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

Shelly Shen, Financial Derivatives at Community Banks

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Xuan (Shelly) Shen, a quantitative analyst at Regions Bank in Birmingham, Ala., presents her paper “Financial Derivatives at Community Banks,” co-written with Valentina Hartarska, a professor at Auburn University. The authors find that the use of derivatives increased profitability at community banks even through the financial crisis and that banning their use would have hurt banks and made them more vulnerable to interest rate risk and credit risk.

Financial Derivatives at Community Banks(PDF)

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.

Conference Videos

Welcome & Overview (Oct. 2)
Moderator: Julie Stackhouse (5:29)

Opening Remarks
John Ryan (4:58)
James Bullard (4:39)
Ben Bernanke (8:40)

Research Session 1: The Role of Community Banks
Research Session 1 Moderator: Scott E. Hein (5:35)
Do Community Banks Play a Role in New Firm Survival? (Smith Williams) (18:27)
Equipment Lease Financing: The Role of Community Banks (Mohammed Khayum) (13:24)
Equipment Lease Financing: The Role of Community Banks (Charles Kelly) (14:03)
Small Business Lending and Social Capital: Are Rural Relationships Different? (Kenneth Spong) (25:08)
Bank Failure, Relationship Lending and Local Economic Performance (John Kandrac) (22:32)
Q&A (16:07)

Evening Keynote Address
Dorothy Savarese (38:04)

Community Banking Performance (Oct. 3)
Moderator: Richard Brown (5:07)
Financial Derivatives at Community Banks (Shelly Shen) (11:12)
Lessons from Community Banks that Recovered from Financial Distress (Andrew P. Meyer) (22:40)
The Effect of Distance on Community Bank Performance Following Acquisitions and Reorganizations (Timothy J. Yeager) (20:43)
Performance of Community Banks in Good Times and Bad Times: Does Management Matter? (Dean F. Amel) (17:02)
Research Session 2 Question and Answer Period (21:41)

Supervision and Regulation of Community Banks
Moderator: Lamont Black (4:09)
Estimating Changes in Supervisory Standards and Their Economic Effects (William F. Bassett) (17:23)
The Impact of Dodd-Frank on Community Banks (Tanya D. Marsh) (15:39)
Capital Regulation at Community Banks: Lessons from 400 Failures (Robert R. Moore) (14:39)
A Failure to Communicate: The Pathology of Too Big to Fail (Harvey Rosenblum) (18:15)
Research Session 3 Moderator Wrap-up (14:43)
Audience Question and Answer Session (14:46)

Afternoon Keynote Presentation
Federal Reserve Governor Jerome Powell (28:27)

Panel Discussion and Presentation of Results from Town Hall Sessions
Presenter: Mike Stevens (13:20)

Panel Discussion: Community Banking in the 21st Century: Opportunities, Challenges and Perspectives
Moderator: Charles A. Vice (13:32)
Curt Hecker (7:38)
Bobby P. Martin (12:24)
Thomas E. Spitz (8:30)
Claire W. Tucker (9:14)
Community Banking Panel Question and Answer Period (1:04:29)
Julie Stackhouse, Closing Remarks (11:13)

Conference of State Bank Supervisor