There has been much discussion in the press, legislature, among regulators and in the banking industry about the growing and untenable regulatory burden on community banks. There is a consensus that even with the current tiered regulation efforts, the burden is unfair, and threatens the very existence of the community bank model.
In the past few months several regulatory officials have made specific statements about their efforts to lighten the regulatory burden on community banks. In April, Maryann F. Hunter, the Deputy Director of the Division of Banking Supervision and Regulation at the Fed, stated before the U.S. House of Representatives:
The Federal Reserve has several internal efforts underway aimed at providing regulatory relief for community banks.
Later the same month, the Fed's Governor Daniel K. Tarullo, at the Independent Community Bankers of America 2015 Washington Policy Summit noted:
At the level of application, we need to tailor prudential regulations and supervisory practices with an eye both to those varying objectives and to the characteristics of differing [sized] groups of banks.
Speaking in March for the Conference of State Bank Supervisors, Candace Franks, who chairs the CSBS, stated:
One of our big concerns is that a one-size-fits-all approach to regulation is really going to harm the viability of community banks.
While the government and the industry try to work out a achievable scenarios to lighten the regulatory load on community banks, what may have gone unnoticed is that the regulators have already outlined how community banks can relieve some of the burden themselves.
Deputy Director Hunter put it this way in her recent speech to Congress:
.... If a well-managed bank's activities are lower risk, we adjust our expectations for examiners to a lower level of review. In this way, we alleviate examination burden on community banks with histories of sound performance and modest risk profiles.
This is a very clear statement of direction that equates the level of regulatory scrutiny with the level of risk management practices of the institution. While most community bankers would agree that banks with higher risk activity are treated more harshly, the statement by Hunter appears to go a step further:
The Federal Reserve has an initiative currently underway ....to identify high-risk community and regional banks, which would allow us to focus our supervisory response on the areas of highest risk and reduce the regulatory burden on low-risk community and regional banks...
This statement should create a very high incentive for community banks to find ways to be perceived by the agencies as "low risk."
What kinds of practices would help a community bank be considered "low risk"? Since the economic downturn numerous guidance and speeches from the various agencies have focused on best practices for risk management in community banks in three key areas:
- Capital Planning
- Stress Testing
- Concentration Management
From the OCC's 2012 bulletins on stress testing and capital planning and adequacy to the comptroller's handbook on concentrations of credit, the message is clear: Demonstration of a systematic approach to proactive credit risk management by a bank is a successful method to create a lower level of risk.
These areas are the obvious "regulatory hot buttons" for risk management and so naturally would be high-visibility areas for community bankers to focus on to demonstrate their lower risk status. The regulators have repeatedly emphasized that the implementation of a framework of proactive risk management (including the three best practices listed above), whether it's described as "enterprise risk management" or just a sound credit risk management program, is a key component of risk management.
Community banks that invest even modestly in proactive risk management best practices will show the measurement, control and monitoring of risk in a manner that makes a difference to the regulators. Since these practices are meant to be performed to a level commensurate with the complexity and risk appetite of the institution, for most community banks they can be performed simply with existing resources such as spreadsheets, or automated with relatively inexpensive software readily available today.
If a bank wants to lighten its burden, a path to get there is to use simple, basic credit management best practices like concentration management and proactive stress testing with linkage to capital planning. Document these practices, perform them regularly, and it is quite likely that the bank will be perceived as "lower risk."
These practices are within the reach of any sized bank today, so shift some of the regulatory burden to those institutions that choose to not proactively manage their risk.
Peter L. Cherpack is a senior vice president, principal and senior director of credit technology at Ardmore Banking Advisors in Pennsylvania, and a 20-year veteran of PNC bank.