ST. LOUIS — Small banks are taking outsize hits from regulation.

That was the main takeaway that Julie Stackhouse, head of supervision at the Federal Reserve Bank of St. Louis, got from this year's community banking conference co-hosted by the Fed and the Conference of State Bank Supervisors.

"The smaller you are, the higher the relative cost of regulation," Stackhouse said, reflecting on several academic papers presented at the two-day conference. "I don't think we can look past that."

The issue raises a plethora of questions, she said. What role should regulators play in reducing compliance burden? Is consolidation the right solution for banks seeking scale, or will there be other, more innovative ways to solve the problem?

Stackhouse said she doesn't have the answers, but she is encouraged that her employer continues to back efforts to better understand those issues as it looks for the proper response.

Other highlights from the conference included an impassioned keynote from Gene Rainbolt, the firebrand chairman of BancFirst in Oklahoma City; and a presentation from students at Southern Louisiana University, who won a case study competition by assessing the economic impact First Guaranty Bank in Hammond, La., has on its home state.

In an interview with American Banker, Stackhouse reflected on her favorite parts of the conference and discussed loan concentrations and other supervisory matters. Here is an edited transcript of the conversation.

What do you think the theme was for this year's conference?

JULIE STACKHOUSE: I think the theme was that the relative cost of regulation is much higher for smaller banks. It came out in different ways in different papers. That is something I want to think about a little bit more. What does that mean to the rate of consolidation at those banking organizations? Or how do they create the same benefits of scale if a merger is not part of their desire?

What made this year's conference stand out from prior ones?

What made me excited about this year — other than that the papers were good — is the fact that we had Gene Rainbolt as the speaker to bring a sense of pride about community banking and to instill what community banking can do at the beginning of a small business. I think that message has been lost over time. I have to admit that our student case study is a hit. When you read the papers and looked at the videos from the students, their interest in banking shone through. It really gives you hope that, although it's small right now, that we have a new angle for building a pipeline of future bankers.

How can banks get younger people engaged in the industry?

I think being involved makes a difference. Today, we can say that our students are reading articles about the Wells Fargo debacle, and that casts a very negative light on the industry. I also look at it from our angle where students sit down one-on-one with bankers and understand what a loan in the community really means. How it grows employment and how it matters to even the goalposts on the school football field. When you look at that you see promise and excitement. That gives them a different image of banking and, at least in a small way, they can see that banking is a promising career.

It is hard for students to decipher, but if we can show them that the value-add with community banking and its roots is very high, it can make a difference. These community banks need new management for the future and they can be more successful with a bigger pipeline.

Is there anything on the supervisory front that bears watching?

There are certainly a few banks with some real estate and some with levels of nonperforming loans that they still continue to manage, but generally we've worked through the vast majority of issues that caused problems during the financial crisis.

The issues today are very different. Cost of regulation. The paper that was produced by the St. Louis Fed makes that crystal clear. That smaller you are the higher the relative cost of regulation, and I don't think we can look past that.

Then there's management succession. These small banks are really starting to look at that and they're wondering how they are going to find that succession, which means the new pool of talent becomes important. We're hearing that and seeing it.

The third issue is the fact that the low interest rate environment is tough on banks with a basic banking model. Banks have gotten used to some of that in a way that is maybe not great, but acceptable. I think many of them are waiting for the next thing and wondering whether it will make them say they can't be in business anymore.

We have to do our part, at least on the regulatory side, to make sure we are calibrating properly, which is going to be an ongoing challenge.

And of course there's the cost of technology to consider.

Technology is intriguing. My takeaway is that your consumers will drive what your technology has to be. So that is going to be different for banks in bigger communities, which will demand more technology more quickly compared to some of the rural communities.

More banks are talking about regulators' concerns about CRE concentrations. What are your thoughts?

Concentrations are starting to edge up but it doesn't look like the peak. [Fed data shows that 11.3% of banks exceed CRE concentration guidelines, which is higher than 8.5% two years ago but well below the 32% that existed at the height of the financial crisis.]

That is the regulatory discussion. And even as you look at the individual loans the amount of leverage behind the loans, by and large, is different than what it was. … We're in a very low interest rate environment and, if left unattended, these conditions could arise again. While we're watchful, and believe it could be an issue, conditions right now are different. As long as we remain on guard, I think we'll be fine.

We know that sometimes supervisory policy and guidance can be very effective in at least causing lenders and bankers to pay attention. … Without question, banking supervisors went out in December with a restatement of the commercial real estate concentration guidance. And when we see a concentration we're looking more closely at how the risk is managed and we're having more candid discussions earlier in the process than we've ever had before. There is a lot of work but I think it is very constructive and it is causing people to pay attention very quickly. I feel very comfortable that this one is moving in a direction that will be beneficial for all.

People are also talking more about agricultural exposure.

It would be great if we all had a crystal ball, but the amount of debt and leverage in agriculture and farming real estate is different now than it was in the 1980s. Having said that, commodity prices are down, more loans are more stressed and bankers are paying more attention than they had to pay in the last few years. I don't see anything imminent in terms of vast concerns, mostly because the amount of leverage is lower this time.

There are always three things: concentrations, amount of leverage and the quality of leadership. You get one of those factors out of whack and you likely have some problems. Hopefully not too many, but some.

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