The Importance of Community Banking: A Conversation with Chairman Ben Bernanke
For the inaugural issue of Community Banking Connections, a Federal Reserve System publication focused on community banking, staff asked Chairman Ben Bernanke for his perspectives on the benefits that community banks bring to the U.S. economy and the various challenges that they face today.
Vision for Systemwide Community Bank Outreach Effort
Why has the Federal Reserve decided to launch this publication aimed at community banks? What is your vision for this publication, as well as the Federal Reserve’s overall effort to enhance communication with community banks? What response do you hope/expect to see from community banks?
Given the Federal Reserve’s role in promoting a strong economy and in supervising banks of all sizes, we strongly believe that it is important to communicate with as many people as possible through a variety of mechanisms. Community banks play an important part in the financial system and in our economy, and community bankers have raised concerns about a number of issues in recent years, including the slow economic recovery and the potential impact on them as regulatory reforms are implemented. We felt it was important, therefore, to enhance our avenues of communications with community banks, which we generally define as those banks with $10 billion or less in total assets.
We hope this publication, as well as other efforts, such as our advisory councils; will provide an effective opportunity to foster enhanced communication between the Federal Reserve and community bankers. We also hope it will inform and clarify expectations and give a better sense of the Federal Reserve’s perspectives on supervisory matters. We want to hear from readers that may have varied perspectives on the subject matter. This publication will be successful if it provides useful insights and promotes greater dialogue, rather than just being a bunch of words on paper that get lost in the shuffle.
Can you say more about the value community banks bring to the economy?
Certainly, community banks have a critical role in keeping their local economies vibrant and growing by lending to creditworthy borrowers in their regions. They often respond with greater agility to lending requests than their national competitors because of their detailed knowledge of the needs of their customers and their close ties to the communities they serve. Such lending helps foster the economy by allowing businesses to buy new equipment, add workers, or sign contracts for increased trade or services. Those effects are felt at a local level and may appear at first glance to be fairly modest, but when you multiply these effects across the thousands of community banks in the United States, you really see how the lending decisions they make help the broader national economy.
Challenges & Changes in Community Banking
What do you view as the biggest challenges facing community banking institutions?
Community banks face a number of challenges, but we see examples across the country where banks are meeting those challenges.
One big concern for community banks is the narrowing of the range of profitable lending opportunities — because larger banks have used their scale to gain a pricing advantage in volume-driven businesses such as consumer lending, community banks have tended to specialize in other areas, such as loans secured by commercial real estate. As you know, certain types of commercial real estate lending have taken a large hit in the financial crisis and its aftermath, so community bankers are looking elsewhere for opportunities for lending, and sometimes coming up with other viable areas can be challenging. This is an especially important issue for community banks because their size and small geographic footprints have traditionally made them vulnerable to concentration risk.
The good news is that, for the most part, community banks appear to be meeting their challenges. On aggregate, profits of smaller banks were considerably higher in 2011 than in the previous year, nonperforming assets were lower, provisions for loan losses fell appreciably, and capital ratios improved. We hope to see further improvement this year as well.
You often refer to the "traditional" community banking model. What elements have kept the traditional model alive for so long, and is there a future for it? How do you think the community bank model will change to meet future challenges?
Although community banks provide a wide range of services for their customers, their primary activities revolve around what I refer to as the traditional banking model — specifically, taking short-term deposits to fund longer-term investments, such as consumer lending and small business, agricultural, or commercial real estate loans. One element that has kept the traditional model alive for so long is that community banks know their customers — and likewise, their customers know them — which I believe fosters greater customer loyalty. Community banks are well positioned to go beyond the standardized credit models used by larger banks and to consider a range of factors when making credit decisions. In addition, community banks tend not to be as exposed to the risks arising from trading, market-making, and investment banking activities associated with the largest banks.
I see a very real need for continuation of the traditional community banking model. Indeed, I believe there is a real place for the customization and flexibility that community banks can exercise to meet the needs of local communities and small business customers. And while I don’t know exactly what the future of community banking will look like, I am confident that the flexibility and creativity of community bankers will allow them to adapt their business model to prevailing financial and economic trends and conditions.
How do you view the balance between community banks needing to maintain strong risk management practices while still being able to meet the credit needs of their communities?
I understand that there can be an apparent tension between community banks’ desire to lend and their need to make prudent risk management decisions, but I do not believe that there is a simple trade-off between the two. If anything, you can make a case that weak risk management may, over time, lead to less lending — and vice versa — because banks must maintain safe and sound operations in order to provide for the financial needs of their communities. For example, during this past crisis, many banks that were struggling to overcome operational deficiencies as a result of risk management weaknesses typically were not in a position to make a lot of new loans. Banks with stronger risk management, on the other hand, were more likely to have the financial wherewithal to continue lending through the crisis.
Communication with Community Bankers
Can you discuss how the Federal Reserve is working to clarify the applicability of its guidance to community banks?
We have always understood that not all regulations and guidance apply to every size or type of financial institution; many provisions of the Dodd-Frank Act, for example, by statute apply only to the largest banks. And even when supervisory policies do apply to all institutions, our expectations are typically higher for larger, more complex institutions. We have realized, though, that we have not always communicated our specific expectations in this regard as clearly as we could have. The last thing we want is for community bankers to have to read through long and complex new supervisory policies that were never intended to impact their businesses. We have, therefore, been trying to provide greater clarity on whether new policies apply to community banks when those policies are issued.
In response to a suggestion that was made by one of the members of our Community Depository Institutions Advisory Council (CDIAC; see related article), we are including at the beginning of each new piece of supervisory guidance a statement outlining which banks are affected. In particular, when issuing supervisory letters, we try to state specifically if and how new guidance will apply to community banks. That way, banks don’t have to waste resources on requirements that don’t apply to them. We also hope that it will provide greater clarification to our examiners, so that they don’t inadvertently try to hold community banks to standards that are intended for the largest banks.
In addition, when the Board and the other federal banking agencies recently published notices of proposed rulemaking to revise our capital rules to implement the Basel III capital framework (see related article), we tried to make these very complex proposals as clear as possible for community bankers. While these proposals totaled 700 pages in length, many of the proposed revisions to the capital rules would only apply to the largest banking organizations. To help community banking organizations better understand the elements of the proposals that would apply to them, the agencies included summary addenda to two of the proposed rules to provide a guide for community banks and a comparison of the proposed rules to the current requirements. I look forward not only to receiving formal comments from community banks on the proposals but also to receiving informal feedback on whether they found these addenda to be helpful so that we can consider whether similar materials would be useful in future rulemakings.
We know there are great benefits to two-way communication between examiners and community bankers. How can both sides ensure that they have and maintain a strong, ongoing dialogue?
I think we would all agree that two-way communication between regulators and community banks is critical. Not only must we clearly communicate our supervisory policies and expectations to banks, but we also need to listen to and understand banks’ concerns. We expect our examiners to make objective assessments and to be as clear as possible in explaining to banks why they have reached particular examination conclusions. I’ve learned that most community bankers are not shy in raising issues where they may not agree with supervisory findings, and I encourage bankers to continue to be open and candid in sharing their views with examiners. In those rare situations where bankers and examiners are unable to resolve disagreements, I encourage bankers to contact management at their local Reserve Bank and, if necessary, contact the Ombudsman here at the Board. Let me emphasize that the Board will not tolerate retaliation against banking organizations that file appeals or raise concerns about the supervisory process, and the Ombudsman has broad authority to investigate and report claims of retaliation or other unjustified reactions.
I should also mention that we have been very happy with the establishment of the CDIAC, which I mentioned earlier. In the less than two years of its existence, the CDIAC has helped ensure that this two-way communication is happening. We look forward to continued work with the council in the years ahead.
And, of course, I hope this publication and the related Community Banking Connections website* will provide yet another vehicle for community bankers and the Federal Reserve to communicate with each other on supervisory matters. It is critical to keep the communications channels open if supervisors and banks are to work together constructively.
Federal Reserve System Regulation
Some community banks have expressed concern about the burdens of regulatory compliance given the size and complexity of the Dodd-Frank Act. How is the Federal Reserve responding to that concern?
Community bankers tell us repeatedly that they are concerned about the changing regulatory environment. They touch on a number of areas, but one particular worry is the implementation of the Dodd-Frank Act.
I certainly don’t want to dismiss these concerns, but I think it is important to emphasize that the vast majority of the provisions of the Dodd-Frank Act do not apply to community banks at all. The Dodd-Frank Act was enacted largely in response to the "too-big-to-fail" problem, and most of its provisions apply only, or principally, to the largest, most complex, and internationally active banks. For example, to mitigate the threat to financial stability posed by systemically important financial institutions, the act required the Federal Reserve to implement enhanced prudential standards to regulate these institutions. We have proposed such standards, which, in conjunction with other elements of the Dodd-Frank Act, are designed to make these firms safer and to force large institutions to take into account the costs that their potential failure could impose on the broader financial system.
These new standards are not meant to apply to, and clearly would not be appropriate for, community banks. Indeed, the Dodd-Frank Act explicitly exempts community banks from these new enhanced standards, and we have no intention of applying them to smaller institutions.
Perhaps the bigger concern that community banks have expressed is that the more stringent requirements for larger institutions may not apply to smaller institutions now, but they might eventually do so in the future. That, however, is not our intent, and we will work to ensure that it does not happen. To give a tangible example, when the Federal Reserve and the other federal banking agencies recently published supervisory guidance on stress testing practices at large banks, we also issued a special one-page statement to make clear that our supervisory expectations for large bank stress testing — especially the types of firm-wide stress tests required under Dodd-Frank — do not apply to community banks.
How can the Federal Reserve strike the right balance between strong supervisory oversight and avoiding unnecessary costs and burden on community banks?
Bank supervision requires a delicate balance, particularly now. The weak economy, together with loose lending standards in the past, has put pressure on the entire banking industry, including community banks. To protect banks from a possible "race to the bottom" and new problems down the road, and to safeguard the Deposit Insurance Fund, I believe that we as supervisors must insist on high standards for lending, risk management, and governance. At the same time, it is important for banks, for their communities, and for the national economy that banks lend to creditworthy borrowers. Lending to creditworthy borrowers, after all, is how banks earn profits. Getting that balance right is not always easy, but it is of utmost importance.
The Federal Reserve is taking a number of steps to help strike that balance. For example, we tailor our examination and supervision to the size, complexity, risk profile, and business model of each institution. For community banks in particular, our examiners are expected to take local market conditions into account when assessing a bank’s management and credit decisions. We also have an intensive training program for our examiners that allows us to get messages out quickly to our staff in the field, and most of this training is targeted at our community bank examiners.
One of the main ways the Board ensures that our supervisory program is calibrated appropriately is through a supervision subcommittee that focuses on issues affecting smaller community and regional banks. Because of their professional backgrounds in community banking and bank supervision, I asked Governors Elizabeth Duke and Sarah Bloom Raskin to serve on this subcommittee. Its primary role is to improve our understanding of community and regional banking conditions and to review policy proposals for their potential effect on the safety and soundness of, and the regulatory costs imposed on, community and regional institutions.
How do other Federal Reserve functions support and provide insight to banking supervision, and vice versa?
One of the lessons we learned in the wake of the financial crisis is that it is important to ensure that the various Federal Reserve functions — monetary policy, bank supervision, consumer protection, payment systems, research — work together more effectively to promote financial stability. I won’t say we’ve got it exactly right yet, but I believe that communication and cooperation across the various Federal Reserve functions is much stronger than it was several years ago.
One thing that I would like to emphasize in this regard is that community banks provide the Federal Reserve with unique insights into local economic conditions, which helps us to have a better understanding of the wider economy and to make better macroeconomic decisions. The Federal Reserve’s decentralized structure, in which supervision is conducted through 12 regional Reserve Banks, helps facilitate our understanding of local economies, as does our ongoing coordination with state banking regulators. This connection to local economies is vitally important to fulfilling both our supervisory and monetary policy responsibilities.
Note: Several Governors have given speeches this year on community banking issues. The speeches can be found at: www.federalreserve.gov/newsevents/speech/2012speech.htm.