For release on delivery
10:25 a.m. EDT (9:25 a.m. CDT)
October 4, 2023

The Role of Research, Data, and Analysis in Banking Reforms

Remarks by
Michelle W. Bowman
Member
Board of Governors of the Federal Reserve System
at
The 2023 Community Banking Research Conference
Sponsored by the Federal Reserve System, the Conference of State Bank Supervisors, and the

Federal Deposit Insurance Corporation

St. Louis, Missouri

October 4, 2023

It's a pleasure to be back in St. Louis for the annual Community Banking Research
Conference. I am grateful for the continued partnership between the Federal Reserve, the
Conference of State Bank Supervisors (CSBS), and the Federal Deposit Insurance Corporation
(FDIC), and I would like to thank the conference organizing committee for putting together this
important forum, now in its 11th year. This conference provides an excellent opportunity for
policymakers to pause and reflect on the impact of current U.S. bank regulatory policies on the
financial system. At the same time, we should also consider how alterations to these policies
will influence the future of the broader banking system.

We get a view into these questions-the effectiveness of past policy choices and insights
that can help shape future policy reforms-from several aspects of this conference, including, of
course, the research that will be presented and from the results of the CSBS Annual Community
Bank Survey. We also gain insight from the experience and perspectives of our participants:
your questions and commentary throughout the next few days can provide important context
about the intended and unintended consequences of past policy decisions. And the combined
perspectives from the wide range of experts gathered here-the researchers, regulators,
policymakers, and bankers-will provide us with valuable insights into how to better establish
and calibrate bank regulatory and supervisory policy in the future.

Research, data, and analysis are essential to thoughtful bank regulatory reform. These
tools can be used to identify issues that must be addressed or remediated; they can help us
evaluate which elements of the current bank regulatory framework may be effective or
ineffective, and they can help us craft reforms with a clearer understanding of the intended and
unintended consequences. Together, these tools can help us develop and implement appropriate

regulatory reforms that do not impair the long-term health or impede the future growth of our

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diverse U.S. banking system, enabling us to avoid the pitfalls of reforms that fail to accomplish
these important goals.

Today I will begin by discussing some of the research around community banks and the
role they play in the U.S. banking system. I will then discuss how this research can inform
policy, including by helping us be more sensitive to the unintended consequences of reform, and
discuss how this perspective can be applied to the evaluation of bank mergers and acquisitions.
Finally, I will mention a few additional areas where I think research could be valuable as an
input to the rulemaking process.

The Role of Research, Data, and Analysis in Rulemaking

Good research leads to good policy. This statement will likely sound familiar to many of
you, as it was how Jim Bullard, the former president of the Federal Reserve Bank of St. Louis,
would describe one of the key purposes of this conference in past years. Over the years, many of
the conference speakers and presenters have echoed that same sentiment since this conference
first launched in 2013.

In my remarks today, I will discuss the importance of using an evidence-based approach
to bank regulatory policy, which has been a long-standing theme and goal of this conference.
While research can provide valuable insights to inform revisions to bank regulatory policy,
research is particularly important when it comes to regulatory efforts that directly affect
community banks, including changes to modernize the Community Reinvestment Act
regulations, or reforms to the supervisory standards and expectations for community banks.
Research also plays an important role in helping us understand policy reforms that affect
community banks indirectly, such as the potential that regulatory requirements designed to apply

only to larger banks could eventually be pushed down to smaller and community banks.

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Research and evidence-based rulemaking can insulate the banking system from wide
swings in policy over time. The banking system faced significant challenges this year, triggered
by the failures of three large banks in the early spring. As I noted at the time, the policy choices
made in responding to these failures will have important, long-term consequences for the U.S.
banking system.! The potentially far-reaching consequences of policy choices we make during
this time highlight the importance of clearly identifying the problems we are attempting to
address using data to craft solutions that are effective, targeted, and efficient. Bank failures
demand scrutiny, but bank failures alone do not justify wholesale revisions to the bank
regulatory framework. Before we undertake reforms intended to address issues that led to bank
failures, we need to develop a comprehensive understanding not only of those root causes, but
also of the costs and unintended consequences of potential reforms. Research can protect against
over-reactive regulation, especially that which is not efficient, calibrated and tailored to address
the actual risks and challenges facing the banking system.

My insistence upon being guided by evidence does not imply that I am opposed to
regulatory reforms, but rather that policymakers should be expected to show their work. The
banking system is not perfect, and policymakers should continually ask themselves if there are
ways to improve regulation and supervision. I am always open to considering evidence-based
proposals that address known deficiencies and shortcomings in our regulatory and supervisory
framework, but any such proposals must stop short of interfering with or stepping into the role of

managing the financial institution.

' Michelle W. Bowman, The Evolving Nature of Banking, Bank Culture, and Bank Runs, speech at the 21st Annual
Symposium of Building the Financial System of the 21st Century: An Agenda for Europe and the United States,
European Central Bank, Frankfurt, Germany, May 12, 2023,
https://www.federalreserve.gov/newsevents/speech/bowman20230512a.htm.


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I am very pleased that this research and policy conference has continued to thrive and
grow over the 11 years since its inception. The research work you all do, especially your efforts
to develop data and analysis to inform policy, is a critical input to the rulemaking process.

While research is a foundation of prudent regulatory policy, the community banks that
operate under this framework are the reason we are gathered together at the Saint Louis Federal
Reserve Bank. So, let's build upon that foundation to highlight the role of community banks in
the U.S. banking system.

The role of community banks in the U.S. banking system

As is necessary and appropriate when speaking at a research conference, let's start with
the research. Research can help reinforce a statement that policymakers often make, which is
that banks of all sizes-including community banks-are a critical part of a healthy and vibrant
banking system. Today, there are around 4,200 community banks in the United States." What
role do these community banks play in the current U.S. banking system and in the communities
they serve?

While my discussion could not possibly do justice to the vast body of research addressing
the important role of community banks in providing credit and supporting their communities, I
would like to highlight a few research findings that will likely resonate with community bankers
and researchers.

A classic 2002 paper from economist Allen Berger and his co-authors looked at how

banks process information to make credit allocation decisions, with the goal of evaluating the

? See Federal Deposit Insurance Corporation, Quarterly Banking Profile, Second Quarter 2023, at 14,
https://www.fdic.gov/analysis/quarterly-banking-profile/qbp/2023jun/qbp.pdf#page=1.


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differences between small and large banks.* The paper provided empirical evidence that small
banks have a comparative advantage over large banks in making small business loans due to
their specialized ability to effectively produce "soft information" on smaller firms and make
effective credit decisions based on this information. In contrast, the paper finds that larger banks
are at a comparative advantage when lending to larger firms that can produce more "hard
information" that can be easily verified and documented. This research validates and confirms
that community banks leverage the power of "relationship banking," and in doing so, are an
important source of credit to a critical segment of the economy. This finding also helps explain
why community banks were able to more effectively and on a large scale implement the
Paycheck Protection Program during the pandemic in comparison with large banks.

As another, more recent example, a paper published last year by economist Elizabeth
Berger provides additional context to the role of community banks and the policy issues
currently being debated. This paper focuses on the role community banks play in the creation of
service sector jobs. We've seen the important role of service-oriented jobs for job growth the
U.S., as our economy has moved away from manufacturing- and production-based employment
over the course of many decades. The paper looks at both the extent to which small businesses'
physical access to a local, relationship lender supports growth in service sector jobs and explores
whether this growth is the result of access to local banking institutions. She found that service

sector job creation is not only supported by relationship lending from local community banks but

3 Allen N. Berger, Nathan H. Miller, Mitchell A. Petersen, Raghuram G. Rajan, and Jeremy C. Stein, Does Function
Follow Organizational Form? Evidence from the Lending Practices of Large and Small Banks, National Bureau of
Economic Research, Working Paper 8752 (Cambridge, MA: NBER, February 2002),
https://www.nber.org/system/files/working papers/w8752/w8752.pdf.


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also depends on smaller, relationship lenders for growth. Her key finding is unambiguous:
"finance [providers] must be local to facilitate service job creation."4

These research findings will certainly not surprise community bankers, state bank
regulators, or those who directly see the positive impact of community banks on their local
communities. But equally important from a policymaker's perspective is what these papers tell
us about the impact of a community bank exiting its local community and the surrounding
market. What happens when a small business has no local, community banker that takes the time
to understand its business, whose business model is based on developing long-term banking
relationships? Would small businesses be better served if their banking relationships are with
large, non-relationship-based banking institutions? Or if the only alternative source of credit for
small businesses were from nonbank lenders that are not subject to the same regulatory oversight
as banks?

Understanding these issues can provide important context, not only to understand the
current banking landscape, but also to evaluate the merit of reform proposals. Reforms that
result in impairing the future of the community banking industry or the elimination of
community bank charters to mergers or acquisition because of over-regulation or excessive
compliance burden can have a significant, adverse impact on small business formation in local
communities given the hurdles new small businesses face when seeking credit. And, while it
might be tempting to assume that alternative sources of credit would arise to fill a gap left by

community banks, this is not a given. For example, while credit unions compete with banks in

+E. A. Berger, "Finance in the New U.S. Economy: Local Finance and Service Job Growth in the Post-Industrial
Economy," Journal of Financial and Quantitative Analysis, September 9, 2020, 57(5), 1987-2021,
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3718458.


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many banking markets, credit unions are not, by design, by structure, and by regulation, small
business lenders.

Some of the research that will be presented later today and tomorrow explores different
aspects of community banking and the role community banks play in the current banking market.
I look forward to learning more about this research and how it can serve to inform current and
future bank regulatory reform efforts.

Implications of the evidence for regulatory policy

The research I mentioned earlier has important implications for policymakers, as it
suggests that factors that contribute to a reduction in the number and lending footprint of
community banks could lead to a number of negative impacts, including credit constraints for
small businesses and small business start-ups. This issue could be especially acute when a
market-an underserved market-is left without a community bank as a source of credit. The
research highlights that a banking desert does not only affect individuals, but also can have a
devastating impact on small businesses, local job formation, and local economies.

One important influence on banking market competition is bank mergers and acquisitions
(M&A), including the important role of regulators in reviewing and approving these transactions.
While one might naturally assume that approving mergers would always lead to a reduction of
community bank lending, this result may not always be the case, as in markets viewed as less
attractive or undesirable to large or regional banks, where the only option for community banks
to survive may be to consolidate with other community banks in the same geographic area.
Surely, some level of consolidation is preferable to the closure of community banks and the

perpetuation of banking deserts or zombie banks.

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At this conference last year, I described what I called the "New Landscape for Banking
Competition" and stressed the urgency of updating and modernizing the framework the federal
banking regulators and the Department of Justice use to evaluate the competitive effects of
proposed bank mergers.° I offered several commonsense proposals that should guide our
thinking about how we evaluate bank mergers in the future and underscored how calibrating our
guidelines correctly is critically important for community banks, given the evidence we have on
their role and impact in providing credit in local communities.

Among those ideas was a more systematic inclusion of nonbank competitors and credit
unions in our competitive landscape. I also proposed factoring in digital banks, and those more
traditional banks who have established a strong national digital presence, in our competition
analysis. These institutions have proven to be very effective at attracting deposits from
anywhere in the country and therefore clearly compete with banks in urban and rural markets
across the U.S.

Why is this important?

e First, in our current analytical framework, more than 65 percent of banking
markets, as currently defined, would be considered noncompetitive or
"concentrated" in the language of antitrust, yet the intense competition for
banking products and services has only grown, principally from nonbanks. We
need to reconcile that.

e Second, in our current framework, only 5 percent of the currently defined banking

markets are considered highly competitive or "unconcentrated." In fact, today

5 Michelle W. Bowman, The New Landscape for Banking Competition, speech at the 2022 Community Banking
Research Conference, sponsored by the Federal Reserve, the Conference of State Bank Supervisors, and the Federal
Deposit Insurance Corporation, St. Louis, Missouri, September 28, 2022,
https://www.federalreserve.gov/newsevents/speech/bowman20220928a.htm.


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there are 19 states in the U.S. that do not have a single market that would be
classified as highly competitive, and only 2 states have one-quarter or more of
their markets designated as highly competitive.°

In our current system, many of the competitors and new entrants that we do have
(nonbanks, fintech firms, credit unions), are systematically ignored. The baseline assumption in
our current framework is that credit unions do not compete with banks, and yet, just last month
we saw five announced acquisitions of community banks by credit unions.' Despite this trend,
after a community bank has been acquired by a credit union, the resulting credit union is no
longer viewed as a baseline competitor with other community banks in the market. I think it is
fair to question whether this view is consistent with reality.

We have also seen significant changes in how consumers access banking products and
services and observed the migration of many types of loans from the banking sector to nonbanks,
including 1-4 family residential mortgage loans. In fact, the top three mortgage lenders in the
country are nonbanks. Even the largest U.S. banks are behind these nonbanks when it comes to
mortgage originations.* But we do not consider these entities as competitors when evaluating a

merger involving a community bank.?

6 Reports of Condition and Income (Call Reports) and the Competitive Analysis and Structure Source Instrument for
Depository Institutions (CASSIDI). CASSIDI combines data from the FDIC's Summary of Deposits and banking
market definition information into a comprehensive analysis tool for use by regulatory agencies and banking
organizations for performing pro-forma competitive factors analyses on potential bank mergers.

7 Jim Dobbs and Ken McCarthy, "Two Credit Unions Are on a Bank Shopping Spree," American Banker,
September 1, 2023, https://www.americanbanker.com/creditunions/news/two-credit-unions-are-on-a-bank-shopping-

spree.

8 Consumer Financial Protection Bureau, Home Mortgage Disclosure Act data, 2022,
https://www.consumerfinance.gov/data-research/hmda/.

° Greg Buchak and Adam Jorring, Do Mortgage Lenders Compete Locally? Implications for Credit Access, working
paper, July 2021, https://www.communitybanking.org/-
/media/files/communitybanking/2021/session2_paper2_jorring.pdf?sc_lang=en.


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Under our current framework, it appears as if regulators have closed the door to a broad
range of potential mergers that are perceived to raise competitive concerns in rural markets, by
using an artificially narrow lens to evaluate competition concerns. Many merger proposals are
regularly forced to go through an extensive, lengthy, and ultimately costly review process. As
we've seen in recent months, this can result in extending the processing of the underlying
merger, sometimes by as much as a year. While there is a lag in the reporting of applications
data, data from 2022 show that the average processing time for applications has increased
significantly from 2019 through 2022 for banks of all sizes.!° Information published by the
Federal Reserve suggests that this increase was primarily the result of the Board's concurrent
consideration of several relatively large and complex M&A proposals requiring Board action.
Data through the first half of 2023 showed some improvement in average processing times, but
the volume of approved M&A applications were down substantially from a year ago, while the
number of M&A applications withdrawn in the first half of 2023 has already exceeded the total
number withdrawn in all of calendar year 2022."

Reported information highlights that community banking organizations also experienced
increased processing time for M&A proposals from 2021 to 2022, with the average time

increasing from 63 days to 72 days for banks under $1 billion in assets, and from 51 days to 96

'0 See Banking Applications Activity Semiannual Report, July 1-December 31, 2022, (10, 1), table 2 (May 2023),
https://www.communitybanking.org/-
/media/files/communitybanking/2021/session2_paper2_jorring.pdf?sc_lang=en (showing that for mergers and
acquisitions proposals considered by the Board, the average processing time for applications increased from 60 days
in 2019 to 87 days in 2022).

"I Banking Applications Activity Semiannual Report, January 1-June 30, 2023, (10, 2), table 2 (September 2023)
(showing 46 M&A applications approved and 12 applications withdrawn in the first half of 2023, compared to 87
M&A applications approved and 4 applications withdrawn in the first half of 2022, with 11 withdrawn M&A
applications for the entire calendar year of 2022).


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days for banks from $1 billion to $10 billion in assets.'? While this average processing timeline
improved slightly for community bank M&A applications in the first half of 2023, the most
recent semiannual report on banking applications acknowledges that there were fewer M&A
applications by community banks in the first half of 2023 as compared with the first half of
2022.'3 Applications of any size can raise novel issues or concerns, but this should raise
concerns with policymakers.

While the cause of such delays may vary-for example, receiving an adverse comment
on a proposal can also result in a longer application processing period-lengthy review periods
can have significant adverse consequences to firms and the banking system. Long delays can
lead to a number of negative outcomes, including loss of key staff, pauses on new investment
and development of new consumer and business products, expensive delays in systems
integration, reputational risk, and shareholder losses. We've also seen that when a merger is
either approved or denied after a lengthy process, the institutions involved are generally weaker
than they would have been had a determination been made in a more reasonable time frame.
This is not the recipe for a responsible regulatory system or a healthy banking system.

Of course, there are alternatives to this view of competition in rural markets. As noted in
the research I cited earlier, when looking at the competitive effects of a potential bank merger, it
might be more appropriate to look at the extent to which small businesses in a market would
have choices that include a community bank when seeking credit, rather than looking only at the

overall share of deposits an institution would have in a given banking market.

Banking Applications Activity Semiannual Report, July 1-December 31, 2022, (10, 1), table 4,
https://www.federalreserve.gov/publications/files/semiannual-report-on-banking-applications-20230522.pdf.

3 Banking Applications Activity Semiannual Report, January 1-June 30, 2023, (10, 2), table 4,
https://www.federalreserve.gov/publications/files/semiannual-report-on-banking-applications-20230929. pdf.


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The research sends a strong signal that preserving local relationship-based community
banks is vital to local economies. This suggests that a regulatory review framework should not
be designed to obstruct mergers that result in stronger, more diversified community banks, with
relationship business models. Clearly, these policies need to change, unless the goal is to
facilitate further consolidation of banking products and services into the hands of a few national
players.

This research has implications beyond just bank merger policy. For example, while bank
regulatory reform proposals may consider the incremental additional burden on regulated
institutions, this approach may be too narrow a lens, particularly for community banks. The
cumulative burden of regulations coupled with extensive supervisory guidance can be a
significant headwind for community banks, and local communities and customers served by
community banks often bear the consequences.

Future Areas of Research

After nearly five years serving on the Board of Governors in the seat designated for
someone with community banking or state bank supervisory experience, I am inspired by the
potential of research to shape policy to reflect the practical reality. Many of you in this room
have contributed important research that has energized policy discussions and debates. I am
confident that this year's lineup of research papers will spark similar conversations.

Year after year, researchers have presented evidence that a banking system with diverse
business models and sizes is better for business formation and leads to better penetration of
financial services products across all industry sectors. You've demonstrated direct benefits to

small businesses (including agriculture-based businesses) and to nontraditional mortgage

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borrowers when smaller, local lenders operate in a market.'* You've shown how community
banks provide a window into local economies and local industries and provide an overall view of
the health of the U.S. economy.

As we look past this conference, I'd like to suggest a few areas that warrant further
research and debate.

Reconsideration of the community bank asset threshold

First, our regulatory system is very complex, and one thing that adds to this complexity is
the often-inconsistent definitions we use, including the definition of a "community bank." These
definitions are important-they are used to clarify which requirements and rules apply to a
certain type of institution. Policymakers should strive to avoid unnecessary complexity or
confusion around these thresholds.

Most commonly, when we refer to a community bank, we are referring to an institution
with less than $10 billion in total consolidated assets. This threshold was referenced in several
sections of the Dodd-Frank Act as a way to differentiate requirements among banks and was
explicitly referred to in the subsequent Economic Growth, Regulatory Relief, and Consumer

Protection Act.!>

Of course, the reality is that our regulatory system applies different rules to
different institutions across a wide range of asset sizes. For example, the Community

Reinvestment Act regulation includes asset thresholds well below any common understanding of

'4 Daniel Rabetti, Non-Information Asymmetry Benefits of Relationship Lending, working paper, Coller School of
Management (Tel Aviv: Tel Aviv University, August 2022), https://(www.communitybanking.org/-
/media/files/communitybanking/2022/sessionI_paper3_rabetti.pdf?sc_lang=en; Claire Brennecke, Stefan Jacewitz,
and Jonathan Pogach, Shared Destinies? Small Banks and Small Business Consolidation, working paper, July 2020,
https://www.communitybanking.org/-
/media/files/communitybanking/2020/sessionI_paperl_pogach.pdf?sc_lang=en.

'S Dodd-Frank Act, PL. 111-203, §§ 165(h)(2)(A), (i)(2)(A), 723(a)(3), 763, 1025(a), 1026(a); Economic Growth,
Regulatory Relief, and Consumer Protection Act, P. L. 115-174, §§ 201 (defining a qualifying community bank as
one with total consolidated assets of less than $10 billion), 203 (giving relief to community banks from the Volcker
tule).


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what a community bank is. It simply makes sense that the definition would be rationalized
across the bank regulatory framework.

Are these asset size thresholds properly calibrated, and are the impacts, costs, and
benefits to institutions and to customers when banks cross these different thresholds rational?
Are these thresholds creating the right incentives to promote prudent lending while appropriately
balancing risk?

We also need a better framework to understand whether we should move beyond simple
asset size thresholds when tailoring our regulatory rules to the risks that different banks pose
based, perhaps not on size, but on business model. Further, is it possible to move beyond asset
size thresholds and still apply our dual banking system's tailored supervisory and regulatory
approach in a way that is clear and transparent to all stakeholders?

Again, research continues to show the benefits that relationship-based commercial
lenders provide to communities. I believe it is of paramount importance to develop a clear and
transparent framework for defining who these lenders are so we can tailor our regulations
appropriately.

Insured and uninsured deposits in bank funding models

A second area that deserves additional research is how banks fund themselves, and
whether the deposit infrastructure-including deposit insurance-could be improved, including
to make the banking system more resilient during times of financial stress. As we saw earlier
this year, the speed at which customers can move money using modern technology is
unprecedented. Much like our competition framework, we need to ensure that the framework
that we put in place today supports the banking system of tomorrow and not the banking system

of yesterday.

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With respect to deposit insurance reform, the FDIC laid an important foundation when it
released its report on the Options for Deposit Insurance Reform in May 2023.'° The framework
shared the FDIC's views of the pros and cons of either providing unlimited deposit insurance
coverage or targeted coverage based on different account types. The report suggested that
targeted coverage might be the best option for maintaining financial stability and protecting
depositors. We need to ensure that our deposit insurance infrastructure can support banking
sector stability in the face of the challenges posed by today's technology.

This report, however, should not just serve as a call for policymakers to react to a narrow
scope of options developed in reaction to a bank run crisis but should be seen as a call to the
research community to provide evidenced research and analysis on these and other options. I see
an opportunity for extensive stakeholder engagement and public dialogue on the topic of deposit
insurance and the evolution of deposit practices. In my conversations with community bankers
this spring, I learned that a large number of concerned customers called their local community
banker with questions about deposit insurance. Community bankers have direct experience and
insights into the benefits and challenges of our current deposit insurance infrastructure. Their
insights can complement research on this topic and can bring a valuable and realistic
practitioner's perspective to this significant matter of public policy.

Conclusion

As I reflect on the past seven years of my participation in this conference, first as a state
bank commissioner, and now as a member of the Board of Governors, I am struck by how the
approach taken by this conference is, in some ways, a smaller scale model of what I see as an

effective approach to policymaking:

'6 Federal Deposit Insurance Corporation, Options for Deposit Insurance Reform, (Washington: FDIC, May 1,
2023), https://www.fdic.gov/analysis/options-deposit-insurance-reforms/index.html.


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e bring researchers and practitioners together to discuss important policy issues that
are grounded in research, and

e leverage the insights and experiences from a wide range of stakeholders to
improve our understanding of both the key issues and of the policy options.

Id like to commend all who have gathered today for participating in person to discuss the
research and to learn from the work and experiences of one another. This conference contributes
a wealth of insights and evidence that lead to better policy choices and can help us understand
where future challenges to the banking industry might emerge.

Our call to action coming from this conference, in my view, is to resist the urge to act ina
reactionary way when addressing policy matters. Instead, policymakers should choose to
exercise restraint and patience, consider the evidence, and strive for well-calibrated policies that
fully incorporate the costs, benefits, and impacts of reform and complement, rather than

complicate or contradict, the existing regulatory framework.