WASHINGTON (Legal Newsline)-U.S. regulators are coming down with a heavy hand on community banks, a move that state attorneys general said could severely hamper the nation's economic recovery.

Representatives from community banks say examiners from the Federal Deposit Insurance Corporation are routinely downgrading banks in safety and soundness examinations, basing their decisions to lower banks' CAMELS ratings on largely subjective information and unofficial capital requirements.

"We're hearing complaint after complaint," said Chris Cole, senior regulatory counsel for the Independent Community Bankers of America, speaking last week at the National Association of Attorneys General convention in Washington.

Bankers say a downgrade forces an institution to put more money in reserves, makes them reluctant to loan money and increases their FDIC premiums.

Those consequences are among the chief reasons many small businesses are finding it difficult to borrow money from their local, small banks, said Cole, whose group represents about 5,000 community banks with about $1 trillion in total assets.

"The regulatory pendulum has swung too far in the direction of overregulation, and until that regulatory pendulum swings back to the middle, I don't believe we will see a good economic recovery.

"Community banks make 50 percent of small business loans under $1 million in this country, and they have cut back substantially."

Speaking to the nation's state attorneys general, Sheila Bair, chairman of the FDIC, said her agency had not changed its policies in evaluating banks.

Bair, an independent regulator, said bank examiners are told to "take a balanced approach" in evaluating the safety and soundness of financial institutions.

But Cole said beginning in 2009, bank examiners were going around the country systematically downgrading banks.

"Up until about 2008, we never heard a complaint (about safety and soundness exams) but then all of the sudden it was like regulators applied the brakes to us," Cole said, adding that most of the downgrades could not have come at a worse time.

"What the downgrades required the banks do is go out and find capital," Cole said.

Regulators have not officially changed their capital requirements, with a leverage ratio still having to be a minimum of 5 percent. But Cole said bank examiners on their own are imposing a capital requirement of up to 10 percent.

"They are going in and they're saying, 'You know, we think it's prudent if you raised your capital to 8-, 9-, 10-percent,' and you have no choice," Cole said. "Community banks are really in a bind here. They can't get the capital yet the examiners want more and more capital."

It is clear that federal regulators have come down with a "heavy hand" on community bankers, said Doug Tippens, chairman and CEO of the Bank of Commerce in Yukon, Okla.

"Every one of us is running scared," said Tippens, who sits on the board of the Federal Reserve Bank of Kansas City. "Lending has locked up in the United States."

Oklahoma Attorney General Drew Edmondson, a Democrat, said community banks seem to be unfairly suffering because the near-collapse of large banks in recent years.

"It is clear that the financial meltdown that put this country in the situation it finds itself today was not caused by community banks but they are suffering some of the fallout in terms of tightened regulation," Edmondson said, adding that the banks' decreased lending is slowing the economic recovery.

Nebraska Attorney General Jon Bruning, a Republican, said Edmondson is correct.

"America won't come out of this recession if small businesses can't thrive. They need that liquidity in the market," said Bruning, president of the National Association of Attorneys General and possible U.S. Senate candidate in 2012.

From Legal Newsline: Reach staff reporter Chris Rizo at chrisrizo@legalnewsline.com.