Michelle W Bowman: Creating a new model for the future of
supervision
Speech by Ms Michelle W Bowman, Member of the Board of Governors of the Federal Reserve
System, at the Community Banking in the 21st Century Research and Policy Conference, St.
Louis, Missouri (virtual conference), 28 September 2021.
* * *
Good afternoon. I'm pleased to be able to join you again virtually for this year's Community
Banking in the 21st Century research and policy conference. Although I think we would all prefer
to be together in person, in the shadow of the St. Louis Arch, I'm optimistic that next year (which
will be the 10th anniversary of the conference, by the way) will give us the opportunity to finally
gather in person after a two-year hiatus.
For nine years, this conference, which brings together researchers, regulators, and community
bankers, has enabled us to hear from top academics around the world who conduct research to
help us better understand the community bank business model. It's not an accident that this
conference is sponsored by three agencies involved in the supervision of banks-the Federal
Reserve, the Conference of State Bank Supervisors, and the FDIC-as the work of this
conference has informed, and will continue to inform, how we think about the supervision of our
nation's community banks.
Our conference sponsors entered this partnership with the belief that what we learn here will
deepen our understanding of the benefits of, and the challenges facing, the community bank
business model, which, in turn, helps to make us better bank supervisors.
It's natural then to ask: What have we learned from this conference that is applicable today?
What might we apply in the future to the supervision of community banks?
To answer that question, or quite frankly, to answer many questions that pertain to the regulation
and supervision of banks, it's instructive to first go back a bit in history. In this case, I'd like to take
you all the way back to...2019.
Seems like a lifetime ago.
Way back then, we were concerned about liquidity. Banks were concerned about a potential
runoff of deposits as consumers found new, more technology-centric ways to manage their money,
often outside of the insured banking system. Although we also saw a decline in technology costs
that enabled banks of all sizes to offer a wider array of digital products and services to their
customers, the innovation taking place outside the banking sector was often seen as outpacing
the innovation in the banking sector.
Consumers seemed to increasingly weigh convenience over safety, as a number of non-banks
increased their market share. To a lesser degree, but still concerning, was that of the
convenience factor. It drove some small business borrowers to move away from lenders with
whom they had longstanding relationships. In some cases, those borrowers were even willing to
pay much more for credit for the sake of convenience. Unfortunately, some borrowers learned
the hard way that convenience does not always outweigh a banking relationship-particularly
when a business or community experiences a significant hardship such as a natural disaster.
I regularly heard stories of how small businesses that borrowed from an online lender were
unable to reach anyone to discuss their situation during a crisis and ultimately had their loans
called because of missing a payment. In these situations, I also heard stories of how the local
community bank that understood the local situation and wanted to see the business and the
community survive, would step in, and refinance the original loan to help the small business
return to more normal operations.
I also heard about challenges with core processors and how legacy contracts and a lack of
competition for core processing services was stifling innovation. We saw several fintechs
become "mainstream" nationally, and we saw a proliferation of technology solutions targeted at
helping community banks become nimbler in adding new products and services.
From a supervisory perspective, the Federal Reserve actively explored ways to reduce
regulatory burden and provide greater transparency into the work of bank supervisors. Using
research presented in prior years at this conference, we applied findings showing the
disproportionate regulatory burden borne by our smallest institutions and looked across our
processes to find ways to tailor our supervisory model to more accurately reflect the risk posed
by these smaller financial institutions.
And then came March 2020 and the arrival of the COVID-19 pandemic in the U.S.
Despite the many choices consumers have for managing their money and purchases outside of
the traditional banking system, we witnessed a systematic flight to the safety of FDIC-insured
deposits in state or nationally chartered banks.
Specifically, total deposits at all FDIC-insured institutions increased by 22 percent when
1
comparing deposit data from 2019 to 2020. Small business lending also increased significantly.
From the end of 2019 to the end of the second quarter of 2020 alone, small loans to businesses
2
at community banks, a proxy for small business lending, increased by 39 percent.
The Impact of the PPP during the Pandemic
One driver for the increase in small business lending was, of course, the Small Business
Administration's Paycheck Protection Program or PPP. The PPP was funded by the U.S.
Treasury Department through forgivable loans that enabled small businesses to maintain payroll,
retain employees who may have been laid off in response to the social distancing protocols that
went into effect in April 2020, or to cover other overhead costs.
To support the PPP, the Federal Reserve provided a liquidity backstop to PPP lenders through
its Paycheck Protection Program Liquidity Facility or PPPLF. In recognition of the evolution in the
banking landscape that I referenced a few moments ago, the PPPLF was designed to not only
provide a liquidity backstop to banks and credit unions, but also to serve non-bank fintechs,
community development financial institutions, and agricultural finance companies that
participated in the PPP. Given the important role minority-owned banks play in the allocation of
credit in their communities, the Federal Reserve also actively engaged minority depository
institutions to ensure they had the tools they needed to benefit from the Fed's emergency liquidity
programs.
To be sure, the PPP and the PPPLF will provide significant research material for years to come. I
understand from reviewing the papers accepted into this year's proceedings that it has already
driven the work of several economists you'll be hearing from over this two-day conference. In
reviewing the data on these programs, however-and here I must credit the Federal Reserve
Bank of New York's "Supervision Transformational Trends" program-we see that a substantial
majority of PPP loans, nearly 73 percent, were made by insured depository institutions. These
loans also accounted for nearly 90 percent of the aggregated loan amount for all PPP loans.
Getting a bit more granular, we can see that community banks made 32 percent of all PPP loans
while large banks made 35 percent of all PPP loans, with credit unions and savings banks
accounting for the rest of the loans made by banking institutions. Fintechs accounted for
approximately 13 percent of all PPP loans and more than half of those were made as a result of
a partner bank relationship.
A recent working paper from the National Bureau of Economic Research (NBER) offers
additional detail on the roles these different types of lenders played in allocating credit through the
3
PPP during the pandemic. The authors found
Community banks originated the majority of PPP loans when the program first launched,
4
while large banks were the majority lender during the second phase of the program.
Community banks provided more loans to middle income borrowers while large banks
provided more PPP loans to upper income borrowers.
Community banks and large banks made loans to lower and moderate-income borrowers in
approximately equal proportions.
Fintech firms, on the other hand, made more loans in zip codes with fewer bank branches,
5
lower incomes, and larger minority populations.
The authors also found that fintech lending, instead of taking market share from traditional
banks, mostly expanded the overall supply of credit and other financial services.
From my perspective, these findings offer evidence of the continuing importance of community
banks to our economy during both "normal" times as well as during times of extreme financial
stress. Or, to paraphrase Mark Twain, "reports of the demise of community banks are greatly
exaggerated."
The NBER paper also highlights how new entrants to banking can meet an unmet need.
The experiences of banks and bank supervisors during the pandemic also offer insights into how
we should think about the Federal Reserve's approach to supervision in the future. For the
remainder of my talk, I will offer my thoughts on a key principle that I believe should guide our
thinking: The future of community banking and the future of banking supervision are
deeply interconnected.
My earlier comments should not be interpreted as suggesting that there aren't real challenges
facing the community bank business model. But I am suggesting that new technologies, new
entrants into banking, and changes in customer preferences that have led to predictions about
the end of the community banking business model simply have not been substantiated.
If anything, this conference has highlighted that the diversity in business models of small financial
institutions is an essential part of our economy. There is strength in being small that enables
institutions to know their customers on a much deeper level. Small financial institutions can
quickly customize products and services to address their customers' needs and, in some cases,
they can leverage the flexibility of their business models to take advantage of new business
opportunities. This flexibility allows banks to maintain strong relationships with customers-
particularly those customers who don't fit a "typical" borrower profile. It also explains why
community banks have a long history of providing essential financial services to households,
small businesses, and small farms in communities across the country.
During the pandemic, I personally began speaking to the leaders of the more than 650 state
member community banks in the Federal Reserve's supervisory portfolio. The conversations to
date have provided important regional insights and perspectives that can only be gleaned from
leaders who know their markets and customers at a very deep level. While I heard that lobby
traffic was down and that lending opportunities were not as robust as they once were, I mostly
heard optimism. I heard that the value proposition of the traditional community bank was on full
display in many communities, urban and rural. I heard that bank business customers needed
bankers who truly knew them and their businesses, and who could work with them to provide the
customized support they needed during that time of great uncertainty.
As banks changed to meet the challenges of the pandemic, we asked ourselves at the Federal
Reserve, do bank supervisors need to change?
By necessity, the immediate answer, of course, was "yes." The Federal Reserve did so by
pausing all on-site exams and using technology that enabled us to remotely supervise the safety
and soundness of our institutions as well as monitor their compliance with relevant consumer
compliance laws and regulations. To be sure, we adjusted our supervisory expectations
accordingly based on the guidance we were providing banks.
We also greatly expanded our outreach and engagement with financial institutions. We deployed
the full range of communications tools that we've developed over many years to provide banks
with real-time information on supervisory expectations as well as the emergency lending
programs that were put in place to forestall any systematic deterioration in the health of our
financial system.
As evidenced by the continued strength of bank balance sheets and the general absence of bank
failures during the pandemic, I think we can confidently say that the actions of banks, bank
supervisors, and policymakers during the pandemic allowed us to avoid the challenges that
plagued our banking system during 2008 financial crisis. The pandemic heightened our
awareness of this important linkage between banking and supervision.
Had we not tailored our supervisory approach during the pandemic, I believe the impact on our
banks, our economy, and on consumers would have been much more severe.
From the beginning, we worked closely with our federal and state counterparts-many of whom
are represented at this conference-to develop a sense of joint action and to agree to work
together in a holistic way.
I knew from my experience as both a community banker and a state bank regulator, that we
needed to avoid overreacting and instead approach supervision in a more measured way that
allowed banks the flexibility to work with their customers. We needed to empower banks to
manage those key relationships in their loan portfolios in a way that was beneficial to their
customers without exposing the banks to risk.
What we saw, as a result of this approach, is that the industry made responsible decisions that
kept credit flowing throughout the pandemic and enabled businesses across the U.S. to continue
operating.
But the question remains: how should supervisors, and banking supervision itself, apply what we
learned going forward? During the pandemic, we changed our supervisory approaches based on
necessity, but now we need to look ahead and make sure that we're adjusting our supervisory
model in ways that allow banks greater flexibility to innovate to compete in today's quickly
evolving banking environment-without sacrificing important consumer protections or the health
and safety of our banking system.
The Future of Supervision
To start, we must acknowledge the interconnectedness of the future of banking and the future of
bank supervision. Supervision has to evolve because the banking industry is evolving. Available
technology, analytical capabilities, and customer and workforce preferences are driving this
evolution in how financial sector products and services are delivered. We recognize that our
workforce, processes, and technology must align with these changes to ensure that an effective,
transparent, and timely supervision program is maintained.
Therefore, the Federal Reserve is embarking on an initiative to investigate the implications of
these changes for the Federal Reserve's Supervision function.6
The goal of this initiative is to ensure our supervisory approaches accommodate a much broader
range of activities while ensuring we don't create an unlevel playing field with unfair advantages,
or unfair disadvantages, for some types of firms versus others. This will include investigating
technology and innovative business practices that increase our agility and efficiency.
Innovation is a way of life for banks, it should be for supervisors as well.
But we must do this in a way that also preserves what we know works and what we learned can
work during the pandemic.
Before sharing my views on the underlying principles that need to guide our thinking on our future
supervisory approaches, I'll first offer some thoughts on a few aspects of Federal Reserve
supervision that I believe must be preserved even as we think expansively about the future:
1. The first being the Federal Reserve's Supervisory structure. Although the Fed's
supervision and regulation of banks is the responsibility of the Board of Governors, the
dayto-day supervision of banks is delegated to the Reserve Banks. This distributed system
ensures we have most of our examination workforce living and working in the same
communities served by our community banks. This structure, perhaps more importantly,
gives our examiners deep insights into thousands of local economies across the U.S. and
helps us understand the local industries that are vital to the long-term health and success of
these communities. This local knowledge is what enables our examiners to tailor our
supervision of institutions based not only on the complexity of the bank but based on the
unique characteristics of the industries they support.
2. The second is the Federal Reserve's direct outreach and engagement with banks
and financial institutions. Since the 2008 financial crisis, the Federal Reserve has built an
extensive communications infrastructure-through national programs, such as Ask the
Fed®, and though hundreds of local Reserve Bank programs-to share important
supervisory and regulatory information with banks. The goal was simple: provide a
mechanism that enables us to quickly share information and perspectives with institutions
outside of the exam process, provide timely and accurate responses to questions, and give
the banks the tools they need to meet our supervisory expectations. I believe supervision
works best when supervisors clearly communicate their expectations with banks-there
shouldn't be any "surprises" about our expectations during an exam. In my calls with
bankers, I'm reminded that one of the biggest sources of regulatory burden is regulatory and
supervisory uncertainty. By clearly communicating our expectations, by engaging the
industry directly to understand the impact of these expectations and, when appropriate,
providing banks with tools and resources to meet those expectations, we reduce uncertainty
for banks.
We continued to expand our communication approach this past July with the launch of the
Federal Reserve's Scaled CECL Allowance for Losses Estimator or SCALE tool. SCALE
gives community banks a tangible tool to help with their calculation of loan loss allowance
under the Current Expected Credit Losses methodology. Our effort to identify simple and
practical ways to implement CECL that would help reduce costs and complexity for smaller
community banks was supported by the Financial Accounting Standards Board. The launch
of SCALE represents a significant cultural shift in how we intend to supervise in the future:
when there is significant uncertainty around a new regulation, supervisory expectation, or
practice, we will look beyond our traditional communications tools to find innovative ways to
reduce that uncertainty.
So, what will this new approach to supervision look like and what principles will guide us?
First, we must maintain a firm commitment to preserving the stability, integrity, functionality,
and diversity of our banking system.
Second, we must maintain consumer protection as we innovate and ensure that banks can
safely offer financial products and services that consumers demand and are uniquely
tailored to their circumstances and goals.
Third, as we adjust our supervisory approach, we must avoid adding new burdens on banks,
particularly on those that maintain a more traditional business model. We must be
consistent in how we view similar activities at similar institutions, but our approach must
also allow for de novo banks and allow for greater innovation at our nation's banks. And we
need to continue to provide examiners with the ability to tailor their expectations based on the
risks posed by individual institutions. We must move even further beyond the "one size fits
all" supervisory model that defined our approach in the past.
Fourth, we must enhance transparency around our supervisory expectations for safety and
soundness and consumer compliance matters and be timelier in our feedback to banks. We
must fully leverage our distributed structure to delegate decision making to our Reserve
Banks, without diminishing the Board's important policymaking and oversight role over the
supervision of banks.
And fifth, we must ensure that we are always able to adjust our supervisory expectations
effectively and efficiently as conditions warrant to enable banks to be more flexible in serving
their communities and in providing credit to the areas of our economy that most need it.
When I spoke at this conference in 2019, I discussed a number of very practical problems that
we needed to solve. These included understanding how technology, competition, regulation, and
other factors drive industry consolidation, quantifying the benefits community banks provide to
their communities, and defining the full economic effects a community bank has on its
7
community.
As we move forward with modernizing our supervisory approach, these questions remain at the
forefront of our thinking. But, based on our experiences of the past few years, we also have a
number of new questions that we'll need to address if we are to be successful.
For example, what do banks see as the most transformative technological innovations that will
drive changes to their business models? How do banking institutions prefer to interact with their
supervisors, and what do they think makes for a successful relationship between the supervisor
and the supervised?
The factors that are identified through this initiative as having the greatest potential influence on
future bank business models will vary based on several factors, including size, complexity,
geography, staff capacity, and business strategy, but, taken together, they will give us important
insights into how we, as bank supervisors, might need to evolve our supervisory practices as the
bank business model evolves.
And as we consider our own evolution in the face of these changes, we will need to ask
ourselves:
What changes to the Federal Reserve System Supervision function's workforce, processes
and technology are necessary to execute our supervisory activities given the factors
affecting the industry?
How should the Federal Reserve structure its supervisory activities across its portfolios of
supervised firms?
Where are we aligned across the Supervision function in conducting our work? Where might
we be out of alignment?
Should innovations in technology, such as artificial intelligence, be used to better accomplish
supervision?
In the future, I look forward to sharing our progress on this initiative and providing specific
examples of how our supervisory practices are evolving alongside those of the industry.
Times of crisis, such as the COVID-19 pandemic, provide us a unique opportunity to see how
our banking system operates under stress-and to see both the strengths of our current system
of supervision as well as opportunities for improvement.
The lessons we learned over the past 18 months, supported by research from this conference
and from other sources, offer important lessons on how we can appropriately evolve our
supervisory approaches.
What we learn over the next two days from the researchers, policymakers, and community
bankers presenting during this year's conference proceedings will factor into our overall thinking
as we embark on this journey to modernize our supervisory practices and develop new
supervisory approaches that can meet the needs of today, and the challenges of tomorrow.
1
FDIC Summary of Deposits (2019, 2020). Summary of Deposits is collected as of the second quarter each
year. Return to text
2
Consolidated Reports of Condition and Income (Call Reports). Return to text
3
Isil Erel and Jack Liebersohn, "Does FinTech Substitute for Banks? Evidence from the Paycheck Protection
Program," NBER Working Paper 27659 (Cambridge: National Bureau of Economic Research, December
2020). Return to text
4
It's important to note that the NBER paper uses $20 billion as the asset size threshold between large banks and
small (community) banks. This is different than the $10 billion asset size threshold that was established via the
2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. Return to text
5
In this study, lending by Minority Depository Institutions and Community Development Financial Institutions is
included in the lending data for small (community) banks. Return to text
6
The scope includes execution of safety and soundness and consumer compliance supervision, risk
identification, and analytical activities. The scope excludes other System Supervision activities, such as training,
applications, enforcement, and policymaking. Return to text
7
Michelle W. Bowman, "Advancing Our Understanding of Community Banking" (speech at the Community
Banking Research and Policy Conference, St. Louis, MO, October 1, 2019). Return to text