Community Banking Connections

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A Message from Governor Bowman

Members of the Community Banking Connections Advisory Board interviewed Governor Michelle W. Bowman for her insights on the Federal Reserve’s efforts to address the challenges and risks faced by community banks.

You’ve highlighted the importance of outreach with community bankers and how these conversations help shape your supervisory policy priorities. Can you provide examples of how your outreach discussions have influenced the Federal Reserve’s policies and supervisory process?

Two recent examples highlight how my conversations with community bankers have resulted in tangible outcomes that have addressed challenges identified by community banks.

The first example is the current expected credit losses (CECL) methodology. A number of conversations with community bankers included a discussion of concerns about the complexity and cost of implementing CECL. To address these concerns, I encouraged Federal Reserve staff to look for ways to ease the burden of CECL implementation for community banks.

During a July 15, 2021, Ask the Fed webinar, Fed staff and I introduced the Federal Reserve’s Scaled CECL Allowance for Losses Estimator, which is referred to as the “SCALE” method. The SCALE method is a simple spreadsheet-based approach for CECL compliance developed to assist community banks with less than $1 billion in assets. The SCALE method is one of many acceptable CECL methods used to estimate allowances for credit losses. Just as with the other acceptable CECL methods, bank management must determine whether the SCALE method is appropriate for the bank. Additionally, Federal Reserve staff developed a customizable and semiautomated SCALE tool for community banks with total assets of less than $1 billion. If a bank chooses to use the SCALE method, the bank may access this tool at no cost. SCALE information and resources, including a recording of the webinar and a link to the tool with instructions, are available at www.supervisionoutreach.org/cecl/scale.

Second, recognizing certain challenges associated with how community banks pursue technological innovation, we made great strides on three related efforts.

On August 27, 2021, the Federal Reserve and the other federal banking agencies released an interagency vendor due diligence guide that can be used by community banks in performing due diligence on prospective and existing relationships with fintech firms.¹ The guide focuses on six key due diligence topics and includes relevant considerations, potential sources of information, and illustrative examples. Community banks can tailor their use of the guide based on specific circumstances and risks.

On September 9, 2021, the Federal Reserve released an innovation partnership paper that describes key considerations for partnering with a fintech firm.² This paper does not establish new supervisory expectations; it provides an overview of the evolving landscape of community bank partnerships with fintech firms and describes effective practices and considerations for seeking out and engaging in such partnerships to access new technology.

On July 13, 2021, the federal banking agencies requested public comment on proposed guidance designed to help all banking organizations (regardless of asset size) manage risks associated with third-party relationships, including relationships with fintech providers.³ The proposed guidance should assist banking organizations in identifying and addressing the risks associated with third-party relationships and responds to industry feedback requesting agency alignment with respect to third-party risk management guidance.

The Federal Reserve made changes to its examination posture early in the pandemic. Can you share how the Federal Reserve has modified its supervisory posture to address lessons learned during the past 18 months?

On August 19, 2021, Federal Reserve staff held an Ask the Fed webinar to provide an overview of the measures taken to refine our community bank supervisory program. This webinar is archived and available at https://bsr.stlouisfed.org/askthefed/Home/ArchiveCall/309. I expect that bankers will be pleased to see that we have revitalized our supervisory approach to incorporate supervisory lessons learned during the pandemic.

In September, the Federal Reserve began transitioning away from our pandemic posture to return to a more traditional supervisory approach.⁴ Since the effects of the pandemic are still present in some areas of the country, examination staff will work with states and supervised institutions to determine when onsite exams can and should resume. We will consider local health and safety conditions when making these decisions.

Some of the important lessons learned during the pandemic will influence our examination processes going forward. For example, we have refined processes for determining the scope of supervisory activities and information we request for examinations — both are highly risk focused and should minimize the examination burden on a bank. Examiners will continue to emphasize the importance of capital preservation and liquidity resiliency. Our supervisory activities will continue to focus on a bank’s higher credit risk exposures and lending activities. Examiners will rely on existing guidance in conducting asset quality reviews and assigning loan classifications. However, examiners may need to engage in more in-depth discussions with bank management about a particular borrower’s performance, evolving conditions, and the basis and reasonableness of cash flow projections.

I encourage you to reach out to your Reserve Bank point of contact for additional information on supervisory activities at your bank.

The pandemic has demonstrated the importance of technology in the examination process and the need to be able to conduct community banking organization examinations remotely. However, many community bankers have expressed the need for some face-to-face interactions with examiners. Do you envision a future in which examinations are conducted entirely offsite?

The Federal Reserve has long conducted certain supervisory activities offsite, including examination planning, scoping, and loan review. As a result, when the pandemic limited our ability to be onsite, examiners and bankers were able to quickly adapt and work remotely. However, the pandemic also limited examiners’ ability to have in-person meetings with community bankers. Examiners and bankers have relied increasingly on emails, conference calls, and video technology to conduct examinations and discuss supervisory findings. In my conversations with community bankers, many have noted the value of in-person meetings with examiners.

Reflecting on the lessons learned during the pandemic, some onsite examination presence is preferred and necessary to ensure that transparent conversations between bankers and examiners continue. Further, with the pace of innovation in technology, I expect that future examinations will rely upon a hybrid approach, with some activities conducted offsite and those activities benefiting from in-person contact conducted onsite.

It’s important to get the balance right, and feedback from community bankers will continue to be an important consideration when determining the appropriate ratio of on- and offsite activities. We will also need to consider a bank’s ability to support offsite supervision and our ability to ensure effective and transparent communications with a community bank’s board of directors and senior management.

Given your role on the Federal Open Market Committee (FOMC) what do you see as the biggest economic challenges and opportunities for community banks emerging from the pandemic?

The U.S. economy is experiencing a strong rebound following last year’s severe pandemic-related disruptions to employment and spending. This activity reflects not just the incredible resilience of U.S. households and businesses but also very supportive monetary and fiscal policy. As a member of the FOMC, in my view, the most important challenge now is to ensure that our policy continues to be appropriately positioned to achieve our statutory goals of maximum employment and price stability.

With this challenge in mind, my FOMC colleagues and I have been discussing the impact of the Federal Reserve’s asset purchases on the economy. Those purchases have played an important role in the Federal Reserve’s response to the economic effects of the pandemic — by helping to support the flow of credit to U.S. households and businesses. But based on the progress we are seeing toward our policy goals, and assuming this progress continues, I believe it is appropriate to begin the process to scale back our asset purchases soon. Continuing these asset purchases seems unnecessary in light of the recovery to this point.

• On the price stability side of our mandate, as we have all seen, inflation has been running well above our 2 percent goal, and I suspect supply and demand imbalances are playing an important role in the rise in inflation this year. As the supply chain bottlenecks are worked out, these pressures will likely ease, but that could take some time, as some supply chain bottlenecks might continue well into 2022. Therefore, I am concerned that inflation could end up being higher than most expect. I will continue to closely monitor inflation pressures.
• On the maximum employment side of our mandate, economic conditions bode well for the achievement of our goal I am watching labor force participation and employment as pandemic benefits programs end. As a result, I do expect to see more workers coming back into the labor force. I expect the unemployment rate to continue to decline, but at a slightly slower rate going forward.

During the pandemic, community banks were the lifeblood of many communities. Is the Federal Reserve doing anything to encourage community bank de novo applications?

Since joining the Federal Reserve Board, I have focused on reviewing the Federal Reserve’s de novo supervisory program. Through this review, we found that de novo state member banks were subject to higher capital standards than state nonmember or national banks. In mid-2020, we addressed this disparity by revising the Fed’s guidance on the supervision of de novo state member banks in Supervision and Regulation (SR) letter 20-16, “Supervision of De Novo State Member Banks,” which in part provides for lower capital requirements and expanded exam frequencies for Fed member de novos.⁵ We are also seeking ways to streamline the Federal Reserve’s membership application process for both existing and de novo banks.

I have long been a strong proponent of additional research to identify the market constraints and regulatory barriers to bank formation. This type of research is necessary to lay the groundwork for future policy actions. We are also exploring ways to encourage the formation of new banks by providing technical assistance to prospective applicants. I also look forward to exploring other options to encourage new bank formation and will work with industry participants to advance this effort.

• ¹ See the August 27, 2021, press release, available at www.federalreserve.gov/newsevents/pressreleases/bcreg20210827a.htm.
• ² The paper is available at www.federalreserve.gov/newsevents/pressreleases/bcreg20210909a.htm.
• ³ See the July 13, 2021, press release, available at www.federalreserve.gov/newsevents/pressreleases/bcreg20210713a.htm.
• ⁴ In March 2020, the Federal Reserve paused examinations at smaller banks. In June 2020, the Federal Reserve resumed examination activity offsite, focusing on assessing a bank management’s response to the crisis and promoting financial resiliency.
• ⁵ SR letter 20-16 is available at www.federalreserve.gov/supervisionreg/srletters/SR2016.htm.