Community Banking Connections

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A Message from Governor Bowman
by Governor Michelle Bowman

The COVID-19 pandemic has caused unprecedented disruption and hardship in nearly every aspect of our lives, and it continues to weigh heavily on our nation. Since the last publication of Community Banking Connections, economic activity has turned around and we are seeing re-openings across a wide range of industries. Banks, especially community banks, have been at the forefront of this recovery, taking proactive steps to weather this crisis. I have been greatly encouraged by stories community bankers have shared with me about making contact with their business and consumer loan customers, checking in to see how they are doing and what they need. The strength of this approach to customer relationships is reflected in the Small Business Administration’s (SBA) Paycheck Protection Program (PPP) loan origination data. The SBA reports that, as of July 20, 51 percent of the nearly 5 million PPP loans were originated by banks with assets of less than $10 billion. More than 1 million of these loans were originated by the smallest banks, with assets of less than $1 billion. These results speak to the importance and the value of relationship banking, which is so central to the mission of community and regional banks. They also demonstrate the crucial role that community banks are playing in response to the pandemic. On behalf of the Federal Reserve, I would like to thank all community bankers for your tremendous dedication and commitment in responding to this pandemic.

Turning to supervision, I would like to highlight several key points from our July 9, 2020, Ask the Fed session.¹ At that session, William (Bill) Spaniel, senior vice president of Supervision, Regulation & Credit at the Federal Reserve Bank of Philadelphia, joined me in providing an update on the Federal Reserve’s examination pause and supervisory posture for small banks during the COVID-19 pandemic.

Small Bank Conditions Going into the Pandemic and the Federal Reserve’s Examination Pause

Small banks entered the pandemic in generally sound financial condition, with the overwhelming majority having satisfactory supervisory ratings. These banks built strong capital positions and substantially improved asset quality in the years following the last crisis. Small banks also entered the pandemic with higher levels of liquidity, which have been augmented by deposit inflows associated with pandemic-related stimulus programs. Finally, in comparison to the last crisis, credit concentrations were generally much lower, especially construction and commercial real estate, and broadly speaking, concentration risk management practices have significantly improved.

As state governors imposed shelter-in-place orders beginning in March, the Federal Reserve implemented a pause on examination work for small banks. We viewed the exam pause as an important way to provide bankers the opportunity to direct their full attention toward adjusting operations to protect the health of their employees and customers, comply with local health restrictions, prioritize the financial needs of their customers and communities, and administer the critical financial relief programs, in particular, the SBA’s PPP.

During the examination pause, the Federal Reserve shifted its efforts to monitoring and communicating with supervised institutions to assess the impact of the pandemic. Initially, monitoring efforts were focused on discussions about operational concerns and liquidity. For many bankers, operational concerns since then have significantly eased or even subsided. Core deposits are stable, and in many cases liquidity has significantly improved. Our monitoring discussions have evolved and are now focused on credit-related matters, such as loan performance, crisis-related loan modifications, provisioning, and associated earnings impacts.

Supervisory Posture for Community Banks

On June 15, 2020, the Federal Reserve announced that examination activities for small banks would resume.² The Federal Reserve’s supervisory focus will be assessing management’s response to the crisis and promoting the efforts of banks to build resiliency through their risk management and capital planning processes. We will continue to assess the safety and soundness of individual institutions while being mindful of avoiding undue burden.

The Federal Reserve has developed tailored plans for the resumption of supervisory activities for community banks.³ The examination process during this pandemic will necessarily be different, for both bankers and regulators. Examinations will focus on offsite conversations versus a traditional onsite presence. Examination work will be more fluid, and timelines may need to be adjusted in order to focus on higher-risk banks. We will also continue to coordinate with our state counterparts on exam planning and scoping.

The Federal Reserve recognizes the unique and challenging conditions under which the industry has been operating, and we will consider these circumstances in resuming examination work. We will continue to be sensitive to banks’ operational capacity, striving to prevent undue burden on any bank struggling with crisis-related operational impacts. Prior to commencing an examination, Federal Reserve examination staff will ascertain each bank’s capacity to engage in the examination process. In order to conduct effective examinations, we will need to have honest discussions with bankers regarding each bank’s capacity and conditions to assess the feasibility and timing of an examination.

Supervisory activities will focus on financial resiliency, continuity of operations, and forward-looking assessments. Management’s response to the pandemic is a critical component. In this environment, we expect that management will have implemented appropriate risk management practices and management information systems to monitor the pandemic’s impact on the condition of their financial institutions.

As supervisory activities resume, the Federal Reserve is focusing on institutions that could be at greater risk in the current environment, particularly those that have credit concentrations in industries severely impacted by COVID-19 (e.g., hospitality, retail), that are located in virus “hotspots,” that recently showed or are showing financial weaknesses, or that are not adequately addressing the risks associated with the pandemic.

Lower-risk institutions will be subject to periodic monitoring and more streamlined supervision to understand the ongoing business environment, in terms of a bank’s condition, risk profile, and operational challenges.

The Fed is providing examiners with training and is increasing communication to promote a consistent supervisory approach throughout the Federal Reserve System. Recognizing the high level of uncertainty at this time, examiners will assess a bank’s condition, taking into consideration that banks could not have foreseen the current crisis. While we remain focused on building resiliency, we also remain flexible, and examiners will not criticize bank management for taking prudent steps to support their communities during this crisis. We recognize that many parts of the country may be facing different operating requirements and that other factors may impact the reopening of businesses. This requires the Federal Reserve to be mindful of these differences, the status of community businesses, and the overall capabilities of financial institutions in these unique times.

As I mentioned earlier, we discussed the Federal Reserve’s supervisory posture for small banks in an Ask the Fed webinar held on July 9, 2020. This webinar is archived and available at https://bsr.stlouisfed.org/askthefed/Home/ArchiveCall/273. We received excellent questions during the webinar, and I remain committed to listening to your individual concerns. I always enjoy hearing your ideas on ways that the Federal Reserve can better provide assistance to bankers. I look forward to participating in future webinars and other virtual events to continue our discussion of important supervisory matters affecting community banks. Until that time, please share your feedback at outlook@phil.frb.org.