Why Does the Fed Supervise Small Banks?

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This post is part of a series titled “Supervising Our Nation’s Financial Institutions.” The series, written by Julie Stackhouse, executive vice president and officer-in-charge of supervision at the St. Louis Federal Reserve, is expected to appear at least once each month throughout 2017.

In the aftermath of the 2008 financial crisis, the Federal Reserve was given substantially more authority to supervise the nation’s largest and systemically important financial institutions. Given that important responsibility, it’s fair to wonder why the Fed supervises smaller banks too.

The Fed has been supervising banks of all sizes since its founding in 1913. The table below shows the breakdown of Fed-supervised banks by asset size.

When the Bank Holding Company Act of 1956 passed, the Fed was also given the task of supervising the nation’s bank holding companies—companies that own or control one or more commercial banks.

Today, about 80 percent of the nation’s 6,000 banks are part of a one- or multi-bank holding company, giving the Fed a window into the economic and financial conditions of much of the country.

The regulation of a wide variety of financial firms provides Reserve Bank presidents and the Federal Reserve Board of Governors a holistic view of the trends and issues affecting firms across the country. Issues facing small financial firms can have a material impact on regions of the country, or—in the case of commercial real estate (CRE) lending prior to the financial crisis—can contribute to the effects of larger systemic trends.

Supervision of financial firms of all sizes also assists the Fed in its lender of last resort responsibility. To provide liquidity to financial firms in times of stress, the Fed depends on information passed on by its bank supervisors and the continual monitoring of firms of all sizes.

Importance of Fed Supervision

The importance of the Fed’s role in supervision was seen in the financial crisis. Although an overheated housing market and accompanying issues in secondary markets are largely blamed for the 2008 financial crisis, problems in CRE markets were a contributing factor in the recession and decline in lending that followed.

Delinquent CRE loans were concentrated in the nation’s small banks, which had increasingly specialized in such lending. Fed supervisors constantly monitored these smaller institutions and kept monetary policy decision-makers apprised. Similarly, having a supervisory relationship with smaller institutions facilitated the underwriting of emergency loans through the Fed’s discount window.

There is no question that large banks are important as the “transmission belt” of monetary policy. But the belt runs both ways. Community banks are still the main source of credit for many communities. Interactions between Fed supervisors and these banks provide useful insight on lending and economic conditions.

Follow the Series

• Why Are Banks Regulated?
• Did the Dodd-Frank Act Make the Financial System Safer?
• Bank Supervision and the Central Bank: An Integrated Mission
• Why Are There So Many Bank Regulators?
• Why Didn’t Bank Regulators Prevent the Financial Crisis?
• Who Funds the Cost of Bank Supervision?

Additional Resources

• Bank Supervision
• On the Economy: Who Would Be Affected by More Banking Deserts?