Financial Update (Second Quarter 2009)

Fed Gov. Tarullo: Small Banks Must Focus on Loan Quality

photo of Fed Governor Daniel TarulloCommunity banks probably will not see the significant supervisory changes that have been proposed for the nation's biggest financial institutions, but small banks must also adjust risk management in response to changing competitive and economic conditions, Federal Reserve Gov. Daniel Tarullo said during a recent speech.

At the North Carolina Bankers Association Annual Convention in Chapel Hill, N.C., Tarullo discussed the effects of the financial crisis, recession, and regulatory changes on large and small institutions. He also summarized his ideas for reworking the nation's financial regulatory structure.

Changes in banking industry reverberate
Legal developments, technological advances and changes in business strategies have fueled massive consolidation in the U.S. financial services industry. As large bank holding companies have expanded and acquired other institutions, the number of banking institutions in the United States has fallen by nearly 50 percent since 1989, Tarullo noted.

That consolidation has cut into smaller banks' market position. For one, the proportion of banking offices operated by community banks has declined more than 25 percent, and smaller banks' shares of deposits, assets, and small business loans have also declined substantially, Tarullo said.

Text of speech off-site image
Earlier Tarullo speech on regulatory changes off-site image
Gov. Tarullo bio off-site image

"Even so, many community banks have thrived, in large part because their local presence and personal interactions give them an advantage in meeting the financial needs of many households, small businesses, and agricultural firms," Tarullo said.

Community banks meet the challenge
He added that the profitability of most community banks appears to have withstood the incursion into their markets by large, diversified institutions. But he said the difficult economic environment has taken a toll: Nearly 20 percent of banks with less than $1 billion in assets lost money in the first quarter, and as of March 31 nonperforming assets were twice the level of a year ago and, when measured against total loans and the category of Other Real Estate Owned, stood at an historic peak.

"In this difficult operating environment, Federal Reserve examiners are encouraging community banks to focus on maintaining sound loan quality and strong credit administration practices," Tarullo said. "In addition, they are working with community banks to ensure that they maintain appropriate capital planning, credit administration, and liquidity management policies."

June 30, 2009