Senate Compromise Bill Would Roll Back Stress Tests For Small Banks

Nov 15, 2017

Across the country, small bankers are calling a compromise in the U.S. Senate a “game changer” that will boost the economy, not just in big cities, but in smaller communities often ignored by the “Too Big To Fail” banks. But watchdogs and academics say the bill rolls back major parts of the Dodd-Frank financial reform bill.

The big banks—like Chase or Bank of America—compete to land business from major companies like Electric Boat or Sikorsky. But those big companies rely on smaller companies as supply partners. When those smaller companies need business loans, they go to small bankers, like George Hermann, CEO at Windsor Federal Savings in Windsor, Connecticut.

“There’s an awful lot of companies that support the Pratt & Whitneys, that support the Electric Boats. So there’s a lot of manufacturing firms, but there are other service firms also.”

Unlike a more controversial bill proposed in the U.S. House, which would roll back many of the reforms put in place after the financial crisis, the legislation being discussed in the Senate has a number of key Democrats supporting it. Which has bankers like Hermann excited.

“We are not the type of institution that had any of the problems, but now somebody is trying to tell us how we should underwrite, and what happens is qualified people that don’t fall into the box are having a difficult time getting credit.”

For example, Hermann says, the new Senate package removes a cap on business loans for banks with under $10 billion in assets. More business loans mean the company that mows Sikorsky’s lawn could buy more equipment and hire another crew.

“There’s going to be more credit available. We’re a mutual institution, so we don’t have shareholders. We operate, in our view, for the good of the community. And it’s going to allow, especially community banks, to make the loans that we were making for years, that we were making before Dodd-Frank came.”

Many regulators agree that Dodd-Frank was too harsh on small banks that didn’t cause the financial crisis. There was also an inside joke that Dodd-Frank restricted credit so much that former Federal Reserve Chair Ben Bernanke couldn’t refinance his mortgage because his lucrative speaking fees weren’t regular. But some academics look at the current Senate compromise and see a dangerous philosophy.

Anat Admati, a finance and economics professor at Stanford Business School, says, “This bill seems to believe that if an institution is small that therefore it shouldn’t be constrained a lot. But you can have a lot of small institutions doing risky things.”

For example, the savings and loan crisis of the 1980s where hundreds of small banks failed because of loose lending standards. Admati worries that the compromise bill declares some assets, like municipal bonds, non-risky, which in turn could crank up the risk of lots of small banks.

“Certainly, one of the most objectionable things here, I didn’t even say, of course, is the fact that $50 billion to $250 billion institutions are not supervised in an enhanced way.”

The compromise legislation in the Senate leaves it up to regulators whether or not to do stress tests for large regional banks. Many are concerned that not requiring tests for financial soundness will give more free market administrations free reign to ignore risky behavior.

Larry White, a, NYU Business School professor and a regulator during the savings and loan crisis, says it’s true small banks don’t pose a huge, systematic risk, and “in that respect, this is harmless and saves the financial institution some costs and in that sense, it’s okay. What does concern me is that stress tests are forward looking.”

Throughout the mortgage crisis of 2008, most banks—on paper—looked healthy. White says more banks, not fewer, should conduct stress tests. And he acknowledges this bill is better than a more radical House bill.

Even though this compromise has support from a number of moderate Democrats, it still has to get more of them on board to overcome a possible filibuster.