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Fed Gov. Duke: Future Still Bright for Community Banks

Fed Gov DukeDespite a challenging economy and a host of regulatory changes, "the future for community banking is bright," said Federal Reserve Governor Elizabeth Duke during a February 5 speech in Duluth, Ga.

In addition to their important role in the U.S. financial system, community banks possess several natural advantages, she said, including deep community ties, daily interaction between managers and customers, and flexibility.

Duke spoke about the future of community banking before the Southeastern Bank Management and Directors Conference hosted by the University of Georgia.

Regulatory burden a top concern
Community bankers have expressed concern about the burden of new regulations. Duke highlighted Federal Reserve research confirming that smaller banks shoulder a disproportionate share of the burden, but noted that regulators have also taken steps to minimize the costs. For instance, smaller banks are exempt from many of the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Also, all new proposals and rules issued by the Board of Governors now include a clear statement about their applicability to community banks.

Community banks must balance new rules, lending
Banks must determine a way to comply with new regulations without constraining lending to creditworthy buyers, Duke said. "I think it is unfortunate when I hear some bankers say that they will stop offering mortgages if they can't make them the same way that they always have."

Community banks play a "small but vital" role in the residential mortgage market. At the same time, mortgages account for, on average, a quarter of their loan portfolios. "I still believe that community bankers can respond within the new environment by creating products that are profitable and meet the needs of their customers, while still managing their interest rate and funding risks," she said.

Research identifies characteristics of high-performing banks
A working group of economists from throughout the Federal Reserve System has been studying the viability and performance of community banks. "Members of this working group are exploring a number of interesting topics that I hope will help us to better understand the issues that affect community banks and, where appropriate, have a practical impact on how we supervise these banks," Duke explained. For instance, a study by two Board economists highlights several bank characteristics that were correlated with profitability from 1992 to 2010. Among them is managerial quality—a relationship that strengthened during times of economic stress, said Governor Duke. Other characteristics include:

  • Relative size—larger banks are associated with higher profitability
  • Portfolio composition—banks with high concentrations of real estate loans earned lower profits, while those with higher portfolio shares of construction loans earned higher profits (except for the 2008 to 2010 period)
  • Market—community banks operating in rural markets enjoyed higher average rates of return than those in urban markets.

This study and others reinforce Duke's own experience as a community banker, she said. That is, "community banks that have deep ties to the community, engaged managers and directors, conservative underwriting, and strong risk management can not only survive, but thrive, even in adverse conditions."

February 20, 2013


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