Federal Reserve System and the Conference of State Bank Supervisors
Community Banking in the 21st Century
October 3, 2013, Federal Reserve Bank of St. Louis
Community Banking Performance
Moderator: Richard A. Brown, chief economist and associate director for regional operations, Federal Deposit Insurance Corp., Washington, D.C. | Video
- Financial Derivatives at Community Banks Xuan (Shelly) Shen, Valentina Hartarska Auburn University Paper (PDF) | Presentation Slides (PDF) | Video | ABSTRACT: Community banks did not actively participate in the derivatives market until the enactment of the Gramm-Leach-Bliley Act of 1999. Call reports show that less than 1 percent of community banks used derivatives in 1999, but around 16 percent of community banks were active derivative users by 2012. Even though there were consolidations of community banks in last decade, these banks remain relatively small, and are therefore more vulnerable to inappropriate derivative activities. However, due to the relatively short history of derivative activities at these banks, not much is known about how financial derivatives affect the profitability of community banks. Meanwhile, recent regulation changes have brought many challenges to community banks. In particular, implementation of the Volcker Rule not only prohibits banks from proprietary trading in derivatives, but also has the potential to deter small banks from permissible risk-mitigating derivative activities because the increased regulatory costs are proportionally higher for these small banks. This study not only provides empirical evidence on how financial derivatives affect the profitability of community banks but also estimates the potential effects of the Volcker Rule on these small banks. Furthermore, specializing community banks have different exposure levels to various risks and their derivative activities tend to be heterogeneous. This work, in turn, studies the effects of derivative activities on profitability at community banks by lending specialties, such as mortgage specialists, commercial real estate loan specialists, commercial and industrial loan specialists, multiple specialists, and nonspecialty banks.
- Lessons from Community Banks that Recovered from Financial Distress R. Alton Gilbert, Andrew P. Meyer and James W. Fuchs Federal Reserve Bank of St. Louis Paper (PDF) | Presentation Slides (PDF) | Video | ABSTRACT: This project is a follow-up to our recent report, “The Future of Community Banks: Lessons From Banks that Thrived During the Recent Financial Crisis,” which appeared in the March/April edition of the Federal Reserve Bank of St. Louis’ Review. In our previous work, we studied the attributes of banks that maintained a CAMELS rating of 1 throughout the financial crisis years of 2006 to 2011. We showed a variety of statistically significant balance-sheet ratios and other attributes that were different between these “thriving” banks and other banks that survived the financial crisis but did not maintain the highest supervisory rating. We followed up the statistical analysis with interview evidence from a sample of thriving bankers to determine what they considered to be the keys to their success. We are taking a similar path with the current project, but instead of studying the essential factors for maintaining health, we are identifying the essential factors for regaining health after suffering significant safety-and-soundness problems. To that end, we have identified a sample of 1,376 commercial banks under $10 billion in assets that were downgraded to a CAMELS rating of either 4 or 5 during the sample period of 2006 to 2011.
- Performance of Community Banks in Good Times and Bad Times: Does Management Matter? Dean F. Amel, Robin A. Prager Federal Reserve Board of Governors Paper (PDF) | Presentation Slides (PDF) | Video | ABSTRACT: Community banks have long played an important role in the U.S. economy, providing loans and other financial services to households and small businesses within their local markets. In recent years, technological and legal developments, as well as changes in the business strategies of larger banks and nonbank financial service providers, have purportedly made it more difficult for community banks to attract and retain customers, and hence to survive. Indeed, the number of community banks and the shares of bank branches, deposits, banking assets and small business loans held by community banks in the U.S. have all declined substantially over the past two decades. Nonetheless, many community banks have successfully adapted to their changing environment and have continued to thrive. This paper uses data from 1992 through 2011 to examine the relationships between community bank profitability and various characteristics of the banks and the local markets in which they operate. Bank characteristics examined include size, age, ownership structure, management quality and portfolio composition; market characteristics include population, per capita income, unemployment rate and banking market structure. We find that community bank profitability is strongly positively related to bank size; that local economic conditions have significant effects on bank profitability; that the quality of bank management matters a great deal to profitability, especially during times of economic stress; and, that small banks that make major shifts to their lending portfolios tend to be less profitable than other small banks.
- The Effect of Distance on Community Bank Performance Following Acquisitions and Reorganizations Gary D. Ferrier, Timothy J. Yeager University of Arkansas, Sam M. Walton College of Business Paper (PDF) | Presentation Slides (PDF) | Video | ABSTRACT: We analyze the efficiency and performance of more than 2,000 U.S. community bank acquisitions and reorganizations between 1988 and 2002. Post-acquisition bank performance deteriorates with the geographic distance between the target and the acquirer. In contrast, bank performance following reorganization (charter consolidation) of a given bank-holding company improves with the distance between affiliates. We argue that distance between the target and the acquirer harms performance because high information and monitoring costs overwhelm any diversification benefits. Conversely, reorganizations benefit geographically distant entities the most precisely because these firms have the most to gain from reducing information and monitoring costs.
Supervision and Regulation of Community Banks
Moderator: Lamont Black, assistant professor of finance, Driehaus College of Business, DePaul University, Chicago, Ill. | Video
- Estimating Changes in Supervisory Standards and Their Economic Effects William F. Bassett, Seung Jung Lee, Thomas W. Spiller Federal Reserve Board of Governors, Division of Monetary Affairs Paper (PDF) | Presentation Slides (PDF) | Video | ABSTRACT: The disappointingly slow recovery in the United States from the recent recession and financial crisis has once again focused attention on the relationship between financial frictions and economic growth. With bank loans having only recently started growing and still remaining sluggish, some bankers and borrowers have suggested that unnecessarily tight supervisory policies have been a constraint on new lending that is hindering recovery. This paper explores one specific aspect of supervisory policy: whether the standards used to assign commercial bank CAMELS ratings have changed materially over time (1991-2011). We show that models incorporating time-varying parameters or economy-wide variables suggest that standards used in the assignment of CAMELS ratings in recent years generally have been in line with historical experience. Indeed, each of the models used in this analysis suggests that the variation in those standards has been relatively small in absolute terms over most of the sample period. However, we show that when this particular aspect of supervisory stringency becomes elevated, it has a noticeable dampening effect on lending activity in subsequent quarters.
- The Impact of Dodd-Frank on Community Banks Tanya D. Marsh, Wake Forest University School of Law Joseph W. Norman, attorney, K&L Gates LLP, Charlotte, NC. Paper (PDF) | Video | ABSTRACT: The American system of banking regulation is a system of regulation by accretion–it is the result of legislative responses to particular crises, from the need to create a market for U.S. national bonds to help finance the Civil War (which led to the creation of national bank charters), to the creation of the Federal Reserve after the monetary panic of 1907, to the creation of the FDIC following the stock market crash of 1929, and, most recently, to the creation of Dodd-Frank after the 2007 financial crisis. Each of these legislative efforts was a well-meaning attempt to deal with the perceived problems that led to each crisis. However, the net result of these policies is a federal regulatory system for banking that is fundamentally flawed and has unintended consequences on community banks.
- Capital Regulation at Community Banks: Lessons from 400 Failures Robert R. Moore, Michael A. Seamans Federal Reserve Bank of Dallas Paper (PDF) | Presentation Slides (PDF) | Video | ABSTRACT: We draw on data from the recent financial crisis and its aftermath to examine factors underlying community bank performance, failure and regulation. In particular, we investigate the failure of some 400 community banks from 2008 to 2013, with a focus on the ability of two measures of capital, tier 1 capital to assets and tier 1 capital to risk-weighted assets, to explain and forecast these failures. Both measures of capital provide useful information for explaining failures in-sample. For predicting failures out-of-sample, we find that both measures have similar Type I error rates for given Type II error rates, particularly if variables beyond the capital ratios themselves are included in logistic failure models. Our results accord well with those of Estrella, Park and Peristiani (2002) who examined an earlier failure wave, and with Haldane and Madouros (2012) who brought a different approach to examining the recent failure wave. Consistent with this previous research, our results support keeping capital requirements for community banks simple.
- A Failure to Communicate: The Pathology of Too Big to Fail Harvey Rosenblum, Elizabeth Organ Federal Reserve Bank of Dallas Paper (PDF) | Presentation Slides (PDF) | Video | ABSTRACT: Guided by an examination of community banks and their relative stability during the recent financial crisis, we propose that lasting financial stability will rest on a level playing field that rewards sound judgment and integrity among profit-seeking financial firms, while penalizing excessive risk and complexity. To promote such an operating environment, government should retain its role as the financial system’s watchdog, but must (1) render no institution immune to market discipline and (2) tailor regulation and supervision to fit the distinct business models employed by different types and groups of financial firms.
Afternoon Keynote Presentation Audience Question and Answer Session
- Federal Reserve Governor Jerome Powell | Video
Panel Discussion and Presentation of Results from Town Hall Sessions Presenter: Mike Stevens, senior executive vice president, Conference of State Bank Supervisors Video
The presentation will include a panel discussion about the findings from town hall meetings hosted by state bank supervisors this spring and summer with community bankers across the country.
Panel Discussion: Community Banking in the 21st Century: Opportunities, Challenges and Perspectives (PDF) Moderator: Charles A. Vice, CSBS chairman and Kentucky Department of Financial Institutions commissioner | Video
- Curt Hecker, president and CEO, Panhandle State Bank, Sandpoint, Idaho | Video
- Bobby P. Martin, chairman of the board, The Peoples Bank, Ripley, Miss. | Video
- Thomas E. Spitz, chief executive officer, Settlers Bank, Windsor, Wis. | Video
- Claire W. Tucker, president and CEO, CapStar Bank, Nashville, Tenn. | Video
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