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July 24, 2020 (Courtesy of the Jacksonville Business Journal)

It’s “almost inevitable” that many banks will fail as a result of the Covid-19 pandemic, a top regulator said Friday.

Jelena McWilliams, a year into her role as chairwoman of the Federal Deposit Insurance Corp., spoke with sister paper the Baltimore Business Journal as she continued her nationwide listening tour getting to know the needs of bankers across the 50 states.

When McWilliams took over the agency last June, the banking industry was cruising along as the economy continued its longest-ever expansion. A year later, the economy has been turned upside down by the global health crisis.

The entire banking industry was hit hard in the first quarter. Looking ahead, banks will likely face difficulties as businesses permanently close and default on loans. During and after the Great Recession, hundreds of banks failed while many more merged or got acquired as consolidation increased.

More than half of all banks reported year-over-year declines in net income in the first quarter and the share of unprofitable institutions increased to 7.3%, according to the FDIC.

It’s almost a sure thing that banks will fail in the coming months and years, McWilliams said, because the number of banks on the FDIC’s “problem bank list” the last two years has been so low. She said the number has hovered around 50, down from over 500 at one point.

“There’s nowhere to go but up,” McWilliams said. “We are going to see some increase because we were at the record lows. What increases, when and what fashion remains to be seen.”

McWilliams, a former chief legal officer for Fifth Third Bancorp who was picked by President Donald Trump to push for deregulation in the banking industry, also spoke about a major change announced Thursday.

Regulators eased the so-called Volcker Rule — a part of the Dodd-Frank Act passed in the wake of the 2008 financial crisis — by loosening restrictions on bank investments in venture capital funds and margin requirements for derivatives trading. However, the Federal Reserve also announced it would be limiting dividend payments and suspending share buybacks for big banks.

Here’s what McWilliams had to say about deregulation, de novo bank activity and the Small Business Administration’s Paycheck Protection Program during the wide-ranging interview.

Regulators seemed to send mixed signals with the easing of the Volcker Rule and the restrictions on payments and buybacks later announced by the Fed. What should bankers expect to see from a regulatory perspective going forward?McWilliams: I don’t think frankly that there was a mixed signal. If any change to the law is deregulation, then what we did was deregulation. I would say it wasn’t deregulation because we changed the way we are looking at some of the metrics and how we are accounting for certain capital and liquidity, etc. You want banks to distribute capital to the economy, right? That’s their job. Now, to be safe and sound, they need to hold some capital. There is all of this tug-of-war between how much capital and how much liquidity do they hold, versus how much of that they disburse to the economy. That is a constant battle for regulators. There is no magic formula.

Maryland was on track to see its first new bank open since 2008 prior to the pandemic. Do you think we will see more de novo bank activity or does that slow down now because of the economic conditions?

McWilliams: We have changed the process of de novos exactly for that reason because there is a consolidation in the banking industry that has been going on for 30 years. We want to make sure that new entrants into the marketplace have a fair chance and that we are not on the regulatory side holding up the costs for the approvals. The biggest issue for banks is really capital. Can they attract enough capital? And they have two years to come up with minimum of 8% capital based on their business model and risk profile. They present the plan to us and tell us what they believe would be an appropriate amount of capital. Then we do our calculations…

It’s a little bit more difficult to attract capital in market volatility and when there is a lot of uncertainty. We have approved 29 community bank applications since 2018. It’s difficult to predict whether the current environment will discourage folks from applying. I wouldn’t say it will encourage them, but I don’t know if it will discourage them.

The Paycheck Protection Program comes to an end on June 30. Some observers have said the big banks did not do their fair share given how much market share they have, while the community banks punched above their weight. What do you think?

McWilliams: I’m very proud of how quickly small banks were able to adjust their systems and start processing the loans. It was quite remarkable. Large banks, I think because they are so complex, it took a while to get them to change their systems to be able to process loans. Their loans are traditionally underwritten. Their systems are set up for underwriting. The small banks were able to manually process these loans, which is why they are able to process a significant amount of loans which was quite remarkable.

What happened also is large banks, because they are so automated, sent a ton of applications to the SBA, which crashed the system. Then the SBA said the loans have to be manually processed. Who is good at manually processing loans? The small banks. A lot of them don’t have the technology to process them otherwise. They were better positioned to process these loans more quickly. I think the big banks caught up later, but in the first few days it was really the small banks who were able to manually process the loans.

In good times, their business model hampers them because they don’t have what they need to be competitive with larger banks, but in times like this it allows them to process loans more quickly and with more agility than the large banks.