Ben S Bernanke: Community banking in a period of recovery and change
Speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the Federal Reserve
System, at the Independent Community Bankers of America National Convention, San
Diego, California, 23 March 2011.
* * *
It's a pleasure to have the opportunity to speak once again before the Independent
Community Bankers of America (ICBA). This is the sixth consecutive year that I've met with
you at this event, and the themes of my remarks over the years tell a story not only about the
financial and economic upheaval that we have all experienced, but also about some of the
very difficult issues that continue to confront both bankers and policymakers today. Back in
2006, less than two months after I started as Chairman, I spoke to you about the strong
performance of community banks as well as about some important longer-term challenges.
In subsequent years, my remarks touched on the need to strengthen regulation and
supervision of Fannie Mae and Freddie Mac, approaches to reducing preventable mortgage
foreclosures, community banking and the financial crisis, and then last year, the need to
address the problem of financial institutions that are "too big to fail." My themes today are the
vital role that community banks need to play in the economic recovery, the value that the
Federal Reserve places on insights from community banks, and the evolving regulatory
environment.
Community banks and the economic recovery
To me, the title of the 2009 ICBA annual report, Empowering Main Street, is a concise and
accurate description of the critical role that community banks play in the U.S. economy.
Community bankers live and work where they do business, and their institutions have deep
roots, sometimes established over several generations. They know their customers and the
local economy. Relationship banking is therefore at the core of community banking. The
largest banks typically rely heavily on statistical models to assess borrowers' capital,
collateral, and capacity to repay, and those approaches can add value, but banks whose
headquarters and key decisionmakers are hundreds or thousands of miles away inevitably
lack the in-depth local knowledge that community banks use to assess character and
conditions when making credit decisions. This advantage for community banks is
fundamental to their effectiveness and cannot be matched by models or algorithms, no
matter how sophisticated. The IBM computer program Watson may play a mean game of
Jeopardy, but I would not trust it to judge the creditworthiness of a fledgling local business or
to build longstanding personal relationships with customers and borrowers.
Given the important role that community banks play in their local economies, we at the
Federal Reserve are keenly interested in their health and their collective future. Local
communities, ranging from small towns to urban neighborhoods, are the foundation of the
U.S. economy and communities need community banks to help them grow and prosper. As
I'm sure you are all too aware, the financial crisis and its aftermath have hit some community
banks especially hard, and those institutions will continue to need time to repair their balance
sheets. Although we are not yet where we would like to be, the good news is that many
community banks are recovering and reporting stronger performance.
Indeed, despite some of the worst economic conditions since the Great Depression and their
own strained balance sheets, community banks have already been doing their part to meet
the credit needs of their customers, notably including small business customers. We have
been spending a lot of time at the Federal Reserve trying to understand and promote lending
to small businesses, and one of the interesting things we have found is that while small
business lending contracted overall from mid-2008 through 2010, this contraction was not
uniform. In fact, a majority of the smallest banks (in this case, those with assets of
$250 million or less) actually increased their small business lending during this period. And
while banks with assets between $250 million and $1 billion showed a slight decline in small
business lending over this period, the contraction was not nearly as sharp as it was for the
largest banks. This hard evidence underscores the important benefits of relationship banking,
particularly in periods of unusual economic and financial stress.
Community banks and the Federal Reserve
You may recall that in my remarks to this group last year, I noted that the decentralized
structure of the Federal Reserve System, with 12 Reserve Banks and 24 branches located in
cities across the country, was designed to ensure that local insights and information would
be incorporated in the deliberations of both the Board and the Federal Open Market
Committee. During the debates leading up to the passage of the Dodd-Frank Wall Street
Reform and Consumer Protection Act, we emphasized that our supervisory responsibility for
state-chartered banks that are members of the Federal Reserve System and bank holding
companies of all sizes not only provides valuable economic information at the grass-roots
level that would be very difficult to replace, it also gives us a fuller picture of the nation's
financial system. At the same time, the range of expertise that the Federal Reserve develops
in making monetary policy and in its engagement with the financial system allows us to bring
unique insights and value-added to our supervisory activities. Fortunately, the Congress
decided to preserve the Federal Reserve's existing supervisory authority over smaller as well
as larger banking organizations. It also broadened the Federal Reserve's connections to
Main Street by adding hundreds of thrift holding companies to the institutions we supervise.
We are delighted that, through our supervision, our gathering of economic intelligence, and
the activities of our community affairs departments around the country, we will be able to
remain fully engaged with grass-roots America.
The Federal Reserve has undertaken several recent initiatives to enhance our interactions
with community banks and ensure that we fully take their perspectives and unique
characteristics into account in our policymaking. First, for many years, the Board has had a
committee of Governors that provides oversight on bank supervisory and regulatory matters.
Although many of this committee's efforts in the wake of the financial crisis have
understandably been focused on the largest and most complex banking organizations, the
Board believes that it is important to sharpen our focus on smaller banking organizations as
well. As a result, we recently established a special supervision subcommittee that focuses on
community banks and smaller regional institutions. This subcommittee is chaired by a former
longtime community banker, Governor Betsy Duke, and also includes a former state banking
commissioner, Governor Sarah Bloom Raskin.
The subcommittee provides leadership and oversight on a variety of matters related
specifically to our supervision of community and smaller regional banks.1 In particular, the
subcommittee is reviewing new policy proposals through the lens of the effect those
proposals could have on smaller institutions, both in terms of safety and soundness and
potential regulatory burden. Among other things, the subcommittee also monitors the Federal
Reserve's working relationship with state banking supervisors, which is particularly important
because we share with them supervisory responsibility for state member banks.
We have also undertaken an initiative to solicit feedback from community banks on a more
regular basis. In October, the Board announced that it would form a Community Depository
Institutions Advisory Council to provide insight and information on the economy, lending
conditions, and other issues of interest to community banks.2 To make this council as
representative as possible, each of the 12 Reserve Banks now has its own local advisory
council comprising representatives from banks, thrift institutions, and credit unions; one
member from each local council serves on the national council that will meet with the Board
twice a year in Washington. Local meetings have already begun, and the first meeting of the
national council with the Board will take place soon. Personally, I am looking forward to
hearing more from community bankers about issues ranging from their local economies to
regulatory reform.
Community banks and regulatory reform
As you know, a key challenge for community banks in the years ahead will be to adapt to the
changing regulatory environment, particularly the regulatory reforms contained in the
Dodd-Frank Act, as well as the changes that will be associated with the Basel III reforms. We
are certainly aware of and appreciate the concerns that community banks have about these
regulatory changes, and, as I have just described, we have stepped up our efforts to
understand those concerns and to respond to them as appropriate. I think it is worth
emphasizing that the changes we will be seeing in the financial regulatory architecture are
principally directed at our largest and most complex financial firms, including nonbanks.
Consequently, one benefit of the reforms should be the creation of a more level playing field
for financial institutions of all sizes.
Focusing reform on our largest, most complex financial firms makes sense. The recent
financial crisis highlighted the fact that some financial firms had grown so large, leveraged,
and interconnected that their failure could pose a threat to overall financial stability. The
sudden collapses of major financial firms were among the most destabilizing events of the
crisis. The crisis also demonstrated the inadequacy of the existing framework for supervising,
regulating, and otherwise constraining the risks of major financial firms as well as of the
toolkit the government had at the time to manage their failure.
As I discussed with you at last year's meeting, a major thrust of the Dodd-Frank Act is
addressing the too-big-to-fail problem and mitigating the threat to financial stability posed by
systemically important financial firms. The too-big-to-fail problem is a pernicious one that has
a number of substantial harmful effects. Critically, it reduces the incentives of shareholders,
creditors, and counterparties of such firms to discipline excessive risk-taking. And it produces
competitive distortions by enabling firms with large systemic footprints to fund themselves
more cheaply than other firms because of the implicit subsidy of too-big-to-fail status. This
competitive distortion is not only unfair to smaller firms and damaging to competition today,
but it also spurs further growth by the largest firms and more consolidation and concentration
in the financial industry. A financial system dominated by too-big-to-fail firms cannot be a
healthy financial system.
The act addresses the too-big-to-fail problem with a multi-pronged approach. Under it, we
are developing more-stringent prudential standards for banking firms with assets greater than
$50 billion and all nonbank financial firms designated as systemically important by the
Financial Stability Oversight Council. These more-stringent standards will include stronger
capital and leverage requirements, liquidity requirements, and single-counterparty credit
limits, as well as requirements to periodically produce resolution plans and conduct stress
tests. Our goal is to produce a well-integrated set of rules that meaningfully reduces the
probability of failure of our largest, most complex financial firms and that minimizes the
losses to the financial system and the economy if such a firm should fail. In doing so, we aim
to force these firms to take into account the costs that they impose on the broader financial
system, soak up the implicit subsidy these firms enjoy due to market perceptions of their
systemic importance, and give the firms regulatory incentives to shrink their systemic
footprint.
Complementing these efforts, the Federal Reserve has been working for some time with
other regulatory agencies and central banks around the world to design and implement a
stronger set of prudential requirements for large, internationally active banking firms. These
efforts include the agreements reached in December on the major elements of the new
Basel III prudential framework for large, globally active banks. Basel III should make the
financial system more stable and reduce the likelihood of future financial crises by requiring
large banks to hold more and better-quality capital and more-robust liquidity buffers. A more
stable financial system will benefit all banking institutions and, of course, our economy as a
whole. We are working to adopt the Basel III framework in the United States in a timely
manner.
A central issue that we and the other banking agencies face in implementing Basel III in the
United States is deciding how these capital rules will be applied for banks that are not
systemic or internationally active. We recognize the importance of striking the right balance
between promoting safety and soundness throughout the banking system and keeping the
compliance costs for smaller banking firms as low as possible. Also, to minimize the impact
of the new capital rules on credit availability while the global economy is still recovering, we
and our international colleagues have agreed to allow long transition periods for the
implementation of the new standards.
In addition to stricter regulation and supervision of large financial firms, the Dodd-Frank Act
places new checks on the growth by acquisition of our major financial firms. It expands
current restraints on acquisitions by bank holding companies to include a broader range of
acquired firms (not just banks) and a broader range of liabilities (not just deposits). This
expansion reflects a financial system that has changed in important ways since 1994, when
the Congress first adopted concentration limits for banks and bank holding companies.
The act also imposes new restrictions on the capital markets activities of banking firms -
restrictions that will disproportionately affect the structure and profitability of the largest
banking firms. For example, the so-called Volcker rule will restrict the ability of banking firms
to engage in proprietary trading of securities and derivatives and to invest in or sponsor
private investment funds.
Among the most important aspects of act are the measures that it authorizes to reduce the
financial and economic effects of the failure of large firms. A clear lesson of the past few
years is that the government must not be forced to choose between bailing out a systemically
important firm and having it fail in a disorderly and disruptive manner. Instead, we need the
tools to resolve a failing firm in a manner that preserves market discipline - by ensuring that
shareholders and creditors incur losses and that culpable managers are replaced - and that
at the same time cushions the broader financial system from the possibly destabilizing
effects of the firm's collapse. Of course, such a framework has been in place for banks for
several decades now, as you know. The Dodd-Frank Act creates an analogous framework
for systemically important nonbank financial firms, including bank holding companies.
Resolving a large, multinational financial firm safely will likely always be a difficult challenge,
and a great deal of work remains to be done to make these new authorities fully effective.
Ultimately, though, these changes will mitigate moral hazard in our financial system by
reducing expectations of government support by the creditors and counterparties of large
firms. Taken together, the measures I have described should give us a financial system that
is safer, more efficient, and more equitable.
In short, two key objectives of financial regulatory reform are, first, addressing the problems
that emerged in the largest, most complex financial firms during the crisis and, second,
creating a better balance with respect to regulation and oversight between banks and
nonbank financial firms. The Federal Reserve believes that these are the right goals for
reform. We are committed to working with the other U.S. financial regulatory agencies to
implement the act and related reforms in a manner that both achieves the law's key
objectives and appropriately takes into account the risk profiles and business models of
smaller banking firms, including community banks.
Before I conclude my remarks, let me say a few words about the transfer of thrift holding
company supervisory authority to the Federal Reserve. We have been working closely with
the Office of Thrift Supervision, the Office of the Comptroller of the Currency, and the Federal
Deposit Insurance Corporation to make this transfer as smooth as possible, and progress so
far has been good. The Federal Reserve believes that any company that controls a
depository institution should be held to appropriate prudential standards, including those for
capital, liquidity, and risk management. As such, we intend to create an oversight regime for
thrift holding companies that is consistent with, and is as rigorous as, the supervisory regime
we apply to bank holding companies. That said, we appreciate that thrift and bank holding
companies differ in important ways, play different roles in our economy, and will remain
governed by different statutes. We will be mindful of these differences and of the unique
characteristics of the thrift industry as we develop our supervisory approach to thrift holding
companies.
Conclusion
My colleague, Governor Duke, recently told our examiners that "community bankers are
creative, committed, stubborn, and resilient." I know she won't mind my repeating that
sentiment here, and I'm sure most of the community bankers in this room would wear those
words as a badge of honor. Community banks face substantial challenges in the months and
years to come, including still-difficult economic conditions, continued uncertainties in real
estate and other key markets, and a changing regulatory environment. But community banks
have faced difficult times before, and the industry has remained vibrant and resilient. I am
confident that community banking will successfully navigate these new challenges as well.
Thank you for what you do every day to meet the needs of your communities and to help our
economy grow stronger.