Senate Banking, Housing and Urban Affairs Committee Hearing
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INTRODUCTION
Good morning, Chairman Johnson, Ranking Member Crapo, and distinguished Members of the Committee. My name is Charles Vice, and I serve as the Commissioner of Financial Institutions for the
CSBS is the nationwide organization of banking regulators from all 50 states, the
In my 25 years as both a federal and state bank regulator, it has become abundantly clear to me that community banks are vital to economic development, job creation, and financial stability. I know this Committee shares my convictions, and I appreciate your efforts to examine the state of our country's community banks and regulatory approaches to smaller institutions.
My testimony today will highlight the importance of community banks and their relationship-based business model, state regulators' vision of a right-sized community bank regulatory framework, and the states' efforts to produce new and enhanced research to promote a better understanding among policymakers about the role of community banks and the impact they have upon our local, state, and national economies and communities. I will also expand upon state and federal regulators' efforts at right-sizing regulation and supervision, and highlight specific ways in which
The U.S. banking system is incredibly diverse, ranging from small community banks to global financial conglomerates. This diversity is not a mistake, but rather a product of our unique dual-banking system. The dual-banking system, comprised of state and national banks chartered by state and federal regulators, has encouraged financial innovation and institutional diversity for more than 150 years.
Community banks are essential to the U.S. financial system and economy. The
Community banks engage in relationship lending in the largest U.S. cities and the smallest rural markets. Their role in providing credit and banking services is just as vital as the largest financial institutions. Their relationship-based lending business model is a complement to the largest banks' model-driven, economies-of-scale business model. In fact, many consumers, businesses, and farms are not served particularly well by standardized, model-driven lending. This is especially the case in rural areas, where the
Simply put, community banks are a vital part of a very diverse financial services marketplace and help ensure credit flows throughout the nation's diverse markets. They provide credit and banking services in a flexible, innovative, and problem-solving manner, characteristics that are inherent in the community bank relationship-based business model.
STATE REGULATORS' VISION FOR COMMUNITY BANK REGULATION
State regulators charter and supervise banks of all sizes, and we support and encourage banking industry diversity as a central goal of the dual banking system. Just as community banks have a first-hand knowledge of their local communities, we state regulators have an in-depth knowledge of our state-chartered banks and the communities in which they operate. Our local focus and authority provide us with flexibility. The 50+ different state banking agencies are able to serve as laboratories of regulatory and supervisory innovation, developing practical solutions and approaches that fit the needs of their particular states.
We are concerned that one-size-fits-all banking regulations are not differentiating enough between types of banks and are preventing community banks from delivering innovative, flexible services and products to their customers and the markets in our states. Recent regulatory reform efforts have centered on addressing the problems posed by the largest, most systemically important banks, and rightfully so. However, a global megabank and a small community bank are simply not the same.
Statistics on the U.S. banking industry illustrate the immense differences between a typical community bank and global megabank. Nearly 90 percent of the 6,656 U.S. depository institutions have less than
Design dictates outcome, and state regulators believe that rules that treat all banks the same, regardless of size and business model, promote further consolidation and will lead to a banking system with very little diversity and innovation. Indeed, I continue to hear from my community banks in
Regulators have the responsibility to regulate and supervise our community banks in a manner that recognizes their relationship-based business model. My testimony outlines a regulatory approach that counters one-size-fits-all, an approach that state regulators call right-sized regulation, and how it is particularly well-suited for community banks. This search for right-sized regulation and supervision is a matter that state regulators take very seriously and, as my testimony illustrates, have taken considerable measures to achieve. Based on this Committee's work and the measures taken by both federal and state regulators, I am confident that we as policymakers can undertake this effort to recognize the community bank business model.
Right-sized regulation does not mean less regulation, but rather regulations and supervisory processes that are appropriately designed to accommodate an institution's underlying business model. In the context of community banks, right-sizing requires understanding the business of community banking, tailoring regulations to meet this business model, and utilizing risk-based supervision.
THE NEED FOR ROBUST COMMUNITY BANK RESEARCH
State regulators recognize that designing a right-sized regulatory framework requires us to truly understand the state of community banking, the issues community banks face, and the nuances within the community banking industry. Data-driven and independently developed research on community banks is sorely lacking when compared to the breadth of research dedicated to the largest financial institutions and their impact upon the financial system and the nation. To address the need for research focused on community banks, state regulators, through CSBS, have partnered with the Federal Reserve to conduct the annual Community Banking in the 21st Century research conference. n5 Bringing together state and federal regulators, industry experts, community bankers, and academics, the research conference provides valuable data, statistics, and analyses about community banking. Our hope is that community bank research will inform legislative and regulatory proposals and appropriate supervisory practices, and will add a new dimension to the dialogue between the industry and regulators.
The research conference represents an innovative approach to research. The industry informs many of the themes studied, providing their perspective on issues through a national survey and local town hall meetings. At the same time, academics explore issues raised by the industry in a neutral, empirical manner, while also contributing their own independent research topics. This approach ensures that three research elements - quantitative survey data, qualitative town hall findings, and independent academic research - all enhance and refine one another, year after year. The research conference's early success underscores the interest and need for community bank research: this year, more than 1,000 community bankers participated in the national survey, more than 1,300 bankers attended local town hall meetings, and more than 37 research papers were submitted by academics for consideration, a considerable increase from the number of papers submitted for the 2013 conference.
Last year's inaugural conference has already provided us with valuable data and research findings on the importance of community banks and the centrality of their relationship-based lending model. For example, a study presented last year found that community bank failures lead to measurable economic underperformance in local markets. n6 Research also shows that the closer a business customer is to a community bank, the more likely the start-up borrower is to receive a loan. n7 Community banks also have a key advantage through "social capital," which supports well-informed financial transactions. This so called "social capital" is the basis for relationship lending and exists because community bankers live and work in the same communities that their banks do business. The success of the community bank is tied directly to the success of consumers and businesses in those communities. This is especially true in rural areas, where the community bank relationship-based lending model results in lower default rates on
These highlights provide examples of the value this type of research can provide. Policymakers can have better understanding of the role and value that community banks play in our economy. This should inform and inspire us to not establish broad asset thresholds out of political pressure, but craft meaningful approaches that are consistent with a banking model that we want to exist because of the value community banks bring to the economy and the limited risk they present to the financial system.
The second annual Community Banking in the 21st Century research conference is next week,
Bankers have been very vocal about the compliance burdens associated with the new Ability-to-Repay (ATR) and Qualified Mortgage (QM) rules. Our research finds that community banks continue to see opportunity in residential mortgage lending, but have a mixed view of making non-QM loans, with 26 percent of respondents indicating that they would not originate non-QM loans and an additional 33 percent only originating non-QM on an exception basis. Assessing the new ATR and QM mortgage standards against existing loans, 67 percent of bankers identified a low level of non-conformance, suggesting the two rules generally align with existing bank practices.
However, bankers in the town hall meetings were quite clear: the ATR and QM mortgage rules have required banks to make significant operational changes in order to comply. These changes have increased the cost of origination, the cost to the consumer, and have reduced the number of loans a bank can make. If a new requirement is generally consistent with most community banks' practices, why does implementation produce increased cost and a reduction in credit availability? This is not an outcome that any of us should want.
It will come as no surprise to hear that community banks have voiced concerns about increasing regulatory compliance costs, but these costs have been difficult to quantify historically. To encourage additional data and research in this area, the survey seeks to identify how increased compliance costs are realized in the bank's operations. Survey data show that rising compliance costs primarily take the shape of spending additional time on compliance, hiring additional compliance personnel, and increasing reliance on third-party vendors.
The survey shows less than a quarter of respondents looking to add new products and services in the next three years. This was confirmed in the town hall meetings, where bankers indicated that the compliance burdens and security concerns are significant headwinds to new products and innovation. Similarly, bankers expressed that new regulations have changed how they approach serving their customers, shifting their mentality away from creating flexible products for customers and towards what regulations allow them to do. We must take this as an important red flag. Any industry that is not in a position to innovate while the world around it is innovating has questionable long-term viability.
In addition to the qualitative feedback from the town hall meetings and the survey results, a dozen research papers will be presented next week. This year's lineup of research papers and speakers will build upon last year's research, and provide some interesting perspectives. n9 For example, one paper set to be discussed looks at the current regulatory burden surrounding community banks, and finds that more than 80 percent of responding banks report a greater than 5 percent increase in compliance costs. Another paper examines the federal banking agencies' appeals processes, finding the processes seldom used, inconsistent across agencies, and at times dysfunctional. The paper recommends establishing an independent authority for appeals that could apply a more rigorous standard of review. Still another paper provides new research on de novo banks. State regulators are concerned by the lack of de novo banks during the economic recovery, and we believe more research is needed to appreciate the role new bank formations play in a vibrant, healthy banking system and to see if there are any regulatory impediments to de novo banking activity. Findings like these are just what policymakers need to inform their work toward designing a right-sized policy framework for community banks.
STATE EFFORTS TO RIGHT-SIZE COMMUNITY BANK REGULATION & SUPERVISION
State regulators have a long history of innovating to improve our regulatory and supervisory processes to better meet the needs of our banks, their customers, and our states. Because of our roles and where we fit in the regulatory framework, state banking departments are able to pilot programs at the local level based on our particular needs. This often leads to innovative practices bubbling up from individual states and expanding into other states. At the same time, each state has the authority to choose what works best in their local context. This regulatory flexibility is a strength of the state banking system. After all, community banks in
I would like to highlight just a few cases in which state regulators have proven to be particularly adept at developing and implementing flexible practices to better serve our smaller institutions. Some of these examples are broad, historic initiatives that have significantly shaped the trajectory of U.S. banking regulation and supervision, such as the joint and coordinated bank examination framework. Other examples provide local snapshots highlighting the flexibility that individual states exercise on a regular basis. The significance that these are state-based solutions cannot be understated. States have the dexterity to experiment with supervisory processes in ways that the federal government cannot without applying sweeping changes to the entire industry. This is by design and a trademark of our dual-banking system. As states develop these practices, CSBS has developed several vehicles for states to share techniques and best practices with one another, allowing for the speedy deployment of successful models nationwide and maximizing regulatory efficiency.
Joint Examinations of Multi-Charter Holding Companies
Joint bank examinations trace their roots back more than two decades, when due to interstate branching restrictions, bank holding companies would often own independently chartered banks in different states. To improve regulatory efficiency, state banking agencies began conducting joint examinations of multi-charter holding companies with other state regulators.
Before the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (Riegle-Neal), states like
This process ultimately leads to a more consistent examination experience for these community institutions. Rather than the holding company having to handle numerous examinations throughout the year, regulators conduct coordinated examinations of all the holding company's institutions at the same time, satisfying state and federal supervisory requirements in a streamlined manner.
This is just one of many illustrations of how state regulatory agencies have shown great flexibility and willingness to reduce burden for their state-chartered institutions, all while maintaining the same level of effective oversight.
Many state banking departments follow the practice of assigning a single individual as a central point of contact to specific institutions to conduct ongoing off-site surveillance and monitoring. The off-site portion of this process promotes efficient and effective state supervision, allowing examiners to carry out their work away from the bank, freeing up bankers' time and office space. At the same time, central points of contact also provide banks with a single person to turn to when they have supervisory questions and issues, ensuring a more direct, faster response to their needs.
Arkansas Self-Examination Program
A state-specific example of regulatory innovation can be found in the Arkansas Self-Examination Program. The program serves both as an off-site monitoring program and an effective loan review report for bank management. Since its introduction in 1986, the program has created significant regulatory efficiencies and benefits to participating community banks.
When an
Both the information provided by the banks and reports generated by the
Although the program is optional, the participation rate of
New Examiner Job Aid
In addition to coordination with the industry to make supervision more efficient, state regulators are increasingly turning to technology to enhance and streamline supervision. In 2012, CSBS published a Loan Scoping Job Aid (job aid) for examiners that encourages state regulators to consider institution-specific criteria that may lead to a smaller, yet more effective, loan review methodology. n12 Loan review is the cornerstone of safety and soundness examinations, providing examiners the best avenue for determining a bank's health. The CSBS job aid provides methods for examiners to improve their loan scope by reviewing a different sample of loans than would otherwise be the case. This more thoughtful, risk-focused, yet surgical approach will help regulators identify new risks and provide community banks with more meaningful and useful examination results.
These examples demonstrate the willingness of state regulators to seek innovative solutions and methods to provide comprehensive and effective supervision, while tailoring our efforts to the business models of banks. Banks should be in the business of supporting their communities. We are working to enact supervision that ensures safety and soundness and consumer protection, while allowing state-chartered banks to serve their customers most effectively and contribute to the success of our local communities, our states, and our nation.
RIGHT-SIZED REGULATION IN THE FEDERAL CONTEXT
While some see the industry's regulatory challenges as being about the volume of regulation, state regulators see the issue as the type of regulation and the compatibility between a given regulation and the business model of the regulated entity. State regulators are concerned that regulations seem aimed at removing all risk from community banking. The tendency is to focus on the 489 banks that have failed since the crisis as justification for a more conservative approach overall. However, when you approach regulation and supervision from the perspective of the over 5,000 community banks that did not fail, I believe you come to a more balanced and accommodative approach. The many smaller banks that successfully navigated the financial crisis and continue to operate today have shown their ability to manage the risks of their business. Laws and regulations should recognize this, and regulators, in implementing policies and regulations, need to focus on whether institutions are properly managing and mitigating - not necessarily eliminating - the risks of their business.
FEDERAL EFFORTS AT REGULATORY RIGHT-SIZING
State regulators recognize that our federal counterparts have made some positive and constructive contributions to a right-sized regulatory framework for community banks. However, we must recognize that in some cases, these efforts would not have been necessary had statutes or rules been appropriately designed or applied to community banks in the first place. By and large, the efforts outlined below prove that federal policymakers, both in
The
The
Tailoring Regulatory Communication to Smaller Institutions
The federal regulatory agencies have made efforts to produce useful and accessible guides for smaller institutions on complex rules. While state regulators question whether overly complex rules should apply to community banks, we acknowledge the agencies have taken important steps in communicating the requirements of such rules.
For example, the ATR and QM statutes in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) resulted in a thorough and complex final rule. n13 To ensure the industry was better informed about this complex final rule, the
The
A key ingredient to making regulation responsive is effective regulatory coordination.
State regulator involvement in the
One of the
Another area of focus for the
Automated Exam Tools
State regulators' ability to tailor loan review to the risks facing an institution, as discussed above, is possible because of technology developed by the
Dodd-Frank and the Role of State Regulators
State regulators are best positioned to recognize risks building up in their local markets, and they can quickly address these local risks at the state and local level.
Money Remittance Improvement Act
Recognizing the unique approach of state supervisory agencies and the value such an approach can bring to federal partners, the recently-enacted Money Remittances Improvement Act improves the
OPPORTUNITIES FOR POLICYMAKERS TO RIGHT-SIZE COMMUNITY BANK REGULATIONS
Right-sizing regulation is not a one and done undertaking; for state regulators, this concept is in our regulatory DNA and part of our regulatory mission, and we urge our fellow regulators and
The following represent specific actions that
Mortgage Rules Should Better Reflect the Realities of Community Bank Portfolio Lending
Community banks that hold the full risk of default of a loan are fully incented to determine the borrower's repayment ability. Laws and regulations regarding mortgage lending should reflect this reality.
QM for Mortgages Held in Portfolio
When a community bank makes a mortgage and holds that loan in portfolio, the interests of the bank and the borrower are inherently aligned. Yet, the survey and town halls conducted in conjunction with our upcoming
Improving the
The Dodd-Frank Act's ATR requirement's restrictions on balloon loans and the
Community banks retain balloon mortgages in portfolio as a means of offering credit to individuals that do not fit a standard product but nonetheless can meet the monthly mortgage obligation. That is the logic behind the Dodd-Frank Act provision providing balloon loans with QM status if those loans are originated in rural or underserved areas by a small creditor.
However, the
CSBS has suggested that the
More fundamentally, portfolio lending is not a "rural" issue or an "underserved" issue, it is a relationship-based lending issue for all community banks. Eliminating the rural or underserved balloon loan limitations for qualified mortgages would effectively expand the
Tailor Appraiser Qualifications for 1-4 Family Loans Held in Portfolio
Current appraisal regulations can curtail mortgage lending in markets that lack qualified appraisers or comparable sales.
Community Bank Fair Lending Supervision Must Acknowledge the Business Model and Be Applied Consistently
State regulators take the difficulties that many underserved borrowers have had in obtaining access to fair credit very seriously, especially in regards to mortgage lending and homeownership. State regulators are committed to enforcing institutions' compliance with the letter and spirit of our fair lending laws, but we are concerned about regulators' overreliance on opaque statistical models that use small samples to judge fair lending performance and inconsistencies in federal regulators' approach to fair lending supervision. Many times it is not the statute that creates the problem, but the interpretation, guidance, and the examination techniques utilized. Federal agency leadership must commit to a more pragmatic and transparent approach to fair lending supervision.
Federal regulators should not use one-size-fits-all techniques and tools on community banks in fair lending examinations. A smaller institution makes case-by-case lending decisions based on local knowledge and local relationships. While statistical analysis plays a role in fair lending supervision, it is not the beginning and end of the analysis. Supervisors must utilize their flexibility to look beyond statistical models to take a more holistic view of the lending decision.
Despite assurances of consistent approaches from "headquarters" to "the field" and of continued collaboration to ensure consistency, state regulators have observed meaningful differences in how the three federal banking agencies treat community banks on fair lending issues and as well as a disconnect within the individual agencies. Federal agency leadership has the responsibility to make sure this is not the case, and they must be accountable for ensuring transparency and consistency.
The current approach to fair lending for community banks is having a chilling effect on credit availability, as banks, frustrated by the examination process, are curtailing or exiting many consumer credit products. From a public policy perspective, we should want community banks doing this business. If there were only 66 banks that had compliance or Community Reinvestment Act problems in 2013, n19 and referrals to the
The Application Process for Community Banks Must Reflect the Business Model
Community bank applications submitted to federal banking agencies for transactions such as mergers and capital investments can take an extended time to process because the agencies have to ensure the decision will not establish a precedent that could be exploited by larger institutions. The approval of a merger, acquisition, or expansion of activities should be related to the overall size and complexity of the transaction, and community banks should not be unnecessarily penalized for the potential action of larger financial institutions. Federal law, an agency rule, or a clause in an approval letter could provide the necessary protection by stating that application decisions for banks below a specified size (perhaps
To further address the length of time the agencies take to review community bank applications, the application review and approval process for institutions below a certain size should be de-centralized with more final decision-making authority given to FDIC Regional Offices and the regional Federal Reserve Banks.
Additionally, the federal agencies need to be open-minded when faced with circumstances that do not fit within predetermined parameters. Most recently in my state of
Federal Regulatory Agencies Leadership Should Include State Supervisory Representation
Meaningful coordination in regulation and supervision means diversity at the highest governance levels at the federal regulatory agencies. The current FDIC Board does not include an individual with state regulatory experience as required by law. n20 The
Similarly, to ensure the Federal Reserve's
CSBS was pleased to see that the
MOVING FORWARD
Community banks need a broad, principles-based regulatory framework that effectively complements and supervises their unique relationship-based lending model. Such a framework acknowledges community banks' distinct contribution to thousands of local markets, ensures banking industry diversity, and ultimately promotes economic growth.
Policymakers are capable of right-sizing regulations for these indispensable institutions, but we must act now to ensure their long-term viability. CSBS remains prepared to work with members of
Thank you for the opportunity to testify today, and I look forward to answering any questions you have.
n1 www.csbs.org
n2 "Quarterly Banking Profile: Second Quarter 2014."
n3 "FDIC Community Banking Study."
n4 Ibid.
n5 "Community Banking in the 21st Century."
n6 Kandrac, J. "Bank Failure, Relationship Lending, and Local Economic Performance." Available at: https://www.stlouisfed.org/banking/community-banking-conference/PDF/Kandrac_BankFailure_CBRC2013.pdf
n7 Lee, Y., and
n8 DeYoung, R., et. al. "
n9 The full line-up of papers presented and the conference webcast will be available at: https://www.stlouisfed.org/banking/community-banking-conference-2014/
n10 Nationwide Cooperative Agreement (Revised 1997). Available at: http://www.csbs.org/regulatory/Cooperative-Agreements/Documents/nationwide_coop_agrmnt.pdf
n11 Nationwide State/Federal Supervisory Agreement (1996). Available at: http://www.csbs.org/regulatory/Cooperative-Agreements/Documents/nationwide_state_fed_supervisory_agrmnt.pdf
n12 Available at: http://www.csbs.org/regulatory/resources/Pages/JobAids.aspx
n13 Dodd-Frank Act Sections 1411 and 1412.
n14 12 U.S.C. [Sec.] 3301.
n15 P.L. 109-351, Title VII, [Sec.] 714(a).
n16 12 U.S.C. [Sec.] 3311.
n17 http://www.csbs.org/cybersecurity
n18 Moore, R., and
n19 "FDIC Annual Report 2013."
n20 12 U.S.C. [Sec.] 1812(a)(1)(C).
n21 "The Composition of the
n22 Available at: http://goo.gl/eCKVrS
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