New Banking Regulations Are Too Complex

A new set of complex financial regulations will impose large costs on community banks, says Paul Kupiec, a resident scholar at the American Enterprise Institute.

U.S. federal banking agencies agreed to apply a new set of regulations known as “Basel III” to American financial institutions. These regulations increase the amount of capital that banks are required to maintain.

But these rules are incredibly complex and confusing, weighing in at almost 1,000 pages in length, and the impact on community banks is significant:

– The rules apply to small and large banks alike. While there are some provisions that exempt small banks from the rules, the capital requirements and other important regulations still apply to small institutions.

– Many smaller banks are subchapter S corporations, meaning that their income is not taxed at the corporate level but is instead taxed as shareholder income. Failure to meet the Basel III capital requirements could result in a corporation being prevented from issuing dividends to shareholders, while still holding those shareholders responsible for taxes. The rules therefore increase the likelihood that subchapter S shareholders could face unfunded tax liabilities.

– Rules are already in place in the United States that keep small bank failures from causing systemic economic harm. These complex Basel III regulations are unnecessary for these types of banks.

Basel III is by far the most complex set of bank regulations that have ever been attempted, and the compliance costs are high for small and large banks alike. Moreover, the rules could inadvertently skew investment decisions in cases where Basel III risk-weighting understates the actual risk of an investment. Instead of issuing rules like Basel III, regulators should attempt to draw simple, bright-line rules that are practical, easily understood and easy to enforce.

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