Janet L Yellen: Tailored supervision of community banks
Speech by Ms Janet L Yellen, Chair of the Federal Reserve System, at the Independent
Community Bankers of America 2014 Washington Policy Summit, Washington D.C., 1 May
2014.
* * *
Tailored supervision of community banks
Thank you for inviting me to ICBA's policy summit. I am pleased to have this opportunity to
share my views on some of the key issues facing community banks and how I see the
community banking model fitting into the financial system in the years ahead. In particular, I
will discuss steps the Federal Reserve has taken to address the "too-big-to-fail" problem and
how these steps affect community banks; I will describe how the Fed strives to improve our
understanding of the unique role that community banks play in the economy; and then I'll
show how we are using this knowledge to better tailor our supervisory expectations and
approaches to community banks.
As you may know, before I rejoined the Federal Reserve Board as Vice Chair in 2010, I had
the privilege of serving for six years as president and chief executive of the Federal Reserve
Bank of San Francisco. The 12th district is the largest of the Fed's districts, covering nine
western states, and it is home to a significant number of community banks, the majority of
which are supervised by the San Francisco Fed directly or indirectly through bank holding
companies. Community bankers helped me, when I served as president, to take the pulse of
the local economy and also to understand how regulatory and policy decisions in Washington
affect financial institutions of different sizes and types, sometimes in very different ways.
During the financial crisis, I saw first-hand the challenges that community banks faced in a
crisis they did little to cause, and I have felt strongly ever since that the Fed must do what it
can to ensure that the actions taken following the crisis do not place undue burdens on your
institutions.
I believe a healthy financial system relies on institutions of different sizes performing a variety
of functions and serving different needs. In some communities, your banks are actually
situated on Main Street, but all community banks serve Main Street by providing credit to
small business owners, homebuyers, households, and farmers.
Because of their important role, I am pleased that the condition of many community banks
has been improving. Although there is still considerable revenue pressure from low margins,
earnings for most community banks have rebounded since the financial crisis. Asset quality
and capital ratios continue to improve, and the number of problem banks continues to
decline. Notably, after several years of reduced lending following the recession, we are
starting to see slow but steady loan growth at community banks. While this expansion in
lending must be prudent, on balance I consider this growth an encouraging sign of an
improving economy.
Addressing too big to fail
Let me begin by discussing an issue that I know has been on the minds of many community
bankers: how policymakers are addressing the problem of banks that are perceived to be too
big to fail.1 Community banks share the interest we all have in reducing the systemic risk
posed by firms that are large, complex, and interconnected, and also in reducing any
potential competitive advantages that such firms may enjoy as a result of too-big-to-fail.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act)
addresses the too-big-to-fail issue through steps intended to limit both the likelihood that
systemically important firms would fail and the potential damage from any that do. The
Federal Reserve and the other financial regulatory agencies have issued a number of
regulations to implement the requirements set forth in the legislation and to enhance the
supervision of the largest financial firms.
But even before Dodd-Frank became law, the Federal Reserve began to strengthen its
oversight of the largest, most complex banking firms and require these firms to materially
improve their capital adequacy. For example, in 2009, we conducted the first stress tests of
the largest 19 U.S. bank holding companies. That test has subsequently evolved into our
annual Comprehensive Capital Analysis and Review, known as CCAR, which requires all
bank holding companies with total assets of $50 billion or more to submit annual capital
plans for review by the Federal Reserve. CCAR helps ensure that the largest banking
organizations will have enough capital to continue operating through times of economic and
financial stress.2 To be clear, as the federal banking agencies have stated previously, these
stress testing and capital planning requirements do not, and should not, apply to community
banks.3
In addition to strengthening requirements for stress testing and capital planning, the agencies
have also strengthened capital requirements for the largest firms by approving more robust
risk-based and leverage capital requirements. Because the financial crisis demonstrated the
importance of having adequate levels of high-quality capital at banks of all sizes, many
elements of the revised capital framework apply to all banking organizations. In designing the
revised capital rules, however, the agencies considered financial stability risks and adjusted
the final rules to make the requirements substantially more rigorous for the largest, most
systemically important banking organizations than for community banks.4
While we have taken a number of steps to address too-big-to-fail concerns, our work is not
finished. Because the failure of a systemic institution could impose significant costs on the
financial system and the economy, the Board recently finalized a requirement for the eight
large, globally systemic banks to meet a significantly higher leverage requirement than other
banking organizations. And we are working to implement risk-based capital surcharges for
speech delivered at the International Monetary Conference, Shanghai, June 3. These speeches are available
at http://www.federalreserve.gov/newsevents/speech/2013speech.htm.
2
The results of the 2014 CCAR exercise are available on the Federal Reserve's website. Board of Governors of
the Federal Reserve System (2014), "Federal Reserve Releases Results of Comprehensive Capital Analysis
and Review (CCAR)", press release, March 26, http://www.federalreserve.gov/newsevents/press/
bcreg/20140326a.htm.
Pursuant to the Dodd-Frank Act, the Federal Reserve and the other federal banking agencies require banking
organizations with total consolidated assets between $10 billion and $50 billion to conduct annual
companyrun stress tests. The agencies recently published guidance to clarify supervisory expectations for these firms.
See Board of Governors of the Federal Reserve System (Board of Governors), Federal Deposit Insurance
Corporation (FDIC), and Office of the Comptroller of the Currency (OCC) (2014), "Agencies Issue Final
DoddFrank Act Stress Test Guidance for Medium-Sized Firms", press release, March 5,
http://www.federalreserve.gov/newsevents/press/bcreg/20140305a.htm.
3
Board of Governors (2012), "Agencies Clarify Supervisory Expectations for Stress Testing by Community
Banks", press release, May 14, http://www.federalreserve.gov/newsevents/press/bcreg/20120514b.htm.
4
To help non-complex community banking organizations better understand the new capital rule, the agencies
published a guide that summarizes changes to the capital rules for exposures commonly held by such
organizations. See Board of Governors, FDIC, and OCC (2013), New Capital Rule: Community Bank Guide
(PDF) (Washington: Board of Governors, FDIC, and OCC, July), http://www.federalreserve.gov/bankinforeg/
basel/files/capital_rule_community_bank_guide_20130709.pdf.
these systemically important firms. We also need to ensure that the new rules are embedded
in our supervision of the largest firms; and, we must continue to watch for emerging sources
of systemic risk and take steps as appropriate to address these risks.
One such risk that the Federal Reserve has been monitoring closely is the reliance of some
firms on potentially volatile short-term wholesale funding.5 We are carefully considering the
systemic vulnerabilities that may be posed by overreliance on short-term wholesale funding
and are weighing potential policy responses. While it would be premature to indicate whether
or how we might address these vulnerabilities, I can say that few, if any, community banks
are reliant on levels of short-term wholesale funding that could raise concerns about
systemic risk, and regulators would carefully consider the ramifications of any action,
including the effect on community banks.
Improving our understanding of community banks
In carefully considering how our actions affect community banks, the Federal Reserve is
committed to understanding your institutions and the challenges you face. We continue to try
to improve that understanding in two important ways - research and outreach. The Fed is
uniquely positioned to employ these two methods because of our traditional strength as a
research institution and because of our structure, with Reserve Banks that have deep roots
in communities in every region of the country.
In the past several years, research staff across the Federal Reserve System who were
independently exploring issues related to community banking have developed an informal
network to share findings and identify areas for further research. After some of the fruits of
this effort were shared with the Board, we decided to join with the Conference of State Bank
Supervisors (CSBS) to host a research and policy conference focused on community banks.
This conference, "Community Banking in the 21st Century", was held in October 2013 at the
Federal Reserve Bank of St. Louis.6 It was one of very few research conferences to focus
specifically on community banks and also brought together researchers, community bankers,
policymakers, and bank supervisors to discuss the practical implications of the papers
presented.
Among the topics that researchers addressed in their papers were the link between bank
failures and local economic performance,7 the role of management in the performance of
community banks,8 and the impact of Dodd-Frank on community banks.9 I'm pleased to say
5
See, for example, Daniel K. Tarullo (2013), "Shadow Banking and Systemic Risk Regulation", speech
delivered at the Americans for Financial Reform and Economic Policy Institute Conference, Washington,
November 22; http://www.federalreserve.gov/newsevents/speech/tarullo20131122a.htm; and Daniel K. Tarullo
(2013), "Macroprudential Regulation", speech delivered at the Yale Law School Conference on Challenges in
Global Financial Services, New Haven, CT, September 20, http://www.federalreserve.gov/newsevents/
speech/tarullo20130920a.htm.
6
Conference materials, including research papers, are available on the conference website. See also Jerome
H. Powell (2013), "Community Banking: Connecting Research and Policy", speech delivered at the Federal
Reserve/Conference of State Bank Supervisors Community Banking Research Conference, St. Louis,
October 3, http://www.federalreserve.gov/newsevents/speech/powell20131003a.htm.
7
John Kandrac (2013), "Bank Failure, Relationship Lending, and Local Economic Performance (PDF)", paper
presented at the Federal Reserve/Conference of State Bank Supervisors Community Banking Research
Conference, St. Louis, October 2, http://www.stlouisfed.org/banking/community-banking-conference/
PDF/Kandrac_BankFailure_CBRC2013.pdf.
8
Dean F. Amel and Robin A. Prager (2013), "Performance of Community Banks in Good Times and Bad Times:
Does Management Matter? (PDF)" (preliminary draft), paper presented at the Federal Reserve/Conference of
State Bank Supervisors Community Banking Research Conference, St. Louis, October 3,
http://www.stlouisfed.org/banking/community-banking-conference/PDF/Amel-Prager_Community_Bank_Draft_918-13_with_Tables.pdf.
that the conference was so successful that the Federal Reserve and CSBS are planning
another in September.10
In addition to research, our understanding of community banks is enhanced by the Fed's
outreach to community bankers. At the most basic level, supervisory staff at each Reserve
Bank gain insights from their regular contact with community bankers. Additional knowledge
comes by way of community outreach initiatives, which provide the added benefit of
informing the Fed about local economic conditions. Here in Washington, in addition to
participating in events like this one, the Board of Governors meets twice a year with the
Community Depository Institutions Advisory Council (CDIAC).11 The council, which includes
representatives from small banks, credit unions, and savings associations from each Federal
Reserve district, provides information about economic conditions around the country and
those issues that are of greatest concern to community institutions.
In addition, we have been taking steps to improve our communication with community
bankers. In that regard, we have been using various platforms to go beyond formal policy
issuances and better explain our supervisory expectations for community banks. We have
also developed and continue to enhance our industry training efforts. In particular, we have
developed two programs - Ask the Fed and Outlook Live - that have become quite popular
with community bankers who are interested in learning more about topics that are of
importance to both banks and supervisors. Ask the Fed is a program for officials of state
member banks, bank and thrift holding companies, and state bank commissioners. Outlook
Live, which is a companion program to the Federal Reserve's quarterly Consumer
Compliance Outlook publication, is a webinar series on consumer compliance issues that is
led by Federal Reserve staff.12
We are also now using periodic newsletters and other communication tools to highlight
information that community bankers may be interested in knowing and to provide information
on how examiners will assess compliance with Federal Reserve policies. In addition to
Consumer Compliance Outlook, in 2012 the Federal Reserve System established a
Community Banking Connections website and quarterly newsletter to focus on
safety-andsoundness issues that are of practical interest to community bankers and bank board
members.13 The Federal Reserve also launched a series of special-purpose publications
called FedLinks.14 These publications highlight key elements of specific supervisory topics
and discuss how examiners will typically address the topic. The common goal for all of these
outreach efforts is building and sustaining an ongoing dialogue with community bankers.
Tailored community bank supervision
One theme that has come through loud and clear in this outreach is concern about regulatory
burden. The financial crisis has prompted significant changes to regulation, so the Federal
Reserve understands this concern and strives to minimize regulatory burden for all
9
Tanya D. Marsh and Joseph W. Norman (2013), "The Impact of Dodd-Frank on Community Banks (PDF)",
paper presented at the Federal Reserve/Conference of State Bank Supervisors Community Banking Research
Conference, St. Louis, October 3, http://www.stlouisfed.org/banking/community-banking-conference/PDF/
Marsh_Norman_Reforming_Regulation.pdf.
10
See http://www.stlouisfed.org/banking/community-banking-conference-2014/.
11
For more information on the CDIAC, see http://www.federalreserve.gov/aboutthefed/cdiac.htm.
12
Consumer Compliance Outlook is available at http://www.philadelphiafed.org/bank-resources/
publications/consumer-compliance-outlook/, and Outlook Live is available http://www.philadelphiafed.org/
bank-resources/publications/consumer-compliance-outlook/outlook-live/.
13
Community Banking Connections is available at http://www.communitybankingconnections.org/.
14
FedLinks is available at http://www.communitybankingconnections.org/fedlinks.cfm.
institutions, including community banks. At the same time, we are taking a fresh look at how
we supervise community banks and possible ways that supervision can be smarter, more
nimble, and more effective. In that regard, and consistent with my earlier points about too big
to fail, we know that a one-size-fits-all approach to supervision is often not appropriate. In
recent years, we have taken a number of actions to tailor supervisory expectations to the
size and complexity of the banking organizations we supervise.
The first step is taking a disciplined approach to judging which supervisory policies should
apply to community banking organizations. This involves not only weighing the costs and
benefits of proposed rules and their implementation, but in some cases also asking whether
it makes sense for a specific policy to apply to community banks.
In other cases, it may not make sense to exclude community banking organizations entirely
from the scope of a supervisory policy, but we may be able to scale expectations to the size
and complexity of the supervisory portfolio, to minimize the burden where possible and
appropriate. The final capital rules for community banks that I mentioned earlier illustrate this
kind of tailoring.
Let me turn now to upcoming changes in the accounting standard for credit losses on loans
and securities. We have heard the concern that overly complex accounting rules in this area
would increase costs with little benefit for the users of community bank financial statements.
We are working with the Financial Accounting Standards Board (FASB) to help ensure that
the new standard, which is an important component of financial reform efforts, can be
implemented in a reasonable and practical way for community banks. We have stressed to
FASB that its proposal should not require community banks to utilize complex modeling
processes. We expect that a final standard will permit loss-estimation techniques that build
upon current credit-risk management techniques used by community banks.15 We will work
with community banks to help implement the new standard when it is final. In addition, our
supervisory guidance will emphasize that regulatory expectations for implementation of the
standard will differ based on bank size and complexity.
In addition to tailoring our rules, we are also taking steps to tailor and improve our
examination processes to be more efficient and effective. For example, we are currently in
the process of developing and adopting common technology tools across the Federal
Reserve System that should allow our examiners to more effectively focus their time and
enhance the consistency of our examination processes nationwide.
Furthermore, we are exploring ways that our community bank examiners may be able to
complete more examination work off site. For example, for banks that have electronic loan
files, examiners may be able to read these files off site rather than on the bank premises. We
are also seeking ways to utilize the financial information that we collect from banks to tailor
the examination procedures that are used on site, with less work being required at
institutions with lower risk profiles. These efforts should reduce the disruption that an on-site
examination can cause to a bank's day-to-day operations.
We recently adopted a new consumer compliance examination framework for community
banks.16 Under this new program, our consumer compliance examiners base examination
intensity more explicitly on the individual community bank's risk profile, weighed against the
effectiveness of the bank's compliance controls. We expect that examiners will spend less
time on low-risk compliance issues at community banks, increasing the efficiency of our
supervision and reducing regulatory burden on many community banks.
Much of the work to tailor our supervisory requirements and programs is being overseen by
the community bank subcommittee of the Board's Committee on Bank Supervision. This
subcommittee oversees the supervision of community and regional banks and reviews
proposed supervisory policies to help ensure that they are appropriate for, and tailored to,
community banks. This subcommittee was formed several years ago under the direction of
now former governors Betsy Duke and Sarah Bloom Raskin, and I want to assure you that
the subcommittee will continue to play an important role in helping ensure that our
supervisory policies make sense for community banks. I should also add that we are working
closely with our colleagues at the state level to help ensure that our supervisory approaches
and methodologies are as consistent as possible.
Conclusion
In closing, let me repeat my strong belief that community banks will continue to play an
important role in our financial system in the years ahead, serving the credit needs of the
communities they are a part of and know so well. The Federal Reserve will continue to
promote a stronger and more resilient financial system, while carefully considering the effects
of our actions on community banks and tailoring supervision appropriately.
Thank you.