Appropriate supervision can lighten regulatory burden, Fed chief says

If the Federal Reserve continues its emphasis on regulatory reform, community bankers may not find much in the exam process to complain about. They already largely welcome the exams and regulators themselves, finding fault with only the redundant and cumbersome natures of some of the compliance requirements, according to a national survey of 611 community bankers conducted by regulators from the Fed and state regulatory agencies.

The survey was released at the fifth annual 21st Century Research and Policy Conference hosted by the Federal Reserve Bank of St. Louis and the Conference of State Bank Supervisors, conducted Oct. 4-5 at the St. Louis Fed.

Fed Chair Janet Yellen delivered brief opening remarks with a focus on continued regulatory changes.

“The Fed has been working hard to ensure that its regulation and supervision of banks is tailored appropriately to the size, complexity and role different institutions play in the financial system,” she said. “For community banks, which by and large avoid the risky business practices that contributed to the financial crisis, we focused on making sure that much needed improvements to regulation and supervision since the crisis are appropriate and not unduly burdensome.”

To date, that burden has played a notable role in community banks’ consolidation. Largely due to a desire to reach an economy of scale, 11.3 percent of respondents said they had received and seriously considered an acquisition offer in the last year, up from 9.75 percent in 2015’s survey. As the mergers and acquisitions market continues to be active, the surviving banks feel they are poised for more success as a direct result of attrition.

“There are fewer and fewer competitors and even fewer still that are locally based,” one respondent said. “We feel that this bodes well for those that remain.”

Another banker pinpointed the cause of the exact regulatory requirements Yellen is aiming to reduce.

“As other community banks throw in the towel and sell or merge due to regulatory burden, our bank may be able to capitalize on being one of the last remaining local institutions,” the banker said.

The regulatory complaints mentioned tie almost entirely to the time, money and effort spent on meeting the requirements, not on the actual enforcement or review of them. Compliance costs increased from $5.0 billion to $5.4 billion in 2016, but some bankers actually want more interaction with their regulators. Bankers in Kansas, Nebraska and Wisconsin specifically mentioned a preference to keep much of each examination on site.

Moving those reviews off-site would diminish interaction between bankers and examiners, a dynamic bringing value in both understanding what the regulator is looking for and what the banker is trying to accomplish. (It should be noted once again, regulators conducted the survey, perhaps slightly influencing respondents’ answers.)

Compared to years past, the responses tied to specific regulations were far less critical, perhaps signs of learning the new rules and of optimism about continued reform. Some of the harshest comments came from a banker in Montana bothered by the “regulatory over-reaction” to the cyclical nature of the agriculture market and ag lending. On the other side of that spectrum, bankers in South Dakota applauded the reduced burden in compliance exams thanks to a more narrowed focus on risk.

Yellen’s five-minute speech did nothing to dissuade those broader hopes moving forward.

“We are well aware that community banks serve communities, businesses and households that are often underserved by larger institutions,” Yellen said. “They offer more extensive and personalized services that are otherwise unavailable. We know that community bankers are part of the communities they serve and often better understand the needs and aspirations of their customers.”

Included in those needs would be tech-based non-lending services. A year ago, 71.15 percent of banks offered remote deposit capture with another 16.13 planning to do so soon. Now, 76.5 percent do and 10.4 percent plan to. Clearly, some of those plans came to be realities.

Similarly, a year ago 13.44 percent did not offer mobile banking but planned to. That has since dropped to 7.3 percent, accompanied by a jump from 81.0 percent to 86.9 percent of banks that do offer it.

These changes have come as direct results of attempting to keep up with competition, both from other banks and from the burgeoning fintech sector, according to the survey. When pondering the greatest sources of current mortgage competition, 4.0 percent of respondents cited fintech firms. If pondering what will be the greatest source in the future, 11.5 percent pointed to fintech firms, one of only two specific fields to rise in that comparison, along with credit unions going from 9.8 percent to 12.4 percent.

Thus, while only 33.1 percent of respondents currently offer online loan applications, another 41.0 percent plan to in the near future.

All of these changes — the consolidation, both the theoretical and the realized regulatory reform, and the growing technological services — will be vital to banks attempting to turn a profit in a “new normal” economy, as described by John Williams, president and CEO of the Federal Reserve Bank of San Francisco.

Williams argued the natural interest rate, or r-star, will no longer sit at about 4.5 percent as it did in the 1990s and early 2000s. Instead, it will be as low as 2.5 percent, combining a new normal Fed funds rate of 0.5 percent with a 2 percent inflation target.

“This is something that is a long-term development, expected to last into the future and is something that is not unique to the U.S.,” Williams said, pointing to slowdowns in both labor force and productivity growth as the limiting factors.

“For banks, the new normal is a slower-growing economy,” he said. “That means slower lending growth, lower profit growth overall, and obviously lower interest rates has effects on abilities and business models.

“For bankers, a new normal of moderate growth and lower interest rates will have a significant bearing on lending growth and profitability.”