Michelle W Bowman: My perspective on bank regulation and
supervision
Speech (via prerecorded video) by Ms Michelle W Bowman, Member of the Board of Governors
of the Federal Reserve System, at the Conference for Community Bankers sponsored by the
American Bankers Association, 16 February 2021.
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Good morning. I want to thank the American Bankers Association for inviting me to speak to you
today. Two years ago, I gave my first speech as a Federal Reserve governor at this conference
in San Diego, and it is always great to be with you-even if remotely from our recording studio at
the Board.
It's fair to say that a lot has happened over the past two years. It is an understatement to say that
the COVID-19 pandemic has created significant challenges inside and outside the banking
sector. Bankers significantly adapted operations to continue serving their communities and
customers. You overcame staffing challenges and other hurdles, kept the virtual doors open,
worked with your customers, and provided assistance to workers and businesses through the
Paycheck Protection Program. Those efforts have made, and continue to make, a huge
difference in the lives of many people affected by the pandemic, and I thank you.
Since becoming a member of the Federal Reserve Board, I have made it a priority to enhance
the Federal Reserve's dialogue with community bankers. I have embarked on an effort to meet
with the leaders of every community bank and regional bank supervised by the Federal Reserve.
This valuable interaction helps build an understanding of issues affecting small and regional
banks, support supervisory decision-making, and shape some of my perspective. It has also
helped the Federal Reserve identify initiatives to support the vital role of community banks in
serving the financial needs of communities.
Today, I would like to share my approach to supervision and regulation, which has helped guide
the Fed's efforts to improve oversight of community banks over the past few years and shaped
our priorities for 2021 and beyond. In most cases, my points about banking regulation also apply
to supervision. I will then focus on several Federal Reserve initiatives that are underway to
support community banks during the pandemic and into the future.
The first principle is fundamental to regulation but sometimes bears repeating-regulation should
always strike the right balance. For banking regulation, that means a balance between actions
that promote safety and soundness and actions that promote an acceptable and manageable
level of risk-taking. The challenge is doing neither too little to be effective to achieve the public
benefit of government oversight, nor too much to prevent the regulated businesses from meeting
their customers' needs. Some regulation is appropriate and necessary but striking the right
balance means that at some point regulation can go too far and end up reducing the public's
welfare. In recent years, the Federal Reserve and other agencies have made oversight more
effective by better differentiating prudential regulation and supervision based on the asset size of
banks, the complexity of their activities, and the related risks they pose to the financial system.
This is especially important for community banks, most of which managed risks well before and
during the 2008 financial crisis and have managed their risks well since. Achieving these
principles also requires following consumer protection laws and regulations, including fair lending
laws, to ensure fairness and broad access to credit and financial services that enable economic
opportunity for individuals and communities.
The second principle is that the regulatory framework should be effective, but also efficient, and
that means assessing the impact of the requirements. For the Federal Reserve, it means that
we consider both a rule's benefit to safety and soundness and any potential negative effect,
including limiting the availability of credit and services to the public, and the implications of
compliance costs on banks. The wisdom in this approach is evident when considering the effect
of a regulation on community banks and their role in providing financial services to their
communities. Community banks have often been one of the few or only sources of credit and
financial services to their customers. Their smaller operational scale relies on fewer staff to
reach a more disbursed customer base with limited resources for compliance activities.
Regulations should consider the potential impact on the availability of services in a community,
as well as the costs to the bank of implementing a rule, particularly in more rural locations. It is
necessary that a full and careful practical analysis of costs and benefits be a part of every
rulemaking.
The third principle is that regulation and supervision should be consistent, transparent, and fair.
Regulators are obligated by law to act in this manner, and it also makes good practical sense.
These principles enhance safety and soundness and consumer compliance by making sure
supervisory expectations are clear and that banks understand and respect the regulatory
requirements. Supervisors should not and cannot be everywhere at every moment. But they
should be available to provide clarification or answer questions when needed. A clear
understanding of the rules and our expectations and a respect for the reasonable application of
them is an effective approach to ensure effective compliance. By promoting respect and trust
between regulators and the supervised institution, banks are more likely to communicate
throughout the examination cycle to inform supervisors of changes they may be considering or
challenges they may be facing and how best to resolve or approach them from a regulatory
perspective.
A final principle that flows from consistency, transparency, and fairness is that rules and
supervisory judgments must have a legitimate prudential purpose, and in the majority of cases
must not be solely punitive. The goal should be to encourage sound business practices and
activities by supervised institutions. By clearly communicating our objectives, we build respect
for the rules and make it more likely that any remedial actions against an institution will not be
necessary because we encourage compliance through our supervisory approach. When a
supervisory action or formal enforcement action is required to address violations at an institution,
those actions should be framed in a way that seeks to promote safe, sound, and fair practices
and not simply as punishment.
These principles that guide my approach to regulation and supervision are consistent with many
of the major steps that the Federal Reserve has taken to improve community bank oversight
since the implementation of the rules following the 2008 financial crisis. Some predate my arrival
at the Fed, and some I have played a significant role in achieving. Most of these actions involve
tailoring rules that treated community banks in the same way as larger, more complex
institutions. For example, the Volcker rule was aimed at curbing proprietary trading by large
banks, but it ended up creating significant compliance costs for community banks, which are not
involved in this type of trading.
Many of the most important improvements to the Federal Reserve's regulatory framework involve
tailoring rules to fit to the size, business model, and risk profiles of community banks. For
example, we raised the asset threshold for small banks to qualify for an 18-month exam cycle
and similarly raised the threshold for small bank holding companies to be exempted from
consolidated risk-based capital rules. The concept of tailoring is also expressed in our
community bank supervisory framework, which has been updated to implement the Bank Exams
Tailored to Risk (BETR) program. The BETR program allows examiners to identify higher and
lower risk activities and, in turn, streamline the examination process for lower risk community
banks, thereby reducing burden. In fact, Federal Reserve examiners have tailored examinations
by spending approximately 65 percent less time on low/moderate risk state member bank exams
than they do on high-risk exams. We also implemented the community bank leverage ratio that
allows institutions to opt out of risk-based capital requirements. The Federal Reserve and the
other agencies also raised the threshold for when an appraisal is required for residential real
estate loans and tailored safety-and-soundness examinations of community and regional state
member banks to reflect the levels of risk present and minimize regulatory burden for banks.
These improvements in regulation and supervision have helped right the balance I spoke of
earlier between safety and soundness and consumer protection, on the one hand, and the ability
to provide financial services and best meet the needs of their customers. We have also
considered the impact of our actions, seeking to revise rules that impose significant costs to
community banks but provide limited benefit to safety and soundness, consumer protection, or
financial stability.
As a part of this approach, I have also prioritized efforts to improve the consistency,
transparency, and reasonableness of regulation and supervision. One of those efforts is
promoting greater consistency in supervisory practices across the Federal Reserve System. For
example, we are actively working to improve the timeliness of providing banks with consumer
compliance exam findings. Further, we are exploring ways to strengthen our ability to
understand, monitor, and analyze the risks that are affecting community banks. A key aspect of
consistency is ensuring the same supervisory approach and outcomes for similarly situated
institutions, with the goal of ensuring, for example, that a "one" composite or component rating in
a particular region would be the same for an institution with similar activities and practices in
another region. This applies to all areas of our supervisory responsibility, whether safety and
soundness, consumer compliance, or analyses of financial stability risk.
I'd like to expand on one important area of focus, which is essential to the future success of the
community banking sector: accessible innovation and technology integration. This subject is one
that I speak about frequently with stakeholders and our staff at the Board. We are committed to
developing a range of tools that will create pathways for banks to develop and pursue potential
partnerships with fintech companies. This includes clearer guidance on third-party risk
management, a guide on sound due diligence practices, and a paper on fintech-community bank
partnerships and related considerations. These tools will serve as a resource for banks looking
to innovate through fintech partnerships.
Technological developments and financial market evolution are quickly escalating competition in
the banking industry, and our approach to analyzing the competitive effects of mergers and
acquisitions needs to keep pace. The Board's framework for banking antitrust analysis hasn't
changed substantially over the past couple of decades. I believe we should consider revisions to
that framework that would better reflect the competition that smaller banks face in an industry
quickly being transformed by technology and non-bank financial companies. As part of this effort,
we have engaged in conversations and received feedback from community banks about the
Board's competitive analysis framework and its impact on their business strategies and
longterm growth plans. We are in the process of reviewing our approach, and we are specifically
considering the unique market dynamics faced by small community banks in rural and
underserved areas.
Soon after the pandemic began early last year, the Federal Reserve took several actions to
support community banks and their ability to help affected customers. We paused examinations
and issued supervisory guidance that made it clear that we would not criticize or take public
enforcement actions against a bank that was taking prudent steps to help customers and making
good faith efforts to comply with regulations. This certainty of regulatory treatment created an
environment that built trust between regulators and bankers. It enabled banks to continue to meet
the needs of their customers who were struggling with circumstances through no fault of their
own.
Let me conclude by again commending the important role that community banks have played in
providing financial services during these challenging times. You responded quickly to the needs
of your customers and communities to provide financial services with limited, if any, interruption.
You persevered to implement the largest proportion of Paycheck Protection Program funds to
small businesses, whether they were your existing customers or new customers. These
relationships are the hallmark of community banking, and as we look toward the future,
community banks will continue to play an essential role in supporting customers, delivering
financial services, and providing resources to their communities and customers.
Let me stop here and thank the organizers for another opportunity to speak to you at this
important conference. I look forward to your questions, Rob.