Fed Official Says 'Too Big to Fail' Threatens Community Banks

Level playing field needed to support smaller, regional banks

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Thomas Hoenig, president of the Kansas City Federal Reserve Bank, said Monday, August 23, that the long-term health of community banks was being strangled by the market's, and the government's, policy of "too big to fail" toward big banks.

Hoenig, in prepared testimony to a field hearing of the U.S. House of Representatives Subcommittee on Oversight and Investigations in Overland Park, Kansas, said that in the near term the model used by community banks was still viable if allowed to compete on an even playing field with big banks.

"Community banks will survive the recession and will continue to play their role as the economy recovers," Hoenig said. "The more lasting threat to their survival, however, concerns whether this model will continue to be placed at a competitive disadvantage to larger banks. Because the market has perceived the largest banks as being too big to fail, they have the advantage of running their business with a greater level of leverage and a lower cost of capital and debt."

Hoenig, at the Federal Open Market Committee's meeting on August 10, was the lone dissenter of the Fed's policy to maintain low interest rates for an extended period because the economy was recovering modestly as expected, he said.

In his prepared testimony on Monday, Hoenig said community banks were generally considered those with less than $10 billion in assets, and accounted for all but about 83 of the 6,700 banks in the United States. He said community banks were a critical underpinning to regional economies, particularly in the Midwest, and why they needed to have policies to level the playing field with the big banks.

Honenig added that big banks had plenty to learn from community banks' basic approach to banking, which had them vested in the success of the customers they served.

"It is the very 'skin in the game' incentive that regulators are trying to reintroduce into the largest banks," Hoenig said. "It's the small community's version of 'risking your own funds' that worked so well in the original investment banking model, and kept partners from making risky mistakes that would result in personal bankruptcy back then, and government intervention more recently."

Read a story about the FOMC meeting on August 10 from the archives of InvestmentAdvisor.com.

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