Federal Reserve Chairman Ben Bernanke noted in a recent speech: "Community bankers live and work where they do business, and their institutions have deep roots, sometimes established over several generations. They know their customers and the local economy. Relationship banking is therefore at the core of community banking."
He continued, "We at the Federal Reserve are keenly interested in their health and their collective future," adding that "local communities, ranging from small towns and urban neighborhoods, are the foundation of the U.S. economy and communities need community banks to help them grow and prosper." Bernanke cautioned that community banks had been hit hard by the recent financial crisis and need time to recover.
While community banks appear to have the attention of Washington leaders, it's important that Washington and bankers understand several trends and factors that impact the role of community banks.
Over the past quarter of a century, community banks (those under $1 billion of assets) have declined by more than half to 7,000. Voluntary and forced consolidations, Federal Deposit Insurance Corp. closures and limitations on new charters lead many to expect the number will be halved again by the end of this decade.
Many community banks have drifted in recent decades from core small-business and consumer lending toward financing commercial real estate. Commercial real estate loans, excluding residential properties, accounted for about 28% of community banks' total loans 15 years ago. That number has jumped to nearly 50%.
During the same period loans for business and investment purposes have fallen from 32% to 19% of total community bank loans.
Various justifications are offered for this change including the loss of local manufacturing and growing competition, yet many community banks found this shift attractive in achieving faster growth, higher yields and reduced servicing costs. Forgotten was the negative impact that economic downturns can have on commercial real estate.
The impact of changed priorities and a weakened economy on community banks has been startling. One indicator is the FDIC's "Problem Bank" list. From a low of 47 banks in 2006, the number rose to 884 at yearend. Nearly 12% of all banking institutions are classified as problem banks, 85% of which are community banks.
The "Texas ratio" compares nonperforming and other troubled assets to capital. A ratio above 50% is concerning and above 100% is frequently fatal. A review of publicly traded community banks indicates that half of the states have average Texas ratios for their banks exceeding 40% and the average in 18 states exceeds 50% with three of these exceeding 100%.
It's imperative that Washington and community bankers work together to preserve the important role of community banks and restore their strength.
This partnership can begin by gaining the support of the Fed, FDIC and other regulators to achieve major changes in Dodd-Frank. This would include repealing the Durbin amendment on debit card charges and exempting community banks from the Collins amendment restricting the availability of trust-preferred securities as a source of capital.
In addition regulators could lower the scale of today's regulation by acknowledging that all community banks are not equal and basing regulation and control on the quality of the institution. Most of the better-performing community banks today have been caught in the web of increased regulatory demands and controls.
Changes might also include less frequent oversight, simpler more limited processes and greater FDIC premium assessment differentials for the better-performing community banks. Changes that are meaningful should encourage weaker banks to achieve stronger performance and higher regulatory status.
At the same time, troubled community banks must recognize their problems and initiate changes to restore their strength. It's essential that community banks return to core small-business and consumer strategies, reduce troubled assets and supplement their capital. Waiting for a quick economic recovery is not an alternative.
Continued consolidation among community banks is a virtual certainty. But both community bankers and government leaders should do everything in their power to keep that consolidation to a minimum and ensure that the surviving banks are strong and able to serve the needs of small businesses and consumers in their communities.
