federal reserve adopts policy statement supporting prudent commercial real estate ( cre ) loan workouts, ” press release, october 30. important as this goal is, it will not be easy to achieve for many banks. for example, one means to this end would be to operate a bank with much higher capital ratios and thereby lower concentrations. this strategy, however, would lower a bank ’ s returns and, while that may be manageable for a closely held bank, it would make any needed capital raises more difficult for a publicly traded community bank. alternatively, banks could further diversify their loan and investment portfolios, expanding into lower risk or new loan and investment segments. but this too presents difficulties. for one thing, lower risk assets have lower returns. also, one of the reasons community banks have been so concentrated in commercial real estate loans is stiff competition for other types of loans, such as consumer installment loans, from larger banks and other nonbank competitors. a second long - term challenge facing community banks is the secular compression in the net interest margin. despite all of the emphasis on noninterest revenues in recent years, community banks have continued to rely heavily on spread income, indicating that many community banks have been unsuccessful in diversifying their revenue streams. 3 the aggregate net interest margin for banks with assets of $ 10 billion or less has also tightened considerably as competition in the debt and lending markets has intensified, compressing by more than 70 basis points over the last 10 years to 3. 63 percent. as a result, it becomes more difficult for community banks to cover their overhead, pressuring their earnings and their ability to support capital needs from internal sources. it is possible that this declining trend in spread income could be reversed once the high level of non - accruing assets falls and if the premium charged for credit risk remains elevated once the current crisis has passed. smaller banks may also find that they are able to win good, solid business away from their national competitors, if customers turn away from large banks as a consequence of the crisis. but community banks cannot count on this happening. as a result, some banks may reach further out on the risk spectrum to relieve earnings pressures. we have seen these actions in the past, for example, when banks have engaged in ill - conceived investment securities leveraging programs or entered the subprime credit card market to expand their income. others may be tempted to cut back on critical riskmanagement infrastructure, such as loan review, to par

daniel k tarullo : the present and future of community banking speech by mr daniel k tarullo, member of the board of governors of the federal reserve system, at the federal reserve bank of new york community bankers ’ conference, new york, 8 april 2010. the original speech, which contains various links to the documents mentioned, can be found on the us federal reserve system ’ s website. * * * these are difficult times for many community banks, a reflection of the difficult times for the many workers and businesses across the nation who depend on the loans provided by your institutions. this morning i will address some of the problems that you currently face and offer a few thoughts about the future of community banking. before doing so, however, i thought it would be useful to explain my perspective on the federal reserve ’ s monetary policy posture, which will obviously have great significance for the economic environment in which community banks will be operating. specifically, i want to speak about what has become known as our “ exit strategy ” – that is, the means by which the federal reserve will bring to an end the extraordinary lending and monetary policies that it adopted in response to the financial crisis. planning and implementing an exit strategy in thinking about an exit strategy, it is important to distinguish between two types of policies that the federal reserve adopted, beginning in 2007 and continuing thereafter, beyond its sharp reductions in the target for the federal funds rate. first, the federal reserve created a number of liquidity programs, which provided well - secured, mostly short - term credit to various parts of the financial system that were under increasingly severe strains. among these were the term auction facility ( taf ), which auctioned short - term funds to banks ; the primary dealer credit facility, which served as a backstop liquidity provider for securities firms ; the term asset - backed securities loan facility ( talf ), which was designed to help revive the market for asset - backed securities, and others. second, and separately, the federal open market committee ( fomc ) undertook large - scale purchases of treasury securities, agency mortgage - backed securities, and agency debt. this unconventional monetary policy action was taken because the fomc, after having reduced short - term interest rates nearly to zero, determined that the severity of the economic downturn made additional stimulus necessary. in addition to improving conditions in mortgage markets, these asset purchases helped lower yields on long - term debt ; they also substantially increased the level of reserve balances that depository