For release on delivery
1:40 p.m. EDT (12:40 p.m. CDT)
September 30, 2020
Community Banks Rise to the Challenge
Remarks by
Michelle W. Bowman
Member
Board of Governors of the Federal Reserve System
at
"Community Banking in the 21st Century," Research Conference
The Federal Reserve Bank of St. Louis
St. Louis, Missouri
(via webcast)
September 30, 2020
Thank you, it is a pleasure to join you virtually today and share a few thoughts on
what I am hearing from community banks in the wake of the pandemic, and what the
Federal Reserve is doing to assist in the recovery.
When I addressed this conference exactly a year ago, the world was a very
different place. COVID-19 has brought hardship and disruption to nearly every aspect of
our lives, and even as economic conditions improve, the pandemic continues to weigh on
households, businesses, and the economy. Today, I would like to offer some of my
observations on current conditions and share with you what I have learned in discussions
with community bankers across the nation. This input has shaped my views of how
supervision and regulation are affecting community banks in these challenging times-
what is working, and what needs to improve. In addition to the Fed's usual consultation
with community banks, I have separately embarked on an effort to meet directly with the
CEOs of all 685 community banks supervised by the Fed, an undertaking that has already
provided valuable insights that I will relate in these remarks.
What Community Banks Have Achieved
America has never experienced a health and economic crisis like the one we are
facing. The measures taken to contain the virus and the ensuing sudden stop to the
economy beginning in March were unprecedented, just as some aspects of the downturn.
One of these is the extent to which small businesses have been affected. Small
businesses tend to be service-oriented and clustered in retail and food services, with many
less able than larger companies to maintain operations via remote work. Because
community banks are a major source of credit and financial services for small businesses,
this crisis has had a heavy impact on their customers, and in their communities.
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Another unusual aspect of this event, which I have noted before, is the geographic
variation in the timing and severity of the pandemic's effect.1 Given the widely varying
rates of infection, and the distinct approaches of states and localities in dealing with the
virus, we are seeing divergent experiences in economic performance in different areas of
the country.
As a result, and to a greater extent than in the past, this slowdown is being felt
differently from community to community, and is being responded to differently from
community to community. So it is no surprise that community banks are standing
shoulder to shoulder with their customers, on the front lines. You have done this before,
of course, during past recessions, but for the reasons I've outlined, your role this time has
never been more critical. That is why one of the government's first responses to the
pandemic was the Paycheck Protection Program (PPP), geared to small business, and
necessarily dependent on community banks. So let me start there, and review what has
been accomplished through PPP and discuss the role of community banks in that
program.
Based on preliminary results, it appears PPP was timely and effective in helping
millions of businesses weather the lockdown period. It was also designed in a way that
made community banks integral to its success. The first funds reached businesses
roughly three weeks after the need for that relief was recognized. To provide perspective,
$525 billion, or roughly 19 times the value of all Small Business Administration lending
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in fiscal year 2019, was distributed in the four months from April through August 8.2,3
Community banks with $10 billion or less in assets made about 40 percent of the overall
number and value of PPP loans.4 Community banks were absolutely essential to the
success of this program.
This outcome is probably not surprising to this audience, because when it comes
to lending to small businesses, community banks have always been an outsized source of
credit, relative to their size in the banking system. Before the pandemic, community
banks accounted for over 40 percent of all small business lending, while they only
accounted for roughly 15 percent of total assets in the banking system.
Community banks know their individual and small business customers, and they
know their communities. In my conversations with community bank CEOs, several
reported to me that early in the pandemic they directly contacted every single one of their
business and consumer loan customers, taking the time to check in with each one to see
how they were doing, and what they needed. They encouraged customers to keep in
touch with the bank, and they noted the available opportunities for payment deferrals that
customers might not have been aware of. They asked, "Do you need us and how can we
help?" In this pandemic, it means going further, than other banks could or would.
According to the 2020 national survey conducted by the Conference of State Bank
Supervisors, more than one-third of community banks reduced or eliminated penalties or
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fees on credit cards, loans, or deposits.5 One banker in Colorado told me that his bank
called 3,700 individual borrowers offering deferrals-and that 2,000 of them accepted.
Let me highlight the role of smaller community banks in the PPP, because they
demonstrate the agility and close relationships with customers that was so important in
connecting with the businesses most threatened by the lockdowns. Banks with less than
$1 billion in assets have made a million loans under the PPP, about one-fifth the total,
delivering $85 billion in relief to their customers.6 Additionally, as shown in figure 1, the
smallest banks made the smallest PPP loans on average, illustrating that these banks play
a key role in serving businesses that may be outside the focus of larger banks. The
average PPP loan size at banks with total assets under $500 million was just $72,000,
about half the size of the average loan at banks with total assets between $10 billion and
$100 billion.
Additionally, preliminary data based on an Independent Community Bankers of
America report indicates that community banks have been the main source of lending for
minority-owned small businesses during the pandemic, accounting for 73 percent of all
PPP loans made to small businesses owned by non-whites. Early estimates also suggest
that community banks provided 64 percent of PPP loans to majority veteran-owned
businesses.7 Within the broader community banking sector, there are banks that have the
mission to serve low-income and minority communities. Specifically, I am referring to
minority depository institutions (MDIs) and community development financial
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institutions (CDFIs). These institutions had previously established relationships with
minority and low-income small business owners and were quickly able to provide them
access to PPP loans. Additionally, as trusted institutions in their communities, new
businesses sought them out as lenders who understood their unique, and sometimes
challenging, business needs. The Cleveland Fed recently published an article entitled "I
can't believe I got a real person," which describes one minority-owned small business's
experience successfully getting a PPP loan from an MDI in Los Angeles.8 The title alone
captures why community banks were so important for small businesses seeking PPP
loans-small banks offer a personalized level of customer service that big banks do not.
It is also striking that smaller community banks were the predominant lenders despite
having a smaller staff and while facing lobby closures and other workforce challenges
due to COVID-19. Several of the bankers I spoke with worked from home, when they
couldn't open their banks. They worked overtime in drive-through facilities. They
worked, in one case, inside a makeshift "disaster recovery site." Through all the ups and
downs and closures and reopenings, they persevered. "We closed lobbies," a banker
from Nebraska told me, "but we never closed the bank."
Actions like these highlight the importance and value of relationship banking,
which is so central to the mission of community banks. According to the Call Report
data, community banks held roughly $400 billion in small business loans in June 2020, as
shown in figure 2. Loans made under the PPP totaled $197 billion-an amount
representing about 40 percent of all funding provided under this program. A banker from
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Virginia told me, "It was a great opportunity for the community banks to show their
strength."
The Federal Reserve's Small Business Credit Survey shows that over one-third of
small businesses turn to small banks for their lending needs.9 The survey data indicate
that these borrowers are far more satisfied with their banks than the businesses who
borrowed from other sources, and three out of five small businesses cite an existing
relationship as a key reason they continue to do business with their bank. The PPP
program strengthened many preexisting relationships between community banks and
their borrowers, but community banks also met the needs of new customers facing stress
from COVID-19. One bank reported 3,000 new customers from a total of 15,000 PPP
loan originations. Over time, the establishment of these new relationships is likely to
benefit both the community bank and the small businesses they serve.
Community Bank Supervision during the Pandemic
Now let me turn to the question of how the Federal Reserve is approaching
community bank supervision during the pandemic, and how that aligns with my
philosophy about how the Fed should always conduct supervision.
As you well know, community banks form a critical part of a strong and stable
financial system, and they are vital to their surrounding communities. Supervising
community banks requires us to strike a delicate balance between ensuring their safety
and soundness and ensuring that they are able to continue serving those vital functions.
This is especially true now, when community banks are supporting the businesses bearing
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the brunt of the economic effects of the pandemic. This situation strongly argues for
flexibility in supervision.
In each of my conversations with community bank CEOs, I ask what they are
experiencing and what they need, while sharing a very clear message about the Fed's
flexibility: Given the challenging environment, the Fed will take into account good faith
efforts by banks affected by COVID-19. In this pandemic, our common goal is to
support individuals, businesses, and communities. This approach is reflected in an April
2020 statement issued by the Fed and other bank supervisors.10 In that statement, we
instructed bank examiners not to criticize bank management for taking prudent steps to
support their communities, and we underscored that we would not expect to take a
consumer compliance public enforcement action against an institution that has made
good faith efforts to comply.
This message has been getting through to examiners. One community banker in
Texas that I spoke to recently said he had been feeling the justifiable concern that
granting the kind of forbearances that everyone recognizes are essential to keep
businesses open will eventually come back to haunt him in an examination. When he
aired this concern to the Fed, he said he felt "incredible support" when the message he
received back was, "Bank your customers." This assistance is helping homeowners. A
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recent Federal Reserve survey found that 5 percent of homeowners with a mortgage had
received a payment deferral from their lender.11
So let me extend the same message to others who might be worried: "Bank your
customers."
Now let me tell you how these actions fit into my overall view of how to conduct
effective bank supervision. Our goal as regulators is to ensure that each institution under
our supervision is successful in managing the risks present within its operations and
product offerings. Effective supervisory practices are not static. They evolve over time
as lessons are learned.
That includes learning by supervisors. As one example, the volume of PPP
lending has driven meaningful asset growth, especially for smaller banks. We recognize
that for some institutions, this asset growth has caused many banks to exceed or nearly
exceed certain asset-based thresholds contained in statutes, regulations, and reporting
requirements. We are currently exploring how to address regulatory and supervisory
challenges caused by this temporary asset growth.
Supervisors encourage banks to adopt best practices, and I believe that we should
also seek to achieve the highest supervisory standards. First, we should clearly
communicate our expectations. It is wasteful, costly, and unnecessary when compliance
activity occurs because expectations have not been clearly articulated or understood.
Examiners should always be able and available to explain written guidance. A second
consideration is that communication must also be timely. Supervisors should promptly
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communicate the findings of off- and on-site analyses, which will further improve the
process of answering questions and addressing issues thereby improving compliance. A
third principle is transparency. The key goal here is to promote a clear and transparent
supervisory process so bankers know and understand how we form our expectations and
judgments, and that they will receive this information in a timely manner.
Overall, I think it is entirely appropriate to regularly ask whether our approaches
to supervision are consistent with the stated policy objectives of efficiency, safety and
soundness, and financial stability. One of those objectives is a healthy community
banking sector that can continue to serve its customers. The pandemic has emphasized
just how important that is.
The Leading Challenge for Community Banks
Another theme I have heard repeatedly from CEOs is the strong message that they
are struggling with the cost and burdens of regulatory compliance. Many bankers have
said they consider this the most significant threat to their existence. According to the
CSBS National Survey, relative compliance costs actually decreased modestly in 2019,
which may be a sign that some of the steps we are taking are helping. This is consistent
with what I heard from one Oklahoma banker, who said the biggest threat to his long-
term survival was regulatory burden-but "not so much in the last few years."
We know examinations are top of mind for every community banker, and we are
aware some bankers are also concerned with the length of time associated with the
examination process. Community bank exams generally consist of phases-pre-exam
contact, scoping, conducting the exam, and, finally, the drafting and delivery of the
report. From a banker's perspective, the exam begins with the first day letter or perhaps
the first contact of an examiner with the bank, and ends with receipt of the report of
exam. From a banker's perspective, exams can seem as though they last for many
months, which can strain resources for community banks that are unable to dedicate staff
exclusively to managing the examination process. This is a valid concern, and achieving
an appropriate timeframe for the length of exams, whether that be safety and soundness
or consumer compliance, is very important to me. We are committed to evaluating our
policies, practices, and implementation processes to understand and identify opportunities
to address these concerns.
There are other significant concerns for community bankers, but these only
compound the challenge posed by regulatory burden. Bankers worry about competition
from larger banks with economies of scale that are sufficient to drive consolidation. One
of the biggest advantages from scale comes in regulatory compliance. As one banker in
Wyoming told me: "Consolidation is a huge threat as larger banks can deliver at a far
lower cost." One of the biggest costs, of course, is regulatory compliance. Researchers
from the St. Louis Fed found that compliance expenses averaged nearly 10 percent of
total non-interest expenses for banks with less than $100 million in total assets. For
banks with between $1 billion and $10 billion in total assets, compliance expenses
averaged 5.3 percent of total non-interest expense. This suggests that the regulatory cost
burden for the smallest community banks is nearly double that of the largest community
banks.
In a speech about community banking regulation, it is entirely appropriate to point
out our work on tailoring efforts. However, on its own, tailoring does not ensure that
existing regulations are not unduly burdensome for smaller banks. These banks may
benefit from further regulatory relief, without undermining the goals of safety and
soundness, consumer protection, and financial stability. Regulatory burden can be
manifested in multiple ways, including the attitude that examiners have in their
interactions with banks. That is why the supervision principles I outlined earlier are so
important. Supervisors need to communicate intentions clearly, in a timely manner, and
in a transparent way. Doing so consistently can significantly lighten the regulatory
burden that is such a challenge for banks.
Current Economic and Financial Conditions for Banks
I will conclude with a few comments about economic and financial conditions as
they affect community banks. Our nation has suffered the sharpest drop in economic
activity in U.S. history, and while unemployment remains quite high, the recent economic
data have been encouraging and suggest that our national economy has been recovering
at a rapid pace. The substantial and timely fiscal stimulus provided by Congress and the
Administration has made a meaningful contribution to this recovery. Looking ahead,
continued monetary and targeted fiscal policy support will likely be needed. Even with
this support, however, I anticipate that the path toward full recovery will be bumpy, and
that our progress will likely be uneven. Asset prices in particular, remain vulnerable to
significant price declines should the pandemic seriously worsen. Some hotels and other
businesses are in arrears on rent and debt service payments, and we are watching the
commercial real estate market closely for signs of further stress. I also expect the pace of
the recovery will continue to vary from area to area, and will be heavily influenced by not
only the course of the virus, but also the public policy decisions made across all levels of
government.
Before the COVID-19 pandemic began, all of the data told us that community
banks began this year in excellent shape-by some measures the strongest in decades.
Ninety-six percent of community banks were profitable; nonperforming assets neared
historical lows, and capital ratios were strong. More than 95 percent of small banks were
rated as 1 or 2 under the CAMELS rating system. These banks built strong capital
positions and substantially improved asset quality metrics in the years following the last
crisis. They also entered the pandemic with high levels of liquidity that have been
augmented by deposit inflows associated with the pandemic-related stimulus programs.
Finally, credit concentrations were generally much lower, especially in construction and
commercial real estate, and broadly speaking, concentration risk management practices
significantly improved since the financial crisis.
Following a weak first quarter that included higher credit loss provisions, second-
quarter earnings showed improvement. Aggregate return on assets recovered more than
two-thirds of the decline reported during the first quarter, driven by higher noninterest
income and lower operating expenses. Origination fees and interest income from PPP
lending fueled some of this improvement, with many community banks reporting
substantial loan growth as a result of the program, and a few actually doubling their
balance sheets. As seen in figure 3, the quarter-over-quarter loan growth would have
been negative, absent the PPP loans. As origination fees and interest income are
generally recognized over the life of these loans or when they are forgiven, PPP loans
will continue to push up bank earnings in the next several quarters. The origination fees
earned by community banks this year will mitigate the impact of provisions for credit
losses, and in turn, may support further lending by these banks.
Despite improvement in these areas, the operating environment remains
challenging. The average net interest margin at community banks tightened during the
second quarter, and it is likely that margins will remain under pressure given the low
interest rate environment. But community banks have historically performed well even
when interest margins were under pressure, and they entered into the pandemic in sound
financial condition.
So what do we take away from this review of bank numbers and performance? In
all, I expect community banks will face challenges during what could be a slow return to
a full economic recovery, but I also expect that this sector is well prepared to deal with
these challenges and will continue to perform the vital role it has played during the
response to the pandemic. My hope is that at next year's conference we will have
additional data and research that paint a fuller picture of the role community banks played
in our nation's response to and recovery from COVID-19, and that we have gained
further insights into the role of all community banks, including MDIs and CDFIs, in
ensuring access by all to credit and financial services.
Community Banks Rise to the Challenge
Michelle W. Bowman
Member
Board of Governors of the Federal Reserve System
St. Louis, Missouri
September 30, 2020
Figure 1: Average Paycheck Protection Program (PPP) loan size by bank asset size range
$ Thousands
200
Community banks All other banks
150
100
50
0
<$250 $250-$500 $500 Million-$1 $1-$5 $5-$10 $10-$25 $25-$50 $50-$100 >$100
Bank size
Million Million Billion Billion Billion Billion Billion Billion Billion
# of PPP
1,775 933 640 608 93 56 28 13 25
lenders
Figure 2: Small business loans by bank asset size range
$ Billions
1,000
800
+40%
600
400
200
0
2015 2016 2017 2018 2019 2020
Bank size < $1 Billion $1-$10 Billion $10-$100 Billion > $100 Billion
Source: Call Report. Commercial banks, state savings banks, and thrifts. Small business loans as defined in RC-C Part II. Second quarter data shown each year. Key identifies series in order from bottom to top.
Figure 3: Community bank loan growth: Second quarter 2020
Q-o-Q Change, $ Billions
250
200
150
100
50
0
-50
Total loan growth PPP loan growth All other loan growth