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wave of consolidation occurred in 1994

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.

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

"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,

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,"

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

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

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.

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.

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."

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

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

three-pronged reform agenda

capital plan

capital holes

it would be somewhere between €100bn ($137bn) and €200bn.

the plan needs to change

forced to meet the planned 9 per cent core tier one capital ratio in such a short time

determined not to raise fresh money – either from shareholders, because equity prices are so disastrously low, or from the state, because of an understandable fear of being stigmatised as a bailed-out bank that is weaker than its rivals

they would shrink their balance sheets, reducing the risk-weighted assets (or lending commitments) that form the denominator of their capital ratios, rather than boosting the capital that forms the numerator.

shrinkage of available bank credit across Europe

protesting about the lack of funding.

politicians and small business

the banks are bluffing

There is a strong reason to call their bluff

second prong

that will not be enough

normalise banks’ access to liquid funds in the bond markets.

Dexia,

often not insufficient capital that kills a bank (Dexia’s ratios were top-notch) but a lack of liquidity

short-term funding and long-term lending commitments proved fatal.

International regulators

come up with a new measure

the net stable funding ratio

will limit profitability and the banks have protested. But it should happen.

there needs to be a quick fix, too

there has been no issuance of bank bonds

Only with a temporary guarantee from a European Union vehicle can bond markets be reopened.

policymakers need to tackle the root cause of the problems in the periphery – namely, their budgetary mismanagement.

Silvio Berlusconi

must be ousted by the Italian people

entirely within the gift of those preparing for the weekend summit.

first two reforms

brave political calls, laying policymakers open to accusations of handing money to bankers again

the lesser of two evils

accompanied by an enforceable regime of business lending commitments

normal rules of capitalism have already been suspended. We should stop pretending otherwise and make the necessary intervention quickly and decisively

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

stimulus spending, as prescribed by mainstream economic theory, to create jobs and promote growth."

Obama intends to ignore the path for getting the economy back to full employment that most economists advocate.

vast amounts of excess capacity.

theory as to how budget cuts could boost growth

lower deficits in the present and/or near future will reduce fears that government spending will be crowding out private economic activity. This would lead to lower interest rates. Lower interest rates will provide a boost to investment and consumption. Also, lower interest rates in the United States will make dollar assets less attractive to investors. This will cause the dollar to decline against other currencies, improving our trade balance.

no part of this story makes sense in the current economic environment. US interest rates are already at ridiculously low levels,

interest rates did fall, it is difficult to believe that it would have much impact on either investment or consumption

policy will be determined by people with no knowledge of economics whatsoever.

Consumers remain heavily indebted due to the collapse of house prices.

The dollar continues to be a safe haven in uncertain times.

keep the dollar from falling too much against their currencies no matter how low interest rates fall.

unlikely that cutbacks in government spending will do much to lower the dollar and reduce the trade deficit.

Obama is apparently not listening to economists anymore, so he wouldn't care, in any case.

politicians who think that biology has no place in teaching the origins of species, we now have politicians who think that economics has no place in designing economic policy.

tens of millions of lives stand to be ruined.

Keynes's basic insights have been supported by a vast amount of economic research over the last seven decades. And we have solid evidence showing (pdf) that the limited stimulus pushed through by Obama in 2009 worked pretty much as predicted in generating growth and jobs.

doesn't matter at the White House any more.

evidence,

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

Jobs for low-skilled workers in manufacturing

lost to international competition

The path to recovery now lies

in upgraded skills, increased exports and public investments in infrastructure and low-carbon energy.

US and Europe have veered

consumption-oriented stimulus packages and austerity without a vision for investment.

good social policy does not mean running big deficits.

globalisation has not only hit the unskilled hard but has also proved a bonanza for the global super-rich

able to convince their home governments to cut tax rates on profits and high incomes

expand investments in human and infrastructure capital

First

through better skills and technologie

Second

Third

balance budgets in the medium term, in no small part through tax increases on high personal incomes and international corporate profits that are shielded by loopholes and overseas tax havens

projects will not add to net financial liabilities if they are repaid through future revenues.

Export-led growth is the other under-explored channel of recovery

cut wasteful spending, for instance in misguided military engagements

through better financial policies.

last missing piece for any recovery

clarity of purpose from the political class

Europe’s fate has been decided by German state elections and small Finnish parties

US has similarly devolved into a mélange of sector, class, and regional interests.

Obama is the incredibly shrinking leader

There is no growth strategy, only the hope that scared and debt-burdened consumers will return to buying houses they don’t need and can’t afford. Sadly, these global economic currents will continue to claim jobs and drain capital until there is a revival of bold, concerted leadership. In the meantime, the markets will gyrate in pangs of uncertainty.