Supervision, Regulation and Community Banks

The Federal Reserve System has increasingly moved to a potentially more effective method for tailoring supervision and regulation to community banks: exemption. In this article, I briefly summarize the Minneapolis Fed’s support for this approach. I then ask community bankers in the Ninth District for their thoughts on where the new approach could apply.

Standard tailoring of supervision and regulation often applied one general approach to all banks, but either (a) made a few specific changes in the application to community banks or (b) called for supervisors to generally apply that methodology only after considering the size and complexity of the bank.

I see two problems with this standard approach. First, some rules just do not fit well for community banks. Second, over time it becomes hard to avoid a trickle-down of standards applicable to large banks that flow to smaller ones. Exemption avoids these two concerns by not applying a rule or supervisory approach to community banks in the first place.

A recent speech by Federal Reserve Bank of Minneapolis President Narayana Kocherlakota¹ focused on the need for a new kind of tailoring. In that talk, he noted:

Federal Reserve policymakers have recently discussed how better tailoring of supervision and regulation to community banks can be helpful in reducing the extent of this problem. The Federal Reserve does some tailoring already, but I think we should do more.

Where can we engage in additional tailoring? Governor Daniel Tarullo has noted potential benefits in reviewing statutes that apply new regulations to all banks. Community banks may not create the risks that a specific regulation addresses. ... I strongly agree with Governor Tarullo’s point that Congress and supervisors should exempt all community banks from certain regulations. Exempting is the best way to guard against regulatory trickle-down.

A second fruitful approach to additional tailoring concerns supervision, not regulation. I worry that our current supervisory methods establish expectations that are too detailed across too many areas of bank operations and too wide a swath of banks. Alternatively, supervisors could concentrate on a smaller number of activities that we believe are correlated with bad outcomes. To be specific, supervisors could choose to focus on rapid loan growth, high lending concentrations, specific high-risk types of lending and wholesale funding strategies and skip some of the more detailed reviews.

Kocherlakota went on to say, “I offer these ideas not as final prescriptions, but in the spirit of open inquiry. My main point is that we need to further investigate ways to tailor the supervision and regulation of community banks.”

In this spirit of an open inquiry and an open dialogue, I want to ask you for your suggestions about this approach. I have some ideas on where we can apply this new approach, but I want to hear from bankers in the district on the topic. Where do you think this new approach of exemption and tailoring supervision for community banks could apply? My plan would be to receive ideas from bankers, consider if and how this new approach could be applied to the ideas submitted and report back to banks in the Ninth District in a future column.

Please send your suggestions to mpls.src.outreach@mpls.frb.org. I thank you in advance for your input.

Endnote