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SRC Insights: Second Quarter 2012

Supervision Spotlight - A Farewell to SRC Insights: New Connections with Community Banks

Community banks are often defined as institutions having less than $1 billion in total assets. Using this benchmark, over 84% of Third District commercial banks are considered community banks. The Federal Reserve Bank of Philadelphia has recognized the important role of community banks for many years and remains deeply committed to understanding the current risks and issues facing this segment and to providing resources to assist community banks in the Third District.

Through the years, a series of well-established local programs and publications has been developed to facilitate greater interaction and to promote information sharing between bankers and regulators. One cornerstone of our outreach effort, this SRC Insights newsletter, will end a 16-year publication run with this issue. SRC Insights is not being retired because it has become obsolete, as its goals and purpose are particularly relevant in today's environment. Rather, SRC's outreach efforts are evolving and being focused on developing a new national Federal Reserve publication directed at addressing issues facing community banks. The first issue of the new publication, Community Banking Connections, will debut in the third quarter of 2012, with a joint website that will provide extensive resources to community banks.

We truly appreciate your readership over the years. Banking is a dynamic industry, and we hope that you found the SRC Insights topics and articles to be timely and useful; one of the articles in this issue takes a look back on pertinent topics discussed through the years. Of course, we remain committed to our other outreach efforts and will continue to convey regulatory developments, as well as Third District regional and local information, through other in-person communication channels, such as field meetings, bankers' forums, directors' workshops, and other events.

In my final Insights article, I will look at today's community banking business environment and highlight some recent Federal Reserve enhancements and initiatives designed to improve the effectiveness of communications with community banks and, to the extent possible, reduce unnecessary regulatory burden.

Community Banks by the Numbers

Third District community banks have been challenged during the financial crisis, and they now face a new set of challenges in its aftermath. For the most part, Third District institutions did not originate material amounts of subprime or nontraditional residential mortgage products, nor did they invest heavily in complex hybrid securities. However, many community banks did take on high concentrations of commercial real estate (CRE). The CRE exposures, particularly exposures to construction and land development lending (C&LD), became problematic as the housing market collapsed and the economy entered into a deep and prolonged recession.

While the recession has technically ended, and the housing market is no longer in free fall, growth remains sluggish, and the housing market remains troubled. In addition, community bankers are also facing an extremely low interest rate environment, rising compliance costs, slack loan demand, and intense competition for creditworthy customers. It is, therefore, not surprising that community bankers cite the difficulty of finding sources of top line revenue growth as one of their biggest challenges.

As a result of these challenges, the number of community banks has been falling due to a combination of consolidation and failures. At the start of 2007, there were 144 commercial banks headquartered in the Third District, but by year-end 2011, that number declined to 116, a decrease of over 19%. For the nation, there were 6,900 commercial banks in 2007, but that number declined to 5,759 by the end of 2011, a loss of 1,141 banks, or 16%. While overall conditions have seen notable improvement and the number of problem banks has been falling slowly, over 800 banks nationwide still remain on the problem bank list, the majority of which are under $1b.

Furthermore, market share has shifted significantly through the decades. The total assets are more heavily concentrated in the nation's largest institutions. The Federal Reserve Bank of Dallas's 2011 annual report notes that, “Since the early 1970s, the share of banking industry assets controlled by the five largest U.S. institutions has more than tripled to 52 percent from 17 percent.” 1

Amid growing trepidation, some critics even began questioning the relevance of the community banking model in today's environment. The Federal Reserve, however, has always recognized the important role community banks serve. As Chairman Bernanke emphasized in a recent speech, “Community banks remain a critical component of our financial system and our economy. They help keep their local economies vibrant and growing by taking on and managing the risks of local lending, which larger banks may be unwilling or unable to do. 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.” 2

Federal Reserve's Enhanced Focus on Community Banks

The Federal Reserve is responding to the current challenges facing community banks in multiple ways, including emphasizing improved communications with the industry. Listening to and understanding bankers' perspectives are integral to this process. Regulators and bankers benefit greatly from ongoing and open dialogue that leads to meaningful solutions. A series of enhancements and initiatives has been designed to improve the effectiveness of communications and to find ways of reducing regulatory burden, where possible.

The importance of constructive two-way communication between industry representatives and regulators cannot be underestimated. Formal frameworks that call for periodic discussions can help facilitate the overall feedback gathering process. One example is the Community Depository Institutions Advisory Council (CDIAC), which was established by the Board of Governors in 2010 and gathers representatives from commercial banks, thrift institutions, and credit unions. During its biannual meetings, the council provides information and advice and offers recommendations from the community depository institution perspective. A current listing of the members of Philadelphia's CDIAC is available online.

In addition, bankers are typically given an opportunity to offer their insights on proposed rulemaking or guidance during set commentary periods open prior to enactment. A diverse array of viewpoints helps to make the overall decisionmaking process more robust and productive. Having spent time at the Board of Governors, I can assure you that your comments are given careful consideration, so I encourage all bankers to actively participate.

Examiners must also communicate clearly with bank management about supervisory concerns and expectations in order to help bankers make appropriate improvements. Banking Supervision and Regulation management is committed to ensuring that examination results are thoroughly vetted, that examiners take a fair and balanced approach, and that examiners provide clear and direct feedback to institutions. Finally, in the event of irreconcilable differences between examiners and bank management, there is a formal procedure in place to appeal supervisory ratings.

Providing greater transparency around the expectations and criteria used in the decisionmaking process helps bankers understand the reasoning behind decisions and allows them to better assess their current status independently. For example, on March 2, 2012, the Federal Reserve issued guidance titled Upgrades of Supervisory Ratings for Banking Organizations with $10 Billion or Less in Total Consolidated Assets.3 This guidance was issued to “clarify application of the interagency ratings guidelines when in a period of stabilized or generally improving economic conditions.”

Major banking reforms were needed to curb excessive risk in the banking industry and mitigate the risk or impact of future crisis. The expectations and costs associated with the implementation of Dodd-Frank rulemaking have remained a prominent concern among community bankers. While regulatory reform impacts the entire financial industry, the majority of the reforms were aimed at addressing issues related to large and systemically important financial institutions. Clearly identifying supervisory policies that exempt smaller banks could save time and effort and reduce regulatory burden. The Fed has embarked on an effort to more clearly communicate distinctions in how regulations and guidance apply to community banks relative to larger institutions. For example, where applicable, newly released guidance and regulations contain a clear and concise statement upfront that allows a reader to quickly determine whether specific regulations pertain to banks below a certain size threshold.

Economic research focused on community banking is mutually beneficial, and more needs to be conducted. Research studies can help regulators gain a better understanding of community bank operations, performance, comparative advantages, and contribution to the broader economy. Analytical studies and surveys may lead to new techniques for improving bank profitability, identifying and assessing emerging risks trends earlier, and better gauging the potential influence of regulatory responses.

Finally, new approaches to conducting outreach are underway. As noted earlier, a new national quarterly publication devoted specifically to community banking is in development and is targeted for release early in the third quarter. The publication's website will also host a variety of resources of interest to community banks. Targeting the narrower audience allows us to highlight nuances and focus attention on the particular issues that are most relevant to the sector. The technology available in today's world has also ushered in new media channels and new expectations around how information is conveyed. The Federal Reserve will continue to expand into new avenues of communication.


The relationship lending and financial services that community banks provide to creditworthy individuals and small businesses help keep local communities vibrant and growing. Both challenges and opportunities are prevalent in today's environment.

The Federal Reserve System is committed to solidifying relationships with community bankers by enhancing our understanding of needs, improving modes of communication, listening to concerns, and pursuing mutually beneficial solutions. The development of this new System publication, Community Banking Connections, is an important new step toward attaining that goal. We at the Federal Reserve Bank of Philadelphia are proud and excited to be playing a prominent role in launching this new publication, and though we close SRC Insights today, we remain dedicated to fostering a constructive dialogue with community banks in the Third District.

The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.