The Systemic Importance of Community Banks

Championing its commitment to community banking, the Federal Deposit Insurance Corp. is hosting a conference Thursday to explore what's happening in the sector and what can be done to ensure its future.

Key policymakers will sound off, including FDIC Chairman Martin Gruenberg and Federal Reserve Board Chairman Ben Bernanke. But the day's highlight is likely to be a panel of six community bank chief executives who were invited to share the lessons of their careers and the strategies that have made them successful.

Interviews with five of the six executives revealed that none of them are doing anything particularly mysterious. But maybe that's the point: the key to thriving in community banking is largely common sense. Build core deposits. Diversify assets. Maintain strong capital. Control expenses. Hire smart people. Provide good service. Cultivate relationships. Invest in communities. Don't let problems fester.

"It's not a sexy business. It's not a flashy business," says Russ Taylor, one of the panelists and the president and CEO of RSI Bank, a $500 million-asset mutual that has been doing business in Rahway, N.J., since 1851.

"We just stick to what we've done all those years, and tweak it when we need to with technology. But we make sure that service and a steadfast approach to honesty and putting the customer first is what we put out there on a regular basis."

The six banks invited by the FDIC range from $180 million in assets to $2.5 billion; from one branch to 70; from 17 years in business to 161; from California to Connecticut.

These bankers don't think they have all the answers. Every one of them said they had no idea why the FDIC selected them to speak. Heck, one of them isn't even under the FDIC's jurisdiction; her bank is a member of the Fed.

But each executive is convinced that community banking is crucial to the nation's long-term growth.

"We play a very significant role in this economy. We are not the brains. We are not the heart. We are the blood supply," says Rick Smith, the president and CEO of Tri Counties Bank in Chico, Calif. "We are the ones able to make loans based on our intuition and judgment and common sense and not some computer form. I know how many businesses in our market are here today because we took a chance on them. That, to me, is entrepreneurialism and capitalism. If we lose the community banks, I am not sure we are going to have the same country."

The head of the $2.5 billion-asset bank adds, "I think this country will be a very scary place if there are only four or five banks providing credit."

These bankers expect the industry to consolidate, but none of them spent much time talking about that. They focused on the need to grow to be able to deal with the increased expense of complying with new rules, accounting standards and reporting requirements.

Even Smith, who runs that largest of the six banks represented on the FDIC panel, said Tri Counties must increase in size.

John Evans Jr., a fourth-generation banker who runs the $960 million-asset DL Evans Bank in Burley, Idaho, agrees. "I do think you are going to have to get bigger in order to be more competitive," he says. "My goal is to be a $2- to $3 billion bank in the next 10 years."

Perhaps the biggest challenge facing these bankers: getting customers to pay for products and services that have long been free. The industry, especially community banks, used fat margins to cover the cost of giving away everything from checking to online banking.

It's been a costly mistake.

"When we were making enough money in spread … we basically trained our customer base to expect everything to be free," says Martin Geitz, president and CEO of the $350 million-asset Simsbury Bank and Trust Co. in Connecticut. "At the time it was a great marketing strategy, particularly for community banks."

Simsbury Bank was born on that strategy. It opened in 1995 and positioned itself as the alternative to FleetBoston Financial, then the dominant bank in New England. "We were going to be personable, respectful and easy to deal with," Geitz says. "We waived lots of fees and that was a real differentiator."

But now that margins have evaporated, many of the larger banks are imposing new fees and requiring bigger balances or certain levels of account activity.

"That trend has not really been acted on at the community bank level, but I think we are all feeling the pressure" of tighter margins and escalating compliance costs, Geitz says. "If we don't step up to the challenge of repricing our products, then we've got a problem. You have got to look at fee income as a way to try to get through this."

Customers, he says, need to be convinced of the "virtues of community banking" like local decision-making and a flat organization that can act quickly and customize its approach.

"Our biggest concern is how do we get people to appreciate that and also appreciate that, in this kind of interest rate environment, the margin simply isn't there to allow us to offer stuff for free, so yes we are going to begin to charge different fees, but no that doesn't make us Bank of America.

"I think that is going to be a hard story to tell."

Smith agrees, and decided recently to take his story straight to the bank's customers.

In a letter posted this month on the Tri Counties website, Smith details all the ways the bank is making a difference in the communities it serves. And he put a bottom line on it.

Tri Counties' $34 million in net income since 2008 works out to be "about $165,000 per branch per year," or "about $7.73 per month per account," Smith wrote.

"We need to show customers that we add value," says Jane Haskin, president and CEO of the $180 million-asset First Bethany Bank and Trust in Oklahoma City. "The bank is not just a place where their money is parked."

Haskin said First Bethany is talking about changing the names of its products to better convey the worth to customers. "I think a good term for a checking account would be 'unlimited value' or 'value account,' " she says.

Often overlooked by customers, according to Haskin, are the fundamental benefits the banking system delivers, like a safe and secure payments system and insurance on deposits.

For all the angst over today's tight margins, these bankers are also plenty worried about the day when interest rates start rising again.

Short-term rates have been near zero for three-plus years, and the Fed late last month said they will stay there through the end of 2014. But that hasn't reassured the bankers booking loans at today's low rates.

"My biggest worry is on the rate side," Geitz says. "If rates went dramatically upward, we would have to deal with a balance sheet with a lot of 5% mortgages, and if the prevailing interest rates were now 8%, we'd have to deal with that."

Haskin adds, "We'll have to increase deposit rates and we won't be able to raise the rates on loans as fast."

Another major concern is how long bank owners will be satisfied with today's so-so payoffs.

"Shareholders, at some point, are going to become unhappy with their returns," Smith says. "And that's really what the issue is for banks going forward."

That's a threat — capital leaving the community bank sector because it can't earn a market return — that the FDIC, as the agency that touches more community banks than any other, can't ignore.

The answers are simple, if politically difficult.

Rationalize the regulatory system by scaling oversight to the risk a class of banks poses to the system. Yes, community banks are more likely to fail than larger banks, but those failures don't threaten to bring down the economy. If community banks are smothered by regulation, consolidation will continue and one day they will be gone. Communities across the country will suffer.

"We live and die by the quality of life and the economic vitality of our community," Geitz says. "Bank of America wants to be successful in Simsbury, Connecticut, but in the end that doesn't matter to them because they are so big.

"This is where I am hoping the FDIC, as my primary federal regulator, does in fact recognize that we are not systemically important. As a community bank, there is no problem if we fail. And so the type of regulatory oversight that we receive should be different than what Bank of America receives."