A Message from Governor Bowman
by Governor Michelle W. Bowman
This spring has brought renewed optimism for the economic outlook. Vaccination rates are increasing, and infection rates are waning. It feels like we are returning to some form of normalcy in our personal and professional lives. Businesses are reopening, travel and leisure activities have resumed, and students are returning to in-person education. In May, I had the privilege of speaking to bank examiners from across the country at the Federal Reserve’s annual community bank examiner conference. At this virtual conference, I discussed the Federal Reserve’s supervisory and regulatory priorities for post-pandemic supervision. Since our examiners are the first line of communication with many state member banks, I will share with you the key points of my message to this group and, specifically, the four important principles of bank supervision.
Core Principles of Bank Supervision
Balanced Supervision and Regulation
The first principle is that we must ensure supervision and regulation remain balanced. Regulation should always strike the right balance between actions that promote safety and soundness by the regulator and actions that promote an acceptable and manageable level of risk-taking by the bank. We should be cognizant of the risks faced by community banks and tailor our supervisory response accordingly. Therefore, in setting and implementing supervisory policy, we need to avoid imposing on smaller institutions standards that are designed to control the risks posed by the activities of larger institutions.
Effective, but Efficient, Regulatory Framework
The second principle is that community bank supervision and regulation must be effective and efficient. That means regulations need to strike the right balance between the safety and soundness of banks and the compliance costs, burdens, and risks banks face.
Accordingly, you will hear more about our efforts to evaluate our regulations, both current and proposed, from a cost-benefit-analysis perspective and to apply these principles to our examination decisions and determinations.
A prime example of this principle is the interim final rule (IFR) to provide temporary regulatory relief to community banking organizations resulting from unanticipated asset growth in 2020 and 2021. As you know, our supervisory practices include asset-based thresholds, which are designed, in part, to appropriately calibrate regulatory requirements to a banking organization’s asset size and risk profile.
As a result of the response to the pandemic, including participation in the Small Business Administration’s Paycheck Protection Program and stimulus payments received by individuals, the balance sheets of some community banking organizations grew unexpectedly during 2020 and 2021. Consequently, some institutions were facing new regulatory requirements based on their unanticipated asset growth.
The IFR, supported by the prudential regulators, provided temporary regulatory relief to community banking organizations to address the consequences of this unanticipated asset growth. The IFR also provides community banking organizations with a temporary safe harbor and gives them time to decide how to manage the growth — including whether that approach is to reduce deposits or to prepare for additional regulatory and reporting standards. In any case, asset growth during this time period will not trigger new regulatory requirements, including reporting requirements, until January 1, 2022, at the earliest.
Consistent, Transparent, and Fair Supervision and Regulation
The third core principle is that supervisory expectations should be clear and transparent to a community bank. Therefore, as supervisors we need to be available to answer bankers’ questions, particularly as they relate to supervisory expectations or findings.
This principle promotes respect and trust between regulators and supervised institutions. It also increases the likelihood that banks will communicate throughout the examination cycle to share and discuss changes they may be considering or challenges they may be facing. With open lines of communication, supervisors and bank management can mutually agree to an appropriate resolution of a supervisory concern that promotes the bank’s safety and soundness, while also considering the cost and risks to the bank.
Legitimate, Not Punitive, Prudential Purpose
A final core principle is that our rules and supervisory judgments must have a legitimate prudential purpose, and in the majority of cases must not be solely punitive. Banks are providing essential services. Therefore, we need to provide a framework that supports community banks in their efforts to serve their customers and communities. Community banks also have to be ready and positioned for the future, and we should assist them as best we can within our supervisory framework.
In mid-June 2020, as operational conditions had begun to stabilize, the Federal Reserve resumed community bank examination activities offsite, and we continue to evaluate our ability to conduct onsite examinations. Many bankers are wondering what future examinations will look like.
The Federal Reserve has begun to assess post-pandemic supervisory practices. As you know, we adopted a number of policy statements to guide our supervision during the pandemic. We are in the process of evaluating these policies to see if we struck the right balance in assessing a bank’s condition while using an efficient and flexible supervisory approach. It is also a good opportunity to consider the lessons learned from our approach and determine what aspects we might want to retain for the future. In light of our experience during the pandemic, and to further reduce the burden and disruption of an examination on a bank, we are reevaluating which parts of an examination can be conducted offsite and which examination activities would benefit from an in-person discussion with bankers.
As the Federal Reserve plans a path forward, risk-focused examinations supplemented by continuous monitoring will be key to helping us identify trends and risks. One reason that banks have been able to withstand the stress and uncertainty of the pandemic conditions is the strength of their capital and liquidity positions going into the pandemic. Community banks’ tier 1 leverage ratios remain relatively robust as of year-end 2020 but have been affected by deposit-driven asset growth. Our ongoing supervisory efforts will continue to proactively monitor the implications from the rapid and unexpected deposit growth and emphasize the importance of community banks’ capital and liquidity resiliency in the near term.
The flexibility we afforded to our institutions during the pandemic should remain. The key message is that examiners should not criticize bank management for taking prudent steps to support their communities and customers, but they do need to be aware of risks to their portfolios and appropriately manage them.
As we move forward in assessing and adapting our supervisory practices, I look forward to maintaining an open dialogue with bankers to receive feedback on what worked well and what has not worked well over the past year.
In closing, I would like to express my appreciation for your efforts and dedication to serving the banking needs of your communities during the pandemic. This spring does give us a renewed hope for a brighter future. I will continue my engagement with community banks in 2021 and look forward to learning about how the Federal Reserve can continue to support the community banking industry.