Jerome H Powell: Regulation and supervision of community banks
Speech by Mr Jerome H Powell, Member of the Board of Governors of the Federal Reserve
System, at the Annual Community Bankers Conference, sponsored by the Federal Reserve
Bank of New York, New York City, 14 May 2015.
* * *
The views I express here today are my own, and not necessarily those of any other person in the Federal
Reserve System.
Good morning. I am delighted to join you here today to discuss the state of community
banking and issues of importance to community banks like yours. New York may be home to
Wall Street, but, just like the rest of the country, most of the banks in the Second District are
community banks. There are more than 170 banking organizations here with less than
$10 billion in assets, serving millions of customers.
Community banks play an essential role in our financial system, supporting the economic
health and vitality of the communities you serve. Unlike many of your larger competitors,
community banks offer customers face-to-face interaction with a local banker who has the
authority to make the final decision on a loan - a banker with a long-term investment in the
community who will not be moving to another branch in a new town within a few years.
Community bankers benefit from local knowledge and relationships that often lead to more
successful and efficient lending decisions. These advantages have enabled many community
banks in the Second District and around the country to maintain or increase their local
market shares while competing with larger regional and money center banks, and I expect
that they will continue to do so.
Nonetheless, community banks face significant challenges today. The number of community
banks has declined significantly over the past decade. The Federal Deposit Insurance
Corporation's "Problem List" of at-risk banks has declined from 888 at the peak of the
financial crisis to 291 at the end of 2014, but that is still well above typical pre-crisis levels of
fewer than 100. There are several factors driving consolidation and elevating the number of
problem banks, beyond the lasting effects of the recession. For starters, community banks
have been challenged in some of your traditional product lines by competition from larger
financial institutions that can achieve lower costs through economies of scale. At the same
time, historically thin net interest margins have constrained profitability, and, although not
aimed at community banks, new post-crisis regulations meant to strengthen the financial
system are coming into place that require additional management attention.
The Federal Reserve recognizes the importance of a healthy community banking sector for
our nation's prosperity, and we are committed to understanding the challenges faced by
community banks and to carefully considering the effects of new regulations on these
institutions. Our mandate is to protect the safety and soundness of the nation's financial
system, and we aim to do so in a manner that promotes a level playing field for all institutions
while taking into account the risks those institutions could pose to our financial system. As
you know, the Federal Reserve tiers its regulations to be commensurate with the risks
presented by different institutions. The risks presented by an institution with $300 million in
assets are very different from those presented by an institution with $300 billion in assets.
Although the credit that a community bank extends to households and businesses within its
local area may be difficult to replace, the failure of a community bank would not cause a
widespread contraction in credit or have any other systemic consequences. For that reason,
community banks are not subject to the same regulations that are applied to the most
systemically important banking organizations.
The Federal Reserve's 2013 capital guidelines are a good example of how we have taken
into account the effect of our regulations on community banks. The recession made it clear
that strong capital positions are essential for banks of all sizes, including community banks.
After issuing our proposed guidelines, we received considerable input from community
bankers helping us to identify which portions of our original proposal were, and were not,
appropriate for community banks. Based on this input, we made some significant
adjustments to the proposal to alter, for example, the risk-weighting of mortgage loans and
the regulatory capital treatment of certain unrealized gains and losses and trust preferred
securities for community banking organizations. Regulators also developed a community
bank guide, which outlined the relevant provisions for smaller, noncomplex institutions and
compared the new requirements to the previous standards.1
In addition, the Federal Reserve Board recently issued a final rule raising the limit on the
maximum size of banks covered by our Small Bank Holding Company Statement.2 This
policy statement, originally issued in 1980, fosters local ownership of small community
banks. While the Board generally discourages the use of debt by bank holding companies to
finance acquisitions, it recognizes that the limited access small institutions have to equity
funding means that such firms often must rely on acquisition debt to accomplish a transfer of
ownership. The policy statement allows small, noncomplex bank holding companies to
temporarily operate with higher levels of debt than would otherwise be permitted. It also
exempts them from the Board's risk-based and leverage capital guidelines and eliminates
some regulatory reporting requirements. Of course, regulatory capital requirements will
continue to apply to the depository institution subsidiaries of these companies.
The policy statement originally applied only to qualifying holding companies with no more
than $150 million in total consolidated assets. In 2006, the maximum asset size was raised to
$500 million. Significant changes in the structure of the banking industry since 2006 led
Board members to believe that a further increase in the limit to $1 billion in assets should be
considered. However, because of limitations imposed by the Collins Amendment to the
Dodd-Frank Act, the Board could not raise the limit without further statutory action. We are
very pleased that the Congress passed legislation in December 2014 that enabled the Board
to raise the limit. The policy statement now covers nearly 90 percent of bank holding
companies.
The Volcker rule and incentive compensation are two additional areas where I believe relief
for smaller institutions would be helpful. The risks identified by the Dodd-Frank Act in these
areas apply almost exclusively to larger financial institutions. Community banks rarely
engage in any of the activities prohibited by the Volcker rule, and community banks generally
do not face the adverse incentives of compensation agreements that may encourage
executives and loan officers to maximize lending volume at the expense of safety and
soundness. I believe community banks should not face significant burdens from complying
with these requirements, so I support raising the asset threshold for both the Volcker rule and
incentive compensation rules, perhaps to $10billion. In the event where the actions of a
community bank might raise concerns in either of these areas, that could be addressed
through our normal examination process.
The Board has undertaken substantial efforts to tailor its supervisory practices to the size of
the bank examined. We supervise banks in four tiers, with requirements that are lowest for
smaller, local institutions and increase with the size, complexity, and geographic reach of
firms. This system helps community banks by eliminating requirements that are relevant only
to large, geographically diversified banks. This tiered approach allows us to account for the
differences in business models and risk levels among different types of banks. Our goal is
not to develop one state-of-the-art approach to regulation and supervision, but instead
multiple state-of-the-art approaches that are appropriate for each type of institution we
oversee. Supervision of community banks is not a watered-down version of supervision of
larger banks, but a significantly different process tailored to the business model of smaller
banks.
For community banks, the primary purpose of prudential regulation is to ensure the safety
and soundness of each individual institution, thereby protecting the deposit insurance fund.
The crisis showed that such a focus on individual institutions was inadequate to account for
and contain the systemic threats posed by risks at larger, more complex institutions, and
much of the improvement in oversight has been directed at systemic risk. The Board is
committed to making sure that new supervisory standards do not trickle down to community
banks when they may only be appropriate for larger institutions, whether they be systemically
important institutions overseen by the Large Institution Supervision Coordination Committee,
other large banking organizations with more than $50 billion in assets, or regional banking
organizations with between $10 billion and $50 billion in assets.3
For example, the Board has made it clear that capital stress tests and other aspects of the
Comprehensive Capital Analysis and Review requirements do not apply to community banks,
either explicitly or implicitly. In addition to Board members making this point in public
speeches and in meetings with bankers, the Federal Reserve's examiner training
emphasizes that these requirements, which were established under the Dodd-Frank Act, will
apply only to large banking organizations.
The Fed also made changes in 2014 to better tailor our program of consumer compliance
supervision of smaller institutions. Under the new approach, the intensity of bank
examinations is based on our assessment of the risk profile of individual community banks,
including how each identifies and manages consumer compliance risk. Risk assessment
begins before examiners arrive at the bank, allowing examiners to focus on higher-risk
concerns at the banks they supervise. We have also directed examiners to spend less time
on those areas of consumer compliance where problems are uncommon, although we are
ready to ramp up that scrutiny if we have concerns about practices at a particular institution.
Since making these changes 16 months ago, the average length of time for examinations
has dropped, and the feedback we have heard from you is mostly positive. Bankers have told
us that the examiners seem to have a better grasp of the key issues and that exams are, as
we intended, more closely tailored to the business characteristics and risk profile of individual
institutions. Examiners also tell us they sometimes see increased consumer compliance risk
at community banks that are expanding beyond their traditional product offerings, often using
outside vendors to introduce new products such as prepaid cards or credit card add-ons.
These products are often complex, and community banks may not always be familiar with the
risks the products pose. Banks may not have sufficient expertise to thoroughly check out a
vendor and monitor its performance.
Beyond consumer compliance supervision, the Federal Reserve has expanded our ability to
conduct more of the work of bank examinations off site. If banks have electronic loan
records, it is possible for examiners to assess loan quality and underwriting practices
remotely, spending much less time on site. This approach has the potential to improve
examination efficiency and to reduce the examination-related disruption to banking
operations. However, if banks prefer more face-to-face interaction with examiners - and
there are banks that do - we will continue the traditional on-site review.
Our efforts to further tailor bank supervision at community banks continue. Staff members
from the Federal Reserve, Office of the Comptroller of the Currency, and Federal Deposit
Insurance Corporation are working through a major review of regulations called for in the
Economic Growth and Regulatory Paperwork Reduction Act (EGRPRA). We are still in the
midst of this effort, which is being conducted with a broad mandate to identify and revise
where possible outdated, unnecessary, or unduly burdensome regulations, including those
that apply to community banks. The agencies are carefully considering public comments.
Although some burden-reducing measures may require congressional action, the agencies
will act to implement regulatory relief when possible before the end of the EGRPRA review
period. The results of our EGRPRA review will be included in the agencies' joint report to the
Congress.
In addition, the Federal Reserve System has expanded our economic research into issues of
consequence to community banks and has worked to encourage similar research efforts at
academic institutions. Several years ago, a group of economists from across the System
formed an informal working group to share ongoing research related to community banking.
Encouraging results from this internal forum led, in 2013, to an inaugural research and policy
conference titled "Community Banking in the 21st Century," sponsored jointly by the Federal
Reserve System and the Conference of State Bank Supervisors. The conference provided a
unique opportunity for researchers, community bankers, and bank supervisors to come
together to hear some of the latest research on topics related to community banking and
discuss the practical implications of this research. The 2013 conference was so successful
that we decided to make it an annual event. The third annual conference will take place this
coming fall at the Federal Reserve Bank of St. Louis, and Chair Yellen is scheduled to
provide opening remarks.
I had the pleasure of participating in the first two conferences and found the presentations
and conversations to be extremely enlightening. Many of the researchers who presented at
these conferences said that the feedback they received from bankers and bank supervisors
was valuable in helping them shape their future research endeavors. The conference
organizing committee has launched a new website with the URL
"www.communitybanking.org," which they hope will become a focal point for all who are
interested in community banking research. The website provides links to the papers and
presentations from the previous conferences, news about future conference plans, and other
information that might be of interest to community banking researchers.
Although research is an important avenue for improving our understanding of the community
bank business model and the effects of changing market and regulatory conditions on the
viability of that model, understanding is further enhanced through direct interactions between
regulators and community bankers. For this reason, the Federal Reserve System has taken
a number of steps to expand its outreach to community banks.
As you probably know, in 2010 the Board created the Community Depository Institutions
Advisory Council, which includes representatives from community banks, credit unions, and
savings associations from each Federal Reserve District.4 The Board of Governors meets
twice each year to hear the council's valuable insights into the most pressing concerns of
community bankers from across the country. There is also a council for each of the
12 Reserve Banks, which meets regularly with its Reserve Bank leadership.
We have taken other steps to improve communications with community bankers so that we
may better explain our supervisory expectations for community banks and hear your
concerns as well. Our Reserve Banks have together developed a number of channels of
communication with community banks over the years, and some of the most promising of
those initiatives have been expanded nationwide. Two programs, Ask the Fed and Outlook
Live, have become quite popular with community bankers who are interested in learning
more about timely financial or regulatory topics of interest to both bankers and supervisors.
Ask the Fed is a program for officials of state member banks, holding companies, and state
bank commissioners. Outlook Live is a webinar series led by Federal Reserve staff that
serves as a companion to our quarterly publication, Consumer Compliance Outlook.5 Last
year I participated in a webinar hosted by the Federal Reserve Bank of St. Louis and very
much enjoyed hearing directly from community bankers.6
Another effort to improve communication with community bankers is our new Community
Banking Connections website and quarterly newsletter. These sources of information focus
on safety-and-soundness issues that are of practical interest to community bankers and bank
board members. We have also launched a series of special-purpose publications called Fed
Links that highlight key elements of specific supervisory topics and discuss how examiners
typically address the topic.7 The common goal of all of these outreach efforts is building and
sustaining an ongoing dialogue with community bankers.
Despite the challenges that you face, I firmly believe that community banks are here to stay.
Banks of different sizes serve different functions, and both large and small banks are needed
to meet the funding needs of a healthy economy. The Federal Reserve does not use a
onesize-fits-all approach to regulation and supervision and is committed to continually
reevaluating and improving oversight to meet the complementary goals of bank soundness,
financial stability, and economic growth. The risks and vulnerabilities of community banks
differ substantially from those of larger banks, and an explicit tailoring of regulation and
supervision for community banks is appropriate.
I look forward to our discussion.