No doubt, ongoing technological advances and the evolving competitive lending landscape will continue to present both challenges and opportunities for community bankers who are deeply committed to the provision of credit to small businesses. I remain confident that community bankers will continue to play a vital role in the small business lending landscape as the respective business models of online platforms and community banks evolve. The advantage that comes from close relationships with their customers and intimate knowledge of their communities that lie at the heart of community banking will continue to provide a powerful advantage in serving the vital banking needs of small businesses, even as the use of nontraditional sources of data and electronic processing platforms may permit faster loan decisions, especially for smaller loan amounts, to a broader set of borrowers.

We recognize that depository institutions come in many sizes, have different business models, and manage different risks. As a result, it is often necessary to tailor regulations to the institution. Applying a one-size-fits-all approach to regulations may produce a small benefit at a disproportionately large compliance cost to smaller institutions.

Of particular concern in this regard is the need to ensure our regulations are appropriately calibrated for smaller institutions. For example, because the largest banks present the greatest risk to the stability of our financial system, many of the regulations passed under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) are specifically targeted at these firms. It would be counterproductive to apply those same expectations to small banks. Accordingly, we think it is important to tailor rules whenever possible to clearly differentiate expectations for different portfolios of banks and reduce undue burden on community banks. Tailoring regulations may be more challenging in some areas, such as rules that provide transparency and fairness in consumer transactions. Those are standards that apply throughout the financial system.

For more than 75 years following passage of the Banking Act of 1933, the motivation for banking regulation was fairly simple: the government had granted deposit insurance and access to the discount window to depository institutions to forestall runs and panics. The resulting moral hazard and the use of insured deposits as a funding source for these institutions justified prudential measures, including prohibitions on non-banking activities, aimed at maintaining safe and sound banks, which would in turn protect taxpayers.

There is now more widespread agreement that these aims should vary according to the size, scope, and range of activities of banking organizations. Most significantly, banks of a size and complexity such that serious stress or failure could pose risks to the entire financial system need regulation that incorporates the macroprudential aim of protecting financial stability. There is also a good argument that very large banks that fall short of this level of systemic importance should nonetheless be regulated with an eye to macroprudential aims, such as the ability of the banking system as a whole to provide credit.

Although individual community banks may be an important source of credit, particularly in local economies outside urban areas, neither systemic risk nor broad macroprudential considerations are significant in thinking about prudential regulation of community banks. So what should the aims of such regulation be? The basic answer is it should protect the deposit insurance fund. In other words, the traditional microprudential approach to safety and soundness regulation continues to be appropriate for these banks.

For that reason, I believe community banks have a vested interest in seeing that regulatory reforms move ahead to ensure that the largest banks are well capitalized, well supervised, well managed and subject to failure. Achieving that end will serve the public well. While that work is underway, regulators must also allow examiner judgment and common sense to play a greater role in their supervisory regimes for community banks.

I'm often told that the world has become more complicated, that we have too many banks in the U.S. and that we cannot go back to less-complex and more-straightforward regulation and rules and greater supervisory judgment. I'm not convinced. One of the best responses to that assertion was from Sir Mervyn King, the former governor of the Bank of England. Although his reference was made in the context of finding a solution to the issue of too big to fail, the same might be said for addressing the regulatory environment more generally. He said, There are those who claim that such proposals are impractical. It is hard to see why. What does seem impractical, however, are the current arrangements.

Senator, I would welcome the appointment of a community banker to our board That said, I don't support requiring it via legislation. There are seven governorships. The board has many different needs. I think if we were to sit down and make a list of all of the kinds of expertise that are needed and are useful, there would be more than seven items on that list. And I would, you know, prefer to see appointments made in light of the priorities, including for a community banker, rather than for the indefinite future locking in and earmarking particular seats for particular purposes.

I feel that's a road that could go further in a direction that would worry me. If we're earmarking we could end up earmarking each seat for a particular kind of expertise. And I think greater flexibility needs due change over time. But that's not in any way to diminish my support for seeing a community banker appointed to the board.

Why was it that the banking system in this part of the country was, apparently, especially vulnerable, and what lessons can be drawn from this experience?

At the risk of some oversimplification, I'll propose four takeaways.

First, concentrations can be deadly. Many of the banks that failed, especially around Atlanta, were relatively young banks that became highly concentrated in residential real estate loans, particularly acquisition, development, and construction, or ADC loans.

Second, many of the banks that failed were excessively reliant on wholesale funding. The median wholesale funding-to-asset ratio of the Georgia banks that failed was 30 percent. Hot money can burn you.

Another factor that contributed to failures was inexperience with severe conditions along with overdependence on collateral values without an understanding of cash flows under various scenarios. I'm a former commercial banker. I was taught that cash generation repays loans, and analysis of the borrower's ability to repay is basic...

Finally, many of the failed banks suffered from weak governance. Banks need board members who understand their role as directors. Directors as a group set policy, define the risk appetite of the bank, and hold management accountable for risk management.

As auto, mortgage, and credit card loans have become increasingly standardized, community banks have had to focus to a greater extent on small business and commercial real estate lending--products where community banks’ advantages in forming relationships with local borrowers are still important. These are not cheap or easy loans to make, and the loss of some traditional product lines has threatened the stability of some community banks. It is incumbent on the Federal Reserve and other regulators to understand the challenges community banks face and to ensure that our regulatory policies do not exacerbate them.

[A]s we and other agencies craft regulations to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and adjust supervisory practices to meet these priorities, I think we must avoid a one-size-fits-all approach to supervision.

No one can argue with the need for stronger regulation to prevent the lending abuses that led to the current foreclosure crisis. However, I think it would also be unfortunate if the laws and regulations put in place to require other lenders to adopt the same responsible practices long used by community banks are so complicated and expensive that they have the unintended effect of forcing some community banks to leave the market.

[L]ending by community banks plays an important role in the ongoing economic recovery, especially by providing credit to small businesses. And it is absolutely critical that examination and supervision do not produce outcomes that are barriers to small business expansion.

[T]he Federal Reserve has placed particular emphasis on ensuring that its supervision and examination policies do not inadvertently impede sound lending to businesses, both large and small, and we will continue to do so. Actions taken to stabilize the largest banks during the crisis have received a lot of attention. However, I think it is equally important to note the degree to which banks of all sizes were offered access to the same loan, guarantee, and capital facilities. We should never forget that the objective was to save the system as a whole, not just a handful of large institutions.

In the past, systemic risk had been thought of as involving a single large institution. In the recent cases, we invoked the systemic risk exception with respect to the system as a whole, thereby allowing assistance to flow to institutions of all sizes.

For its part, the Federal Reserve has also taken steps to assist smaller institutions. For example, all banks can borrow funds under the Federal Reserve Term Auction Facility, which operates much the same as the discount window, but offers longer terms. And Regulation D was recently modified to allow community banks to earn interest on excess reserves held in bankers' banks on a pass-through basis.

As the effects of the financial crisis and the resulting economic downturn have spread, there has been increased focus on preserving the gains made in low- and moderate-income communities over recent decades. Accomplishing that objective requires preserving the institutions that helped build these communities. Without strong CDFIs, attracting investments and capital to rebuild and revitalize communities would be even more difficult. Economic recovery, like economic development, is a bottom-up as well as a top-down process. Through their work at the community level, CDFIs, together with other community development organizations, can help build a sustainable recovery for all of us.

[T]he importance of traditional financial intermediation services, and hence of the smaller banks that typically specialize in providing those services, tends to increase during times of financial stress.  Indeed, the crisis has highlighted the important continuing role of community banks. 

Although I am aware, as you are, that community banks originated few subprime mortgages, community bankers are keenly interested in these issues; foreclosures not only create personal and financial distress for individual homeowners but also can significantly hurt neighborhoods where foreclosures cluster.  Efforts by both government and private-sector entities to reduce unnecessary foreclosures are helping, but more can, and should, be done.  Community bankers are well positioned to contribute to these efforts, given the strong relationships you have built with your customers and your communities.