“Thank you for inviting me to ICBA’s policy summit. I am pleased to have this opportunity to share my views on some of the key issues facing community banks and how I see the community banking model fitting into the financial system in the years ahead. In particular, I will discuss steps the Federal Reserve has taken to address the “too-big-to-fail” problem and how these steps affect community banks; I will describe how the Fed strives to improve our understanding of the unique role that community banks play in the economy; and then I’ll show how we are using this knowledge to better tailor our supervisory expectations and approaches to community banks.
As you may know, before I rejoined the Federal Reserve Board as Vice Chair in 2010, I had the privilege of serving for six years as president and chief executive of the Federal Reserve Bank of San Francisco. The 12th district is the largest of the Fed’s districts, covering nine western states, and it is home to a significant number of community banks, the majority of which are supervised by the San Francisco Fed directly or indirectly through bank holding companies. Community bankers helped me, when I served as president, to take the pulse of the local economy and also to understand how regulatory and policy decisions in Washington affect financial institutions of different sizes and types, sometimes in very different ways. During the financial crisis, I saw firsthand the challenges that community banks faced in a crisis they did little to cause, and I have felt strongly ever since that the Fed must do what it can to ensure that the actions taken following the crisis do not place undue burdens on your institutions.
I believe a healthy financial system relies on institutions of different sizes performing a variety of functions and serving different needs. In some communities, your banks are actually situated on Main Street, but all community banks serve Main Street by providing credit to small business owners, homebuyers, households, and farmers.
Because of their important role, I am pleased that the condition of many community banks has been improving. Although there is still considerable revenue pressure from low margins, earnings for most community banks have rebounded since the financial crisis. Asset quality and capital ratios continue to improve, and the number of problem banks continues to decline. Notably, after several years of reduced lending following the recession, we are starting to see slow but steady loan growth at community banks. While this expansion in lending must be prudent, on balance I consider this growth an encouraging sign of an improving economy.
Addressing Too Big to Fail
Let me begin by discussing an issue that I know has been on the minds of many community bankers: how policymakers are addressing the problem of banks that are perceived to be too big to fail.1 Community banks share the interest we all have in reducing the systemic risk posed by firms that are large, complex, and interconnected, and also in reducing any potential competitive advantages that such firms may enjoy as a result of too-big-to-fail.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) addresses the too-big-to-fail issue through steps intended to limit both the likelihood that systemically important firms would fail and the potential damage from any that do. The Federal Reserve and the other financial regulatory agencies have issued a number of regulations to implement the requirements set forth in the legislation and to enhance the supervision of the largest financial firms.
But even before Dodd-Frank became law, the Federal Reserve began to strengthen its oversight of the largest, most complex banking firms and require these firms to materially improve their capital adequacy. For example, in 2009, we conducted the first stress tests of the largest 19 U.S. bank holding companies. That test has subsequently evolved into our annual Comprehensive Capital Analysis and Review, known as CCAR, which requires all bank holding companies with total assets of $50 billion or more to submit annual capital plans for review by the Federal Reserve. CCAR helps ensure that the largest banking organizations will have enough capital to continue operating through times of economic and financial stress.2 To be clear, as the federal banking agencies have stated previously, these stress testing and capital planning requirements do not, and should not, apply to community banks.3
In addition to strengthening requirements for stress testing and capital planning, the agencies have also strengthened capital requirements for the largest firms by approving more robust risk-based and leverage capital requirements. Because the financial crisis demonstrated the importance of having adequate levels of high-quality capital at banks of all sizes, many elements of the revised capital framework apply to all banking organizations. In designing the revised capital rules, however, the agencies considered financial stability risks and adjusted the final rules to make the requirements substantially more rigorous for the largest, most systemically important banking organizations than for community banks.4
While we have taken a number of steps to address too-big-to-fail concerns, our work is not finished. Because the failure of a systemic institution could impose significant costs on the financial system and the economy, the Board recently finalized a requirement for the eight large, globally systemic banks to meet a significantly higher leverage requirement than other banking organizations. And we are working to implement risk-based capital surcharges for these systemically important firms. We also need to ensure that the new rules are embedded in our supervision of the largest firms; and, we must continue to watch for emerging sources of systemic risk and take steps as appropriate to address these risks.
One such risk that the Federal Reserve has been monitoring closely is the reliance of some firms on potentially volatile short-term wholesale funding.5 We are carefully considering the systemic vulnerabilities that may be posed by overreliance on short-term wholesale funding and are weighing potential policy responses. While it would be premature to indicate whether or how we might address these vulnerabilities, I can say that few, if any, community banks are reliant on levels of short-term wholesale funding that could raise concerns about systemic risk, and regulators would carefully consider the ramifications of any action, including the effect on community banks.
Improving Our Understanding of Community Banks
In carefully considering how our actions affect community banks, the Federal Reserve is committed to understanding your institutions and the challenges you face. We continue to try to improve that understanding in two important ways–research and outreach. The Fed is uniquely positioned to employ these two methods because of our traditional strength as a research institution and because of our structure, with Reserve Banks that have deep roots in communities in every region of the country…..”