mark w olson : a regulator's view of emerging issues in community banking speech by mr mark w olson, member of the board of governors of the us federal reserve system, at the 118th assembly for bank directors, las croabas, puerto rico, 27 february 2004. * * * in 2003 community banks once again demonstrated their value to their shareholders, delivering solid profitability. community banks - by that i mean commercial banks with assets less than $ 1 billion earned $ 12. 9 billion in 2003, based on preliminary call report data. this figure translates into a return on assets of 1. 18 percent and a return on equity of 11. 55 percent. fourth - quarter returns were a bit below that, following a familiar seasonal pattern. overall, return on assets has been consistently between 1. 10 percent and 1. 20 percent and return on equity has been close to 12 percent. higher non - interest income - including mortgage origination and servicing income - and decreases in required provisioning allowed earnings to remain strong despite pressure on margins. only about 6 percent of community banks lost money for the year, representing less than 3 percent of their total assets. consolidation continued in the industry in 2003. according to our preliminary figures, there were about 7, 300 community banks at year - end 2003, some 140 fewer ( 1. 9 percent ) than a year earlier and about 500 ( or 11 percent ) fewer existed five years ago. the consolidation in the industry, and the search for efficiency and scope, should not be misunderstood. it does not signal a threat to the community banking franchise ; far from it. the market for community bank charters makes this point clear. seventy - seven new commercial bank charters were issued in the first nine months of 2003, and nearly five hundred since the beginning of 2000. over that same period, for every five banks that disappeared through consolidation, another two new charters were granted. in total, that represents $ 2. 4 billion in new equity capital invested in community bank charters. community bank net interest margins continue to be above those of the industry as a whole. for 2003, the community bank margin was about 4. 1 percent, nearly thirty - basis points higher than the comparable figure for the industry. to some extent, this reflects a different business mix, despite the role of high - spread credit card lending at larger institutions. a closer look at the call report shows that community banks seem to pay more for their nonmaturity deposits than do larger institutions. the average effective rate

should be particularly attentive to this possibility given the extended period of weak loan demand that we've recently experienced. a natural temptation for a banker when facing pressures for earnings growth would be to extend maturities in search of more attractive rates of return. i'd like to say a few cautionary words about this temptation. with a steep yield curve, the portion of community bank assets maturing beyond five years has grown steadily since year - end 2000, from 16. 9 percent to 18. 4 percent of assets. larger institutions hold a greater share of their assets in long - term instruments and have also seen an increase in long - term assets over the same period. they arguably may have better access to derivatives markets and more sophisticated programs for managing their interest rate risk. rather than resorting to the derivatives market - fewer than 600 commercial banks hold any derivatives contracts at all - most community bankers may simply choose to rely on the interest rate protection provided by their stable and reliable core deposit base. they may believe this base to be more stable and reliable than at larger institutions, and from a historical point of view that belief might be difficult to dispute. community bankers depend on these deposits maintaining the stability and reliability they have exhibited in the past. as a result, interest rate and liquidity management become even more closely intertwined. money market deposit accounts and savings deposits at community banks grew sharply in 2003, although they dropped slightly - less than $ 2 billion or 0. 6 percent - in the fourth quarter. a drop of this size hasn't taken place at community banks for some years, and has not occurred at all at the larger banks. if our analysis is correct and deposit growth has been fueled by low interest rates and weakness in the equity markets, community bankers should be aware that they may face unexpected liquidity and interest rate pressures if their deposit customers shift their funds to other investment vehicles. this is not idle speculation. we need to remember that depositor behavior can change. an excellent example is the high - interest rate period we experienced in the late 1970s and early 1980s, when long - term certificates of deposit were redeemed early - despite the significant penalties assessed - in order to lock in higher market rates. the relative stability of these nonmaturity deposits and the liquidity they provide have been an important strength to community banks, although there have been too many instances in which rapidly growing banks have faced unexpected liquidity pressures because they relied more heavily on non - core or volatile funding sources.