Yesterday, the 111th Congress returned from its spring recess, undoubtedly rested and re-energized following the tumultuous and bruising year-long battle over health care reform.  With less than seven months remaining before the mid-term elections in November, the Democrat-led Congress is putting everything on the table, forging ahead with an aggressive agenda that includes financial regulatory reform, a third stimulus “jobs” bill, immigration reform and confirmation of a new Supreme Court justice.

The weeks and months ahead will be trying ones for those of us who care deeply about the banking industry.  Politicians and talking heads will cast aspersions about bankers, painting us all with the same brush and labeling us as “greedy fat cats.”  And yet, if the economic meltdown has proven anything, it’s that two classes of financial institutions exist in this nation; one, the community banks that sustain and encourage growth in Main Street America and, two, the “too big to fail” banks that pose a substantial risk to us all through unscrupulous and unsafe business practices.

With this disparity in mind, we must speak out against “one size fits all” efforts at financial regulatory reform and encourage members of Congress to enact real reform that addresses the sectors of the industry that pose the biggest threat to the American economy.   In order for real financial regulatory reform to be realized, there are four criteria that should be included in any bill sent to the President for signature:

1) End “Too Big to Fail” -  “Too big to fail” is a reality.  We believed, perhaps naively, that businesses succeeded or failed based on the merits of their business practices.  But not the so-called “systemically important” banks.

The bailout of financial institutions deemed “too big to fail” has created a competitive disparity in the marketplace, with the federal government ultimately choosing the winners and the losers.  Meanwhile, 197 smaller community banks have been allowed to fail since the fourth quarter of 2008.  It would take just more than $22 billion to bring all of the currently undercapitalized banks up to minimum capital standards as defined by regulators, contrasted with the $45 billion needed to bail out a single “systemically important” bank, Citibank. 

2) Rethinking how we deal with risk – When a bank fails, it costs millions, perhaps even billions of dollars to untangle that bank’s business dealings and to wind down the operations of that bank.  Under the current system, other banks pick up that cost through the Federal Deposit Insurance Corporation (FDIC).  At this time, community banks account for approximately 70% of the money that goes into the FDIC fund, while multi-billion banks account for just 30% because the assessments on banks are not based on actual systemic risk, just balance sheet objects.  This disparity must be addressed through real deposit insurance reform.  Future assessments should be assessed on assets, not deposits.  After all, it is the assets (loans) that go bad, not deposits!

Further, real reform would involve the creation of a systemic risk fund for the largest financial institutions with more than $50 billion in assets.  Just as you buy life insurance before you actually die, the systemic risk fund would be capitalized by fees charged to every bank over $50 billion, thus making those banks liable for their own systemic risk rather than transferring that risk to all other financial institutions.

3) Totally exempt banks with under $10 billion in assets from the oversight of the Consumer Financial Protection Agency (CFPA)
The CFPA is a classic overreaction by lawmakers who have little understanding of the way that financial regulation works in the first place.  The current economic collapse was not caused by sound business practices used by community banks, but rather by the employment of unscrupulous and unsafe practices in the interaction between large banks and the so-called “shadow banking” industry, which simply over-leveraged its debts to its assets until their house of cards came tumbling down.

The banks that should fall under the oversight of the CFPA are those that pose the biggest threat to consumers and the economy because of their large systemic risk.  These are the banks that did the harm in the first place and those that can most easily threaten the economy if left unchecked in the future.  Subjecting community banks to even greater levels of regulation will do nothing but stifle innovation in the marketplace and increase more red tape and costs to the consumers.

4) Preserve regulator choice
Under the current system, banks have the choice of whether they want to be regulated at the state or federal level.  This choice preserves health in the regulatory arena by providing a checks and balances system as state and federal regulators strive to be fair, equitable and, most importantly, consistent in their oversight of banks.

Despite the recent challenges in the economy, the United States continues to have the world’s strongest banking system, in large part because the system of regulator choice works so well.  Preserving a strong banking system is in the best interest of the consumer and the economy and any attempt to centralize authority of the banking system under the federal government should be recognized for the significant threat it poses to the strength of the industry.

The failures of the banking system cannot be allowed to be repeated.  However, there is a right way and a wrong way to go about creating strong system. The key to getting it right lies in recognizing the essential differences between financial institutions in the United States.

Congress has an opportunity to make it right.  The question is, will they do so, or allow themselves to become mired in partisan battles rather than solving the issues at hand?  They must ensure that the mistakes which led to the current financial crisis are never repeated.  Reform efforts must focus on the area of the industry that is sick, leaving community banks out of the reform rhetoric and allowing them to continue working for real citizens and small businesses in every community.