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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

In 1933 alone, about 4,000 commercial banks and 1,700 savings and loans institutions failed.

Kenneth H. Thomas

not all customers will benefit from greater consolidation

U.S. federal government rolled out various laws in 1784 to encourage multiple banks in individual states.

wave of consolidation occurred in 1994

"Many small banks feel that they are being pushed out of existence by new regulations,

swing of the pendulum last year, consolidation returned to 1994 levels. But in contrast to previous times, much of the consolidation has been due to failures

Loretta J. Mester

"In the short term, I think consolidation will pick up as weaker banks go through mergers and acquisitions, and stronger banks take time to get their capital shored up" in their pursuit of greater efficiency and economies of scale,

institutions that will likely be hardest hit by all this activity will be the community banks

have less than $1 billion of assets, but account for 92% of all banks and savings institutions,

Dodd-Frank Wall Street Reform and Consumer Protection Act was a death knell

experts expect consolidation to continue, and predict that the trend will leave the banking system better off in the long run. "We don't really need as many banks as we used to,"

Their plight hasn't been lost on the FDIC, which has launched various initiatives to give community banks some relief.

guidelines that lighten requirements for how these banks manage customers whose accounts are consistently overdrawn.

community banks play an important role in local economies. They typically have close relationships with individual customers

Todd A. Gormley,

"Smaller firms and local individuals trying to get loans from larger banks could be a subset of the population that is worse off because of consolidation,

concentration in geographic markets

are an important factor in the reciprocal relationship between lender and borrower

consolidation also leaves a handful of banks controlling the majority of certain types of products.

Four "mega banks" -- Wells Fargo, Bank of America, JPMorgan Chase and Citigroup -- now hold three-fifths of the home mortgage market, which limits consumers' choice of products and their ability to shop around for competitive pricing. "It's a textbook issue of a concentration of power," Guttentag says. "A limited number of firms control the market, and they will engage in implicit collusion."

borrowers with low incomes or bad credit are significantly less likely to default on loans if they borrow from a local bank than if they receive a loan from a distant bank or mortgage company.

some cities, states and regions have just one dominant bank.

Pittsburgh metropolitan area, PNC Bank has 47% of the deposit share, according to the FDIC. The second-largest bank in the area is Citizens Bank of Pennsylvania, which has 8.5% of the deposit share.

no limits on deposit shares in certain markets, 1994's Riegle-Neal Act imposes a 10% cap on nationwide deposits for a single bank.

Treasury Department is now looking into modifying the cap to include all consolidated liabilities.

consumers need not worry

Mester

While the total number of banks may be declining, the number of branches isn't.

In the last 10 years, the number of bank branches nationwide has increased 15%, although that expansion has primarily involved banks with $500 million or more in assets. The number of branches dropped slightly for the first time in a decade in 2010.

Guttentag

the number of banks will continue to shrink, but he doubts the U.S. will ever look like, say, Canada -- which has just 22 banks. Indeed, if consolidation continues as it has over the past 20 years at the average annual rate of 3.3%, it would take 60 years for the total number to fall below 1,000 banks and nearly 130 years to get below 100.

if the number of banks shrinks from 6,000 to 100, if those 100 are operating in all market segments and if consumers have many options, there is no reason for concern," Guttentag

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.

Stress testing is a "useful tool to gauge potential losses from different economic scenarios. It is no substitute for supervisory judgment and examination," she said.

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."

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 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.

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

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."

Robert Shiller

Columbia

Peter Diamond

Santa Fe Institute

Brian Arthur

sceptics of the efficiency of markets in all circumstances

Three of the participants

being a study of complex human behaviour, in which the world is created by human understand and motivations, economics is hard

orthodox economics had, in the years leading up to the crisis, become more a cult than a science

talking to political scientists and even sociologists. They also recommended looking at the causes of inequality, the economics of happiness, the role of institutions, the importance of culture, and the effects of power.

the sociology of the profession

militates against such heterodoxy

human beings are not rational calculating machines

time matters in economic processes

economics suffers from physics envy. It seeks to be an exact science, which is impossible.

the world is not computable

There cannot be just one general model of the economy or just one approach to economics

in theory it is right and proper to abstract in order to focus on a specific phenomenon. In addressing policy, this is irresponsible.

even though economists get much wrong, they still have much to offer to non-economists who tend to assume that economic problems are far more simple than they actually are.

great danger that in rejected the most simplistic pro-market mantras, economists and policymakers will embrace even more dangerous and naïve statism.

Chancellor to take control and veto decisions made by the Bank of England

previous regulatory structure

not having clear lines of accountability

FSA will be abolished

creation of three new bodies to regulate financial services

Financial Policy Committee (FPC) will work within the Bank of England

responsibility for regulation and monitoring risks to the financial sector to the economy.

oversee and instruct two new financial watchdogs.

Prudential Regulation Authority

Financial Conduct Authority

PRA will supervise the safety and soundness of individual financial firms

FCA will focus on consumer protection and ensuring employees who work in financial services comply with the rules.

"The Consumer Panel welcomes the intention to transfer responsibility for consumer credit regulation to the FCA

George Osborne said: "The Financial Services Bill will overhaul the failed system of financial regulation which allowed such dangerous levels of leverage to emerge.

"Everyone was so focused on ticking off a regulatory checklist that nobody felt it was their responsibility to use their judgment. "We are putting in place clear lines of accountability, and restoring that crucial element of judgment."

ack of clarity over who was accountable for what created the conditions whereby the Royal Bank of Scotland (RBS) was able to complete its takeover of Dutch bank ABN Amro which led to RBS requiring a £45 billion bailout from the UK taxpayer

British Bankers' Association

“Good financial supervision is not just about structure - decisions taken made by bankers and regulators matter too.

an important milestone in rebuilding trust in the financial services sector. There are still many issues to work though and we will continue working with government so the new structures, as they emerge,

the Bank of England will be in charge of regulation in “normal” times but the Chancellor will have the power to take over in a crisis if taxpayers’ money is at risk.

Director of Financial Services at Consumer Focus

This is a once in a generation opportunity to reform our financial regulation and it is vital we get it right. Consumers have been losing out for too long.

The Financial Services Bill must be passed by parliament before it becomes law.

has been seen as a key source of the 2008 crisis because it fostered a rapid rise in debt and tremendous asset price inflation

a major threat to long term stability

worldwide effort to monitor shadow banking so that regulators will be able to rein it in future.

including money market funds, securitisation, securities lending and short-term secured lending known as “repo” as well as other shadow banking entities. They are looking at how regular banks interact with their shadow counterparts.

The US has the largest shadow banking sector at $24,000bn

direct lending to companies and other means, are the single largest part of the shadow banking sector, with 29 per cent of the assets, and structured finance vehicles come second with 9 per cent.

regulators will focus their efforts on entities that use lots of borrowing, those that take in short-term money but lend it for longer periods – a process known as maturity transformation – and those that might destabilise markets by selling lots of hard to value assets quickly.

important to address systemic risks – such as maturity transformation and leverage – arising from the shadow banking sector and its interaction with the regular banking system,