FRB Governor Duke, a former community banker, made a presentation to the Southeastern Bank Management and Directors Conference at the University of Georgia’s Terry College of Business concerning the future of community banking. Ms. Duke is the Chair of an FRB Subcommittee that makes recommendations about matters related to community bank supervision and regulation.
Governor Duke stressed that credit metrics at community banks are continuing to improve since the recent financial crisis: the levels of problem loans have been reduced; credit underwriting standards remain restrictive; deposit growth has outpaced loan demand; and reliance on wholesale funding has been reduced. Community banks’ capital positions are stronger, but they face substantial interest margin pressure because of historically low interest rates and weak loan demand. Governor Duke stated that even with this relatively weak economic environment, community banks can thrive if they use their creativity, deep community ties; and dexterity to customize financial solutions and provided that they maintain strong risk management processes.
Governor Duke next discussed the burden of new, post-financial crisis regulations on community banks and said that the FRB recognizes that the burden of regulations often falls disproportionately on smaller banks. However, Governor Duke asserted, community banks have been extremely successful in convincing the banking agencies to direct Dodd-Frank Act regulations primarily at larger, systemically important banks and to reject “one-size-fits-all” regulations, i.e., to cause new regulations to take into account the size and business model complexity of the applicable bank.Governor Duke commented on recent developments in the types of lending that are key components of community banks’ business activities. She recognized that compliance with the new residential mortgage regulations will require community banks to change their loan processing systems and to provide extensive staff training, but she suggested that “it is also possible that the systems and expertise necessary to make qualified mortgages for the bank’s books could also be used to originate loans for sale,” which, Governor Duke suggested, could provide a new source of revenue for a community bank. With respect to community bank management of commercial real estate lending and bank regulatory supervision of credit risk, Governor Duke said that FRB research showed that over the period from 2007 to 2011, banks whose total construction and land development loans represented 100% or more of the bank’s total capital were “far more likely to have failed” than banks where total commercial real estate loans (of all types) represented 300% or more of the bank’s total capital and the bank’s commercial real estate portfolio had increased by 50% or more over the prior 36 months. Finally, with respect to small business lending (commercial and industrial loans and commercial real estate loans with original principal amounts of $1 million or less), Governor Duke said that FRB research has confirmed the importance of small business lending to the community bank business model. Governor Duke said that it was critically important that boards of directors of community banks “insist on appropriate risk management [of small business lending] that retains the flexibility to use the bankers’ knowledge of their customers’ business to [the bank’s] best advantage.” Governor Duke added that it was also critical that bank regulatory supervisors use tools that measure the overall effectiveness of a community bank’s risk management of small business lending “without being overly prescriptive for individual loans.”