missouri’s 273 state-chartered banks performing well and somewhat improved from a year ago. As of June 30, equity capital to assets averaged 10.06 percent versus 9.88 percent in 2011; past due and nonaccrual loans were down to 3.03 percent from 4.08 percent at this time last year; allowances for loan and lease losses were down to 3.03 percent from 4.08 percent; and return on assets averaged 1.02 percent, up from 0.81 percent.

Asset quality continues to show signs of improvement, Weaver noted. The number of problem banks is down significantly, net chargeoffs to total loans are declining, and just 12 Missouri banks have Texas ratios over 100 percent.

State-chartered banks with 1 and 2 CAMELS ratings number 220, according to Weaver; half of the rest are “improving,” and two-thirds of the other half of the rest are “stable.”

The industry is not without challenges, he noted. The low interest rate environment is pinching banks, higher-yielding assets are rolling off the books, and it is difficult for small banks to generate fee income. He sees more commercial and industrial lending and he doesn’t have a problem with that. He cautioned, however, that it takes a different skill set than commercial real estate lending.

Among the leading causes of bank failures is inadequate corporate governance, according to the FDIC’s Office of the Inspector General. Offering some advice for directors and would-be directors was Kevin J. Funnell of the law firm Bieging Shapiro & Barber LLP, who stressed the duties of loyalty and care, plus the duty to supervise, which he characterized as a sub-category of the duty of care.

He described the duty of loyalty as administering the affairs of the bank with candor, personal honesty and integrity; doing what he or she believes in good faith to be in the best interest of the bank; and being prohibited from self-dealing. The duty of care means acting with the prudence and diligence of a reasonable business person, and the duty to supervise requires properly overseeing the affairs of the bank.

Among the general director duties Funnell incorporated in the duties of loyalty and care were selecting and evaluating competent management; establishing business strategies and policies; monitoring and assessing the progress of strategies; monitoring adherence to policies and procedures and applicable laws, regulations, safety and soundness; and, most importantly, making decisions on a disinterested, fully informed basis after meaningful deliberation.

A critical element of corporate governance for both officers and directors is the business judgment rule, according to Fennell. He suggested that, in the event of bank failure, directors and officers may not be held liable for breach of the duties of loyalty and care based on reasonable business decisions made in good faith, in a disinterested manner, on a fully informed basis, after proper deliberation.

“If you comply with this,” Funell said, “and if the FDIC sues, you have a good case that you weren’t grossly negligent.”

Bill Poquette is editor-in-chief of BankNews.

Copyright (c) October 2012 by BankNews Media