Conference Highlights Opportunities and Challenges Facing Community Banks
by Julie L. Stackhouse, Senior Vice President, Banking Supervision, Credit, Community Development and the Center for Learning Innovation, Federal Reserve Bank of St. Louis
If the inaugural Federal Reserve System and Conference of State Bank Supervisors' (CSBS) community bank research and policy conference had one key takeaway, it was this: The community banking industry has experienced challenges and ongoing consolidation; however, there is a future for community banks that have strong management teams, adhere to solid banking fundamentals, and leverage their "social capital," or community relationships, to tailor products and services that meet the needs of customers in their local markets.
Armed with hard and soft data underscoring the successes and failures of community banks in recent years, more than 175 academics, researchers, regulators, and community bankers met on October 2 and 3, 2013, at the Federal Reserve Bank of St. Louis. The conference, Community Banking in the 21st Century, featured speeches and comments from Federal Reserve Board Chairman Ben Bernanke, CSBS President and CEO John Ryan, Federal Reserve Governor Jerome Powell, and community banker Dorothy Savarese, president and CEO of Cape Cod Five Cents Savings Bank in Orleans, MA. In addition to featuring the latest academic research on the community banking industry, the conference gave voice to the perspectives of more than 1,700 community bankers who participated in 51 town hall meetings during the spring and summer of 2013.
Evolution of Community Banking in the U.S.
Dramatic changes within the community banking industry over the past 20 years are evident. According to the Federal Reserve's definition of community banks (those with less than $10 billion in total consolidated assets), there were more than 10,000 community banks 20 years ago. At the end of 2012, however, there were fewer than 6,000 community banks. Over that same period, the percentage of total U.S. banking assets held by community banks fell from 50 percent to 17 percent. The past five years have been particularly challenging for community banks, as net interest margins have compressed, regulatory challenges have increased, and competition from other financial institutions has grown more intense. Since 2008 alone, there have been nearly 500 community bank failures.
What Current Community Banking Research Tells Us About the Future of Community Banks
Despite these challenges, the conference papers indicated that there were many strengths and opportunities for community banks. The academic papers were divided according to the session in which they were presented: the role of community banks, community bank performance, and the supervision and regulation of community banks.
The Role of Community Banks
The papers presented during the first session, "The Role of Community Banks," attempted to quantify how community banks leverage their knowledge of soft information about their communities, customers, and borrowers to successfully allocate credit. For example, one paper found that community banks play an important role in providing funding to borrowers who want to start a small business. In particular, findings from this paper suggest that when a start-up borrower is physically located closer to a community bank, the borrower is more likely to receive a loan. Other findings from this session included:
- Community banks that effectively managed their equipment lease financing operations outperformed similarly situated community bank peers that did not engage in this type of business;
- Community banks headquartered in rural regions of the United States experienced lower default rates on Small Business Administration (SBA) loans than peer banks that served urban markets;
- Default rates on SBA loans were higher when the borrower was located outside of the community bank's primary market; and
- Loss-sharing agreements between the Federal Deposit Insurance Corporation and the acquirer of a failed bank actually lessened the adverse consequences of a community bank failure on its community.
Community Bank Performance
In the second session, "Community Bank Performance," researchers explored community bank performance during several different periods since the late 1980s, including during the recent financial crisis. In general, community banks with less than $10 billion in total consolidated assets have lagged noncommunity banks in terms of overall profitability since the end of the financial crisis. This can be attributed to several factors, including low interest rates and tepid loan demand. The papers in this session explored opportunities to sustain strong performance.
One paper in particular looked at community banks that undertook "big shifts" in strategy from 1992–2011 to facilitate growth. This paper found that such shifts rarely improved community bank performance (and frequently risked hurting performance) and that, in general, smaller community banks tended to underperform compared with larger community banks. Other findings from the papers in this session included:
- Community banks that recovered after experiencing significant stress during the financial crisis generally exhibited a lower loan volume and were less concentrated in construction and land development loans, commercial real estate loans, and home equity lines of credit. They were also less reliant on brokered deposits.
- Derivatives can be used to improve community bank performance as long as the bank understands how to use them.
- Mergers can be a highly successful strategy. However, local knowledge is a more important determinant of success than the growth or diversification benefits derived from the merger.
- The most important success factors for community bank performance included local knowledge, strong management, stable funding, an adherence to conservative underwriting principles, and organic growth.
Supervision and Regulation of Community Banks
In the final session, "Supervision and Regulation of Community Banks," research papers examined the effect of complex supervisory rules on community banks and on the overall health of the U.S. banking system. Findings from the papers in this session included the following:
- The tier 1 leverage ratio was as good at predicting bank failures during the financial crisis as was the tier 1 risk-based capital ratio;
- The Dodd-Frank Wall Street Reform and Consumer Protection Act increased compliance costs for community banks because seven of the act's 16 titles affected banking institutions with less than $10 billion in total consolidated assets; and
- Standards used in recent CAMELS ratings have been in line with historical norms.
Findings from a Nationwide Series of Town Hall Meetings
The conference concluded with the release and discussion of findings from a series of 51 town hall meetings held across 28 states during the spring and summer of 2013. The discussion featured a panel of community bankers from across the nation who analyzed the findings of the town hall meetings and offered their thoughts on the opportunities and challenges facing community banks in the future.
The town hall meetings highlighted differences across community banks operating in different states and regions. However, there were also many similarities. For example, social capital was generally viewed as the community banking industry's greatest strength and as providing community banks with the greatest opportunity for growth and success in the future. Many community bankers shared examples of how individuals and small businesses in their markets preferred to bank with a community bank because of its emphasis on personalized customer service. Customer knowledge also gives community bankers a real-time understanding of customer demands and provides them with an opportunity to respond more aggressively to these demands — particularly in regard to the use of technology.
The challenge most frequently cited was what bankers saw as a "one-size-fits-all" approach to regulation that had affected the community banking industry's ability to leverage its social capital and tailor products and services to meet the specific needs of its customers. Bankers from across the country also cited increased competition from credit unions, government-sponsored enterprises such as the Farm Credit System, nonbank payment providers, and banks without a brick-and-mortar branch network.
Community bankers also offered thoughts on the types of research they felt would be most beneficial in assisting policymakers in understanding the community banking industry. The types of research most frequently recommended included:
- Understanding the types of customized products community banks offer and understanding the effect that the loss of some of those products, at least in part because of changing regulations, has had on the industry and on certain types of borrowers;
- Exploring the relationship between increased regulation and the number of individuals accessing banking services outside the banking system;
- Quantifying the local economic effect of community banks; and
- Identifying opportunities created by a shared services model.
The inaugural community banking conference has laid a strong foundation for continued engagement by academics, researchers, regulators, and community bankers. Following the success of this year's event, the conference will now be an annual gathering of thought leaders committed to exploring how community banks can remain competitive in an ever-changing banking landscape.
All conference proceedings, including webcast versions of the sessions, copies of academic papers, and photographs of community banking in action from across the United States can be found at www.stlouisfed.org/banking/community-banking-conference.