Community Banks Have Bigger Problems than Regulation

In the last few years, much attention has been given to how the volume of regulations emanating from Basel III and Dodd-Frank are making it difficult for community banks to compete with bigger banks with greater resources.

The challenges small banks are facing these days, however, go well beyond the impact of regulations. At the Omaha conference, speakers identified four other areas of concern that, in my view, are even bigger challenges for small banks. They are: managing interest rate risk when the Federal Reserve eventually raises rates; the impact of a weakening global economy; a lack of diversity in their boardrooms and C-suites; and succession planning.

First: At some point rates will go up and, depending on local economic factors, borrowers may face what is known as "wrong-way risk." That is, they could see their revenues decline as local economic conditions weaken at the same time that they have to start paying more for their loans when they refinance in a rising rate environment.

At a recent community banking conference in Omaha, I witnessed a wide range of level of preparedness to cope with a rising rate environment. If they do not already have them in place, community bankers need well-defined processes to improve their monitoring of existing borrowers, especially those who have floating rate loans or whose loans will be refinancing in the near term. Community bankers also need to review what options they have in terms of asking for more or higher quality collateral from borrowers.

Other economic factors will definitely influence community banking portfolios. Steve Cochrane, a managing director at Moody's Analytics (which, along with Web Equity, organized the Omaha conference), analyzed state by state the influence of exports, energy and wealth generated from the equity markets. All states and the community banks in them are sensitive to these three factors in different ways. And it is largely factors outside of the U.S., like anemic growth in Europe, slowdown in Chinese growth and recessions in Brazil and Russia, that are largely affecting exports from the U.S., global energy prices, and the U.S. equity markets.

Alaska, Colorado, Oklahoma, Louisiana, North Dakota, Texas and Wyoming are the most sensitive to low oil prices, which have fallen over 60% in just the last 12 months. The states that are most sensitive to exports to China and China's major trading partners, such as southeast Asia and Brazil, are Alaska, Idaho, Oregon, South Carolina, Texas and Washington. And the states most sensitive to stock market volatility are wealthier ones, such as California, Florida, Illinois, Virginia and most states in the Northeast. I am concerned that by definition, community bankers are focused on local factors that impact their borrowers' ability to repay loans. Community bankers have never been required by regulators or by their own boards to have a process to monitor the effect of global events and to integrate those factors into their risk assessments to monitor their borrowers. Thomas Friedman's adage that the world is flat very much applies to community bankers and their borrowers.

As I spoke and moderated a panel at the conference, I could not help but noticing that men significantly far outnumbered the women. There were also few minorities in attendance. I asked several male community bankers whether their staff and boards were more diverse than what I was seeing at the conference and it was clear that some were very uncomfortable with the question. Others, however, like Greyson E. Tuck, attorney and consultant at Tennessee-based Gerrish McCreary Smith, said: "Frankly most boards have been like male country clubs. Yet, some are starting to change in order to better reflect their changing communities."

Apart from being male-dominated, directors tend to skew older and more conservative, resulting in boards that are "set in their ways," according Dr. David Kohl, Professor Emeritus of Agricultural Finance and Small Business Management and Entrepreneurship at Virginia Tech.

This is concerning because boards that are set in their ways may be too slow to invest in the technology needed to improve customer service, efficiency and overall risk management. Banks' succession planning could also suffer if these boards aren't thinking about developing younger talent.

More than ever, community bankers will need to be acutely tuned in to this combination of global and domestic factors, which is changing their world at an unprecedented pace.

Mayra Rodríguez Valladares is managing principal at MRV Associates, a capital markets and financial regulatory consulting and training firm in New York.