Keys to small banks’ survival: One regulator’s view

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Regulators are sensitive to community bankers’ complaints about an uneven playing field. The challenge lies in addressing those concerns.

That was the main message from Julie Stackhouse, executive vice president of supervision, credit, community development and learning innovation at the Federal Reserve Bank of St. Louis, after a recent community banking research conference. The event, held in St. Louis, is hosted each year by the regional Fed bank, Conference of State Bank Supervisors and the Federal Deposit Insurance Corp.

For Stackhouse, the central issues are tax policy, compliance expectations and determining which financial institutions should be subject to the Community Reinvestment Act. Tackling most, if not all, of them would require legislative action.

The issues are important because they are spurring mergers among smaller banks, she said.

“I think the level playing field is important because the consolidation pressures are there,” said Stackhouse, who late last week announced plans to retire in the near future after nearly 40 years with the Fed system. She began her career in 1980 as an examiner at the Federal Reserve Bank of Kansas City.

Stackhouse also emphasized the growing importance of technology, noting that now is the time for all banks to evaluate whether they need a better digital banking strategy.

Here is an edited transcript of the conversation.

What were your biggest takeaways from the conference?

JULIE STACKHOUSE: There are two things that I think are forward-looking and important. The first deals with the constant message we heard about leveling the playing field across financial services providers. That’s so hard. We’ve got the banking sector, the credit union sector — we have nonbanks. And there’s an intersection where they’re competing for the same customer.

We heard it in three places. Tax alignment, in terms of credit unions. That’s more interesting now that we’re seeing more credit unions acquiring banks. Then you have the bank-nonbank CRA alignment. Banks must [comply], but credit unions and others don’t need to. That’s a much bigger issue than CRA itself, but it's out there if you’re looking at level playing fields. And the third one is compliance expectations. We have a methodology for looking at banks’ compliance with consumer laws and regulations. In theory these expectations apply to all lenders, but is the same expectation really there?

I think the level playing field is important because the consolidation pressures are there. Some of that is framed as regulatory burden. But I think it is about more than regulatory burden, and a level playing field is one of those factors.

The second takeaway is that technology will be an increasing part of banking even if it may not be evident today. And it will be driven by the consumer. That’s necessarily agreed upon by bankers. Often it is framed as, “My customer base hasn’t asked for things like online loan applications.” My usual response is, “What about the customer you don’t have?” Offering high-touch to one customer while making the necessary investments to attract — or at least avoid losing — the other customer will be a huge challenge for many community banks.

Are there areas where you would like to see more research?

Management succession. What do the demographics look like? How much ... ties into the ownership’s desire to have cash liquidation, or their own needs since many of these are family-owned? To me that would be very telling.

I think it would be very useful to see because if consolidation is driven, at least partly, by demographics, then that’s … not something where we can just flip a switch and change it. You could tailor regulations to take pressure off, but it isn’t going to overcome demographic issues.

The ability to attract talent [is another area]. We’ve worked hard on [the conference’s] case-study competition … with the idea that it would be valuable to have [students] come back and work on something that improves the reputation of community banking among the next generation. I think that’s been successful when you look at the number of schools that have participated.

The challenge is the expectations of the individual and what they want as a lifestyle. If you’re in an urban community it is probably relatively easy [to hire younger people]. … But when you’re in a very rural community, that’s a very different lifestyle. And what’s the capacity to attract talent? Can you measure that? That would be something worth studying to see how much could we affect that.

What are your thoughts about banks’ liquidity?

I try to be intentional with my comments to plant the seed as to why liquidity has changed. Some of it is where we are in the economic cycle. … That’s to be expected. Banks were flush with liquidity for many years after the financial crisis. But larger banks can more effectively compete for deposits than in any time I can remember. That’s a permanent structural change.


As regulators, I believe we just have to accept that there are some permanent changes that have happened and now we have to start to look at liquidity from a different perspective. Two things come to mind. Interest rate risk management is a bigger deal, and the extent to which deposits reprice is going to be meaningful. Right now, we’re in a low-rate environment, but it is going to change [over time].

The other thing is how maturities are structured. We’ve had very few bank failures lately. But when you rewind 10 to 12 years — we had some banks fail because of a lack of liquidity. … As regulators, I think we need to be thinking about things like the maturities structures, how interest rate risk is managed and how experienced is a bank’s management team on the implications of those things. I think that’s probably a sensible approach.

Banks are going to handle these liquidity pressures differently depending on their community. I think that will be important for regulation. A bank that has moved heavily into internet deposits, like Live Oak Bank, will have to be viewed in a different lens than the Bank of Bennington, which is still a very traditional bank. I think that we can calibrate it.

The key for the deposit relationship is the loan relationship. If you’ve got both, then the deposit relationship is going to be a whole lot stickier than if you’re just competing on rate. And I think deposit relationships tied to lending will be a lot more stable.

Some banks are willing to handle deposits without being the primary bank.

I think that’s right on the consumer side, and even with small business. But the commercial relationship, at least for now, seems pretty sticky. But the options are wide open for consumers and small businesses. There’s a different psychology [for millennials]. Often, when we talk about community banking, the last thing you want to do is suggest that things are changing overnight. I hope bankers understand that these [changes] are occurring, and will continue to occur, so the digital strategy should be top of mind.

Anything concerning in terms of credit quality?

There are definitely some [agriculture] customers that are stressed, but we’re just not seeing a lot of ag banks show stress at this point. The good news, because I was around in the 1980s, is that a lot of things are different. Many ag borrowers are not as levered as there were in the ‘80s. That gives banks a lot more room to make adjustments. Second, the banks have really good capital, and we’re happy to see that. Third, when we do have one-off issues, like flooding, things like flood insurance programs help along the margins. There are a number of things that make those things, while worrisome, not a crisis.

We don’t see it much in our district, but I hear that corporate debt levels have become an area of concern. There’s just a little more risk there, so we really need to see where those credits rest. But by and large our communities are doing pretty well. Do mistakes get made at banks? Yes, but nothing that is keeping us up at night.

What are your thoughts on CRA reform?

We have been working with several communities in our district to encourage high-quality partnerships between banks and well-situated nonprofits, but not necessarily because they have a CRA obligation. We try not to put that tone to it because it can come across as pretty negative.

We’ve been doing events called Investment Connection. For us it has been really positive. The community banks in St. Louis, and the local branches of some regionals, have really engaged with some of the less well-known, but high-potential, nonprofit organizations. That can make a difference in low- and moderate-income areas in the St. Louis community.

From our program we can account for something just short of a million dollars in new investment, but that’s not all we’re seeing happen. Once the connections are made, and the banking organizations work side by side with nonprofits, we’re seeing that result in relationships with other nonprofits and coalitions of banking organizations that are interested in investment. I think it goes well beyond the obligations of CRA to get to the more fundamental issue of how can communities support development in low- to moderate-income areas to make a difference in the community.

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Community banking Digital banking Liquidity CRA Federal Reserve
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