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How Some Small Banks Are Firing the Fed

Bank of the Ozarks was regulated by the Federal Reserve, the Federal Deposit Insurance Corp., a state banking agency and others. When it wanted to cut costs, it ditched the Fed.

By

Christina Rexrode

Bank of the Ozarks wanted to cut costs, so it ditched the Fed.

The Little Rock, Ark., bank was regulated by the Federal Reserve, the Federal Deposit Insurance Corp., a state banking agency and others. It figured one way to reduce expenses would be to remove a layer of oversight.

So, the bank in June shed its holding-company structure, an umbrella corporation regulated by the Fed. With that gone, the Fed was out of the picture.

“We didn’t really need to be regulated by both,” said Chief Executive George Gleason, referring to the FDIC and the Fed. Although the bank hasn’t detailed savings, it expects to reduce administrative, accounting and regulatory costs.

Cutting costs holds obvious appeal for banks at a time when tepid economic growth, superlow interest rates and stringent regulation have kept profitability in check. But dollars and cents aren’t the only driver of decisions like Bank of the Ozarks’: Changes in U.S. banking laws in recent decades have limited the advantage of the holding company structure for many firms, and the pro-business shift in Washington has helped embolden some bankers.

While some skeptics of the move worry about banks shedding a layer of oversight—potentially enabling them to engage in more risky lending or other activities—bank executives counter that they will still be under the scrutiny of the FDIC.

Even some regulators back such moves. “Banks should be able to structure themselves in whatever way they want,” Keith Noreika, acting head of the Office of the Comptroller of the Currency, one of the main federal bank regulators, told The Wall Street Journal. “Holding-company form is an anomaly throughout the world.”

Bank of the Ozarks, with roughly $21 billion in assets, is the biggest company in recent years to make such a change. Its move has stirred interest among small banks looking to save money at a time when loan growth has often been hard to come by and superlow interest rates are squeezing profits.

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BancorpSouth Bank in Tupelo, Miss., completed a similar conversion last week. “We’re spending time, money and effort with the Fed that we really don’t have to,” said CEO Dan Rollins. “Keep it simple.”

Others are considering the strategy, too. Speaking on his bank’s earnings call last month, New York Community Bancorp Inc. finance chief Thomas Cangemi said, “Do we have to stay as a bank holding company?” Changing that, he added, could be “an option going forward.”

“This is taking regulatory relief into their own hands,” said V. Gerard Comizio, a partner at law firm Fried, Frank, Harris, Shriver & Jacobson LLP, who said he has heard from dozens of banks interested in the transition.

It is also a way for banks to sidestep things such as Fed-administered stress tests, even if they surpass a $50 billion asset threshold that usually triggers such oversight. Stress tests are costly in terms of both time and staffing.

San Francisco-based First Republic Bank , for example, has grown to $84 billion in assets from $33 billion five years ago. Although it crossed the $50 billion line, First Republic doesn’t undergo Fed stress testing.

First Republic executives declined to comment but have talked favorably about their structure in calls with analysts and investors. “We keep it very, very simple,” CEO James Herbert told an industry conference in late 2015. “We don’t even have a holding company.”

New York-based Signature Bank is another lender that doesn’t have a holding company. Although at $41 billion in assets it hasn’t crossed the $50 billion mark, executives note the benefit of a streamlined structure. “We’re so heavily regulated to begin with—why would you add on to that?” said Executive Vice President Eric Howell.

Granted, not all banks can get rid of their holding companies. Banks that engage in certain riskier activities, such as securities underwriting, must have a holding company to keep those units separate from the one holding bank deposits. For instance, J.P. Morgan Chase & Co. and Bank of America Corp. wouldn’t be able to shed their holding companies.

The simpler structure also holds some potential drawbacks. For example, banks without a holding-company structure have less flexibility to invest in other companies. That could be a turnoff for those that want to buy stakes in financial-technology firms, said Chip MacDonald, a partner at law firm Jones Day who is working with banks considering such a move.

Smaller community banks also can hold higher levels of debt if they operate under holding companies, which can help with mergers.

A holding company is essentially a parent organization for a bank and its related entities, and about 80% of U.S. banks and thrifts operate under this structure. But in recent years, the benefits from such an arrangement have shrunk while regulatory costs have risen.

Many banks adopted the holding-company structure in the 1980s so they could do business across state lines. Banks today no longer need a holding company to do so.

Other banks created holding companies to get more flexibility to count various forms of capital toward their regulatory benchmarks. Post-financial-crisis regulatory changes curbed that benefit.

To make the change, Bank of the Ozarks merged its parent company into its bank. It had to hold a shareholder vote and file merger applications with the FDIC and state banking regulators, but it didn’t need the Fed’s permission.

Eliminating the holding-company structure holds other benefits. A holding company generally requires a separate set of financial results, its own board meetings and oversight of transactions between the holding company and the bank.

Plus, banks, unlike bank holding companies, don’t file quarterly and annual reports with the Securities and Exchange Commission. Instead they file with bank regulators. The FDIC also doesn’t charge a registration fee when banks issue new shares, as the SEC does, Bank of the Ozarks said.

Having one less regulator could also speed up some processes, such as getting mergers approved. That was an important consideration to Bank of the Ozarks, which has gobbled up rivals and quintupled its assets in the past five years.

Such moves have caused some concern that banks could shop for more lenient regulators, engaging in regulatory arbitrage. That became an issue before the financial crisis.

Bank of the Ozarks and other firms counter by saying the FDIC isn’t a lenient regulator. The FDIC and Federal Reserve don’t have an official position on holding-company changes.

“It might be arbitrage,” Karen Shaw Petrou, managing partner of policy-analysis firm Federal Financial Analytics Inc., said of banks changing their structure. “But it’s also a huge boost to their challenged earnings.”

Mr. Gleason described shedding Bank of the Ozarks’ holding company the way he shed an unused lake house:

“I got rid of it, too,” he said. “We hadn’t used it for anything for years.”

Write to Christina Rexrode at christina.rexrode@wsj.com

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