Group items tagged

challenges from an enhanced regulatory regime that has evolved in the wake of the crisis.

The ultimate focus of examination and supervision is the safety and soundness of the bank, as well as compliance with laws and an assessment of the bank's ability to withstand risks and shocks.

how the Federal Reserve's monetary policy aims to increase the availability of credit to foster economic growth, and how we are tailoring our examination and supervision of community banks to ensure that we are not inadvertently constraining lending. 

examination and supervision of community banks is a timely and important topic. Why do I say that? Because, as I will discuss shortly, lending by community banks plays an important role in the ongoing economic recovery, especially by providing credit to small businesses. And it is absolutely critical that examination and supervision do not produce outcomes that are barriers to small business expansion.

potential effects of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).

Supervision and Examination of Large and Community Banks

good examiners will help them to be proactive and identify problems early, and because a strong and durable banking system is in everyone's best interest.

They are relatively diversified, but also tend to be more highly leveraged than smaller institutions, and often rely on more volatile wholesale funding. These organizations often are tightly interconnected, raising the prospect that the failure of one institution could rapidly destabilize the wider financial system, giving rise to the "too-big-to-fail" problem.7  

the examination and supervision of the lender should not hinder the ability of creditworthy businesses to access credit.

I am encouraged that community banks are faring better in the current environment.

While profitability remains below long-run historical norms, returns on equity and assets have reached their highest post-crisis levels.3

we must continue to think about how we can improve the examination and supervision of community banks. One issue that we constantly must evaluate is the appropriate balance in the allocation of responsibilities between banks and examiners.4

community bankers typically welcome effective and appropriate examination and supervision.

there are key differences between these two sets of institutions, and these differences have implications for our supervisory framework.

over at least the past decade indicates a trend toward greater concentration. Ninety-nine percent of banks in the United States are community banks, with most of these holding less than $1 billion in total assets. The remaining 1 percent of banks together hold more than 80 percent of the assets in the banking system, with much of this concentrated at a handful of the very largest banks. The four largest commercial banks, each of which has more than $1 trillion in consolidated assets, collectively hold just under half of all U.S. banking assets.6   

The largest commercial banks are characterized not only by their size, but also by their scope of operations and complexity.

we must always think about whether the allocation of responsibilities should be different depending on whether the supervision is of a community bank rather than a large bank,

The characteristics of the largest commercial banks stand in contrast with those of community banks.

community banks are not immune from taking on excessive risk. But there are reasons why risks at community banks are likely to be less dangerous to the financial system. First, community banks generally are less complex and more easily understood. Second, community banks tend to be more traditional in approach.

our supervision of these firms has become arguably much more intensive, which I believe is perfectly appropriate given the effect that problems at the largest firms had on the financial system and the broader economy. 

All of these characteristics have implications for how large and complex banks should be supervised, as compared with community banks. Notably, our supervision of large banks reflects the scope and complexity of their activities as well as their interactions with other firms and possible effects on financial markets, and incorporates systemic risk considerations that could arise from the failure of these banks.

In recognition of their systemic importance, the largest firms also are required to plan for their own orderly resolution in the event that they should fail. 

Because of their complexity and risk characteristics, these firms require intensive and continuous on-site supervision;

examiners also understand local market conditions to be able to put the bank's management and credit decisions in the proper context.

What does this have to do with community banks?

The community banking model is very different from that of the largest banks. Community banks are local by their very nature. They have deep roots in their communities.

This trait is particularly important when it comes to small business lending, where a local community bank may understand things about a prospective customer that cannot be captured in a more quantitative credit-scoring model that might be used by a larger institution.

these characteristics call for a very different model of examination and supervision than what is required for the largest banks.

Third, community banks are less interconnected, so when a community bank fails, the effects are less widespread. 

Strong lines of communication between examiners and community banks are vitally important.

Examiners need to listen carefully to management to understand their perspective where views may differ

We encourage our examiners to be responsive to questions from bankers and help banks understand new regulatory requirements, and they take this responsibility seriously.

the risk-management system of a healthy bank can be pictured as a series of concentric circles. The inner circles consist of the systems and functions that keep the bank healthy and allow it to meet the credit needs of its community while remaining financially sound and compliant with its legal and regulatory obligations. Moving outward, additional circles include processes and checks such as internal audit, executive management committees, risk-management and internal controls, and appropriate governance by the board of directors. The outermost circle is effective supervision. The critical element of this model is that problem identification is first and foremost the responsibility of the bank, while banking supervisors kick the tires of the bank's risk-management and internal control systems. The examiners are, in this sense, a last line of defense and do not substitute for a bank's own processes for risk identification and mitigation. They are not a guarantee of the bank's ultimate success or failure. 

this model of concentric circles generally holds true for banks of all sizes, the complexity of the largest institutions requires far more complex inner circles.

the outer circle that is necessary at a systemically important bank should be far more layered than what is needed at a small community bank. 

think about the effects these policies are likely to have on community banks and the areas they serve.

Federal Reserve are working to ensure that our supervisory program is properly tailored to the wide array of institutions

considering the effect that these policies might have on smaller institutions

we consider not only whether specific policies are appropriate for community banks, but also whether these policies could have the effect of reducing the availability of credit to sound borrowers.

Community Bank Supervision at the Federal Reserve

I hope my remarks will at least continue our conversation about how best to structure a regulatory and supervisory framework for the banking system that effectively supports the real economy and encourages sound and sustained lending to creditworthy borrowers. In order to sustain the economic recovery, we need strong, well-run community banks that operate in a framework of smart and effective supervision

Cross-jurisdictional liabilities.

take into account the liabilities of all offices of the relevant bank to entities outside the home market and include all liabilities to non-residents of its home jurisdiction.

international banks’ activities outside their home jurisdiction

Size.

bank’s distress or failure is more likely to damage the global economy or financial markets if its activities comprise a large share of global activity.

ts failure is therefore more likely to damage confidence in the global financial system

Interconnectedness

contagion in respect of other institutions depending on the network of contractual obligations in which it operates.

Intra-financial system assets.

Intra-financial system liabilities

Wholesale funding ratio.

Substitutability.

systemic impact of a bank’s distress or failure is expected to be negatively related to the substitutability of its services.

lack of realistic alternatives to a major business line

Assets under custody

disrupt the operation of financial market

Payments cleared and settled through payment systems

these institutions and customers may be unable to process payments immediately, affecting their liquidity.

Value of underwritten transactions in debt and equity markets

impede new securities issuance.

Complexity.

failure is likely to be greater, the more complex its business, structure, and operations are.

Notional value of OTC derivatives.

Level 3 assets.

Trading book value and “available for sale” value.

The BCBS provides some opportunity for individual supervisors of banks to make adjustments to a bank's G-SIB criteria determined by reference to the above criteria but states that it believes the bar for any such adjustment should be high, and it only expects such adjustments in exceptional cases.

continuing review of banks against the relevant indicators,

not proposing to develop a fixed list of G-SIBs. Banks could therefore migrate in and out of SIB status over time

G-SIBs, each bank will grouped into a category of systemic importance based on its score under the indicator based test specified above.

there will be 28 G-SIBs

Assessment Methodology

“indicator based measurement approach”

Each of these indicators is given a 20% weighting and, as specified below, most of the indicators are made up of two or more sub-indicators

Each indicator’s score is then aggregated.

Agency problem

Shareholder discipline.

Contingent capital holder discipline.

Market information.

Cost effectiveness.

Trigger failure.

Cost effectiveness.

Complexity.

Adverse signalling.

Negative shareholder incentives.

contingent capital should not be capable of meeting the additional loss absorbency requirement for G-SIBs

for consideration at the next G-20 meeting in November 2011, and it is expected they will be endorsed at such meeting.

28 banks will initially be specified as G-SIBs

The effect on such banks will, however, be significant

the common equity requirement for the largest global banks increasing from the current 2% of risk weighted assets to 9.5% (and potentially 10.5%)

G-SIBs will have some time to plan for the new loss absorbency requirement. The BCBS is proposing that the requirement will be phased in at the same time as the new capital conservation and countercyclical buffers between 1 January 2016, becoming fully effective at the start of 2019

the minimum “cut-off score” in relation to which banks will be regarded as G-SIBs will be set by 1 January 2014, and national jurisdictions will be expected to incorporate the new rules into legislation by 1 January 2015.

new Basel III framework at the end of 2010, the BCBS mandated all banks to hold significantly more capital than is currently the case as well as introducing new leverage and liquidity ratios

The Basel III rules apply to all banks. In addition, the FSB and the BCBS have been considering additional rules to apply to the largest global banks to deal with concerns that such banks are regarded as too big to fail

Basel Committee on Banking Supervision (“BCBS”) and the Financial Stability Board (“FSB”) published two papers relating to entities regarded as globally systemic important financial institutions (“G-SIFIs”)

Additional Loss Absorbency Requirement

Background

y.   Cons

: Pros

didn't the Dodd-Frank Act of 2010 end "too big to fail," and won't its "living wills" provision nudge our largest banks to become smaller and simpler?

"I can be hopeful. I am an optimist at heart, but I don't see any evidence of that."

his plans to protect commercial banking from riskier forms of finance

realizes regulatory tactics and strategies must evolve as banks balloon in size and scope, George insists boots-on-the-ground supervision is crucial. She worries complex approaches are overshadowing common-sense judgments.

funding advantage that has come from growing consolidation in the industry

helps calibrate capital,

"but to really know a bank's condition, you have to go in and examine those credits."

While the central bank has taken many steps in recent years to open its monetary policy decisions to more scrutiny by outsiders, its regulatory policy making has grown more opaque. Gone are the days when Fed governors debated policy decisions in open meetings. George would reverse that trend.

we have to apply the transparency pledge to everything we do

Part of what we have succumbed to is a sense of urgency. Things are moving fast."

time to "ponder the unintended consequences."

These rules have big import

her philosophy on regulation.

concern I have

You can make any rule as complicated or as simple as you want. The more complicated you make it, and I learned this watching Basel II get crafted, I don't think you ensure any chance of success."

I would like to see us go back to a time when examiners were required to use judgment. You gave them simple, clear rules and they had to make judgments."

it's all going to affect a lot of people.

I worry about the burden on small banks,

Consumer compliance issues seem to cause the most friction among bankers and their examiners, she said.

due to prescriptive rules that tell the examiner that you don't get to apply judgment here. If it meets this, this and this test, then it's a problem. That's the frustration of bankers."

Forbearance drags things out,

I think about it pretty simplistically. Anytime you have an asset, a loan, that gets into trouble, somebody has to take the loss. The sooner you take the losses," the better.

George belongs to a growing cohort of folks who question some of the conventional wisdom growing up around community banks, namely that a massive wave of consolidation is coming and the average size must increase.

I don't think there has to be a wave of consolidation."

I don't think they all have to be $1 billion" in assets

worried about credit risk at community bank

both margin pressure and competition from larger banks that can use lower funding costs to undercut smaller rivals.

is they [banks] need more yield so they will go out for more risk," she said. "And when they do that in a low interest rate environment it can look OK. But those borrowers start looking worse when rates start ticking up.

I have watched over the years. It is an accumulation of compliance, and community banks do not have the scale to spread those costs, so they bear them disproportionately."

I hear bankers saying

I am going to have to start making some credits that I wouldn't normally make because I have to generate earnings.'

community banks also are telling her about losing business to large banks.

but that big bank is coming in and pricing a loan in a way that I cannot and would not."

They say I am trying to compete with the big bank in my market

Community banks that survive will be the ones that hold the line on risk but continue to adapt, she said

community banks are core to the payments system and core to lending in these markets. I don't see that model being outdated. It's always got to be tweaked, but I worry the thing that is going to drag them down is regulation. That seems like something we could address and should address."