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FDIC Community Banking Conference
Strategies for Long-Term Success

Panel 2: Regulatory Developments

Moderator: Doreen R. Eberley, Director, Division of Risk Management Supervision, Federal Deposit Insurance Corporation

Panelists:

Transcript - PDF

Introduction

Just as the banking industry has undergone far-reaching changes over the past few decades, so has the job of the bank regulator. Advanced notice of examination start dates, pre-exam planning, and other off-site examination activities have helped make the on-site process more efficient and more productive. Regulators also have had to respond to new challenges related to technology and financial innovation while maintaining their focus on the principles of risk management. Panel 2 began with a discussion of recent initiatives to provide regulatory relief, and went on to address changes in the competitive landscape and shared services, before returning to a discussion of the long-standing fundamentals to be considered in the initiation of any new product or service.

Regulatory Relief

The panelists began by outlining the efforts their agencies are making to review regulatory requirements individually, under the ten-year review mandated by the Economic Growth and Regulatory Paperwork Reduction Act (EGRPRA) and through the efforts of the Federal Financial Institutions Examination Council (FFIEC).

The ongoing EGRPRA review has collected input on the effects of regulations from community bankers in every region of the country. Among the themes identified by bankers have been the cumulative costs of complying with multiple rules; the need to simplify Call Reports, review regulatory thresholds, and simplify capital regulations; and the long-standing effort to make the examination process more efficient. Each of the federal agencies has already been acting on suggestions received under the EGRPRA process, which will continue through the end of 2016.

The FFIEC is another active venue for efforts to provide targeted regulatory relief. These include a review of Call Report requirements for community banks and the introduction of the Cybersecurity Assessment Tool to help bankers determine their vulnerability to and preparedness for the growing threat of cyber risks.

One example the panelists cited of the agencies working together to respond to the concerns of community banks was the recent rule expanding the extended examination cycle for small, well-rated banks. Ms. Hunter described those concerns: “There were some banks in their comments [that] said We just do the exam, we get the report, we’re just responding to the report, and then the next request letter was coming in.’ So, I think the extended time period was intended to—and should—help alleviate some of that.”

Ms. Eberley described the long-term evolution of the approach the agencies have taken to the examination process: “All of us moved to risk-focused examinations in the late 1990s after the last crisis … and we are all continuing to evolve how we do risk-focused supervision.” This approach provides flexibility for both examiners and bankers to tailor what they do to the particular situation of each bank, and it works best with two-way communication. “A lot of our guidance is broad and it’s principles-based. And it says that you should apply it to your bank based on the nature of your activities, the complexity of your bank, and your risk profile,” said Ms. Eberley. A conversation between the banker and the regulator can set the expectation up front, so both are considering the issues in the same context.

The panelists also described how improvements in pre-examination activities have affected the on-site exam process. Ms. Kelly explained: “Doing more of the work off-site … reduces the burden that we’re creating by our presence there. Frankly, it allows us to be more efficient with the use of our resources, since we don’t have the travel time when we’re working off-site from the bank. So, hopefully, we can get the exam wrapped up more quickly.”

Added Ms. Hunter, “We’ve been really focused in on how we can, one, maximize the use of the information you’re already reporting to us through the Call Report and, two, minimize the time that we actually physically spend in the bank to those activities that have value added by being there.”

Changes in the Competitive Landscape

Panelists emphasized that regulation must constantly evolve in response to changes in the competitive landscape. High on the list of competitive challenges is the rise of fintech companies in making loans and providing other services through online platforms.

The OCC recently released a white paper on banks leveraging the innovations that are being introduced under fintech. In describing the OCC report, Ms. Kelly said, “What you’ll see in this white paper … is that we want to be sure that we’re being perceived as being receptive to responsible innovation ... . And we really want to make sure we’re striking the right balance between risk and innovation.”

Ms. Eberley added, “It’s clear that changing customer preferences and market developments are resulting in new types of technology and delivery channels for banks. We’ve paid attention to that, all of us, through the FFIEC.”

David Cotney of the Conference of State Bank Supervisors (CSBS) acknowledged that cost-cutting is a strategic priority for community banks. But he cautioned against losing focus on long-term, strategic opportunities: “Cutting costs is a big challenge. Whether you think about cutting personnel costs at branches, for most of you here in this room, that is not going to contribute to your long-term growth. Cutting back on IT or regulatory compliance costs, that’s not easy to do. I think that is when a lot of folks get caught in the trap that was mentioned on the last panel, of acquire-or-be-acquired. And it doesn’t, quite honestly, it doesn’t have to be that type of decision.”

Mr. Cotney also addressed the competitive challenge of developing new community bankers, describing a case study competition co-sponsored by the CSBS and the Federal Reserve Bank of St. Louis. According to Mr. Cotney, the competition in its first year attracted 33 entries from 25 colleges and universities in 18 states.

Shared Services

As community banks have sought to expand services and cut costs, the issue of shared services has come to the fore. Third-party technology service providers (TSPs) have assumed increasing importance as a means by which community banks can compete by providing online and mobile banking services while managing both the costs and the operational risks of doing so.

Reliance on TSPs introduces its own set of challenges. During Q&A, audience participants pointed to issues such as market dominance among a few leading TSPs that may lead them to restrict the use of new technologies and to impose liability caps that absolve them from acts of negligence or misconduct. The regulatory panelists acknowledged these challenges, and described their efforts to address them by sharing information through the FFIEC and making information available to regulated institutions through handbooks.

More banks have also experimented with sharing services among themselves, sometimes as a response to unforeseen challenges. Panelists described one instance when two banks shared a single chief information officer and other instances where banks shared the use of retail offices. In pursuing any type of shared service arrangement, the panelists pointed to the importance of dialog between banks and regulators. “We would just hate to have someone get too far down the road with something, and there may be something they’ve overlooked that comes to our mind, and we could just point it out early on. We don’t want to be at the point of saying, Whoa, you didn’t even think about this.’ We really want to be a resource,” said Ms. Kelly.

Applying the Fundamentals

Amid the ongoing changes and new challenges facing community banks and their regulators, the panelists emphasized the enduring value that banks gain from upholding the standards of risk management and safe and sound banking. As always, these standards apply to banking operations in a number of different ways. Ms. Hunter referred to the ongoing regulatory attention to credit concentrations, particularly in commercial real estate loans: “With commercial real estate we have seen the concentrations growing again. This was clearly a source of problems back in the earlier part of the 2000s leading into the financial crisis. And we’re very committed to not getting behind the eight ball on that very issue again. So you’re likely to hear lots of conversations.”

Ms. Eberley pointed to the importance of governance and efforts the FDIC has undertaken to clarify guidance as to the expectations placed on directors and management. Part of this effort is a special edition of Supervisory Insights published in April 2016, titled “A Community Bank Director’s Guide to Corporate Governance: 21st Century Reflections on the FDIC Pocket Guide for Directors.”[1] “We talk about the difference between the responsibilities and expectations of directors and management. … We’re all trying to be responsive to the concerns that have been raised, and make it clear in our guidance what our expectations are,” said Ms. Eberley.

Community bankers in attendance emphasized the importance of scaling regulatory expectations for risk management processes to the size and complexity of each institution. In discussing the implementation of new loan loss allowance accounting rules, Jane Haskins, President of First Bethany Bank in Bethany, Oklahoma, said, “I would implore you, when you’re considering the issuance of the guidance, that you understand that we don’t do complicated loans and make the loan loss reserve allocation comparable to the type of loans and the risk that we have in our community banks.” Ms. Eberley responded, “So, fair comment. And I can say that each of our Chief Accountants has been actively engaged with the Financial Accounting Standards Board (FASB) throughout this process … FASB has committed to making this a scalable pronouncement.”

Conclusions

As the community banking industry emerges from the post-crisis period, bankers and regulators alike continue to update their practices to increase efficiency and meet new challenges. Regulators have taken steps to provide regulatory relief where it makes business sense. They also are reaching out to community bankers through white papers and guidebooks to clarify regulatory expectations and assist the efforts of bankers to upgrade their governance and risk management practices. Meanwhile, community bankers are making the case that regulators should apply common sense in tailoring the application of risk management standards to the size and complexity of each institution. They are also updating their practices to cut costs and meet new competitive challenges such as fintech. Panel 2 demonstrated that constructive dialog between regulators and community bankers will continue to be essential as this innovation proceeds.

Footnote:

[1] https://www.fdic.gov/regulations/examinations/supervisory/insights/sise16/SI_SE2016.pdf.

Last Updated 12/06/2016
FDICcommunitybanking@fdic.gov