September 8, 2022

Participants on the Federal Open Market Committee (FOMC) have a great deal on their plates, as you doubtless know.

But even as the FOMC wrestles with elevated inflation and uncertainty across the global economy, the Federal Reserve is paying close attention to community banks. As critical sources of credit to small businesses and nonprofits, community banks are a pillar of our economy and communities.

Portrait photo of Raphael Bostic
Raphael Bostic, Atlanta Fed president. Photo by David Fine

For evidence, we need look no further than the essential role community banks played in the recovery from the COVID-19 pandemic. Entering the pandemic, small businesses tended to have far smaller savings and reserves than larger firms, so they were hammered by the broad lockdowns instituted in response to the public health crisis.

Local lenders stepped up. In the Small Business Administration’s Paycheck Protection Program (PPP), community banks accounted for almost 60 percent of total dollars loaned—$429 billion through 4.7 million loans, according to the Independent Community Bankers of America (ICBA). What’s more, community banks made 87 percent of PPP loans that were extended to minority-owned businesses, 81 percent of the loans given to women-owned businesses, and 69 percent of the loans made to veteran-owned businesses, the ICBA reported.

Community banks under pressure

In recent years, community banks have been reasonably prosperous. For example, more than 60 percent reported increases in their pretax return on assets ratios from year-end 2012 through the end of 2019, according to the December 2020 Community Banking Study from the Federal Deposit Insurance Corporation (FDIC).

Yet the outlook is not entirely rosy.

For one, the ranks of community banks, particularly the smallest ones, are dwindling. From 2000 to 2021, the number of institutions with under $500 million in assets fell by more than 60 percent, from about 8,000 to roughly 3,100, according to data from the FDIC.

While some of this decline reflects banks growing above the $500 million asset threshold, much of it is the result of consolidation. Over the past 20 years, more than 3,500 mergers were completed involving banks with assets of less than $500 million, according to data from S&P Global Capital IQ. Technological advances, competitive and cost pressures, general operating costs, and succession planning have fueled a wave of mergers, as small banks have found it difficult to go it alone. And the Great Recession was particularly tough for the smallest financial institutions.

Doris Quiros, head of the Atlanta Fed's Supervision, Regulation, and Credit Division. Photo by David Fine

Along with a historically high rate of mergers, few new banks are starting. Federal Reserve governor Michelle W. Bowman spoke to this in an October 2021 speech, in which she noted that, over the past decade, an average of fewer than five de novo banks were established per year. This compares to an average of more than 100 a year from 1990 to 2008.

Starting a de novo bank has never been easy. If anything, for numerous reasons, it has only become more difficult over the past decade. The pressure to quickly generate shareholder returns has perhaps never been higher. Investors have more options for deploying capital than ever before, making it harder to get their attention and support. And the many data points and articles describing the so-called war for talent make clear the fierce competition for hiring staff with specialized expertise.

These challenges are especially acute for de novo banks. Their need for expertise in regulatory compliance and internal controls creates heightened pressure to bring on experienced staff to quickly make progress in meeting operating goals and profit projections.

De novo bank founders also face hurdles raising capital. A 2014 Board of Governors study found that statutory capital requirements for a new state-chartered bank could be as high as $30 million. Among the 20 banks the FDIC lists as opening in 2021 or 2022, the average paid-in capital was $26.9 million. Given stiff initial capital requirements, a de novo bank has little margin for error.

As the environment for starting and operating community banks remains perhaps as challenging as ever, we'd like to touch for a moment on their place in the larger financial services landscape.

As the environment for starting and operating community banks remains perhaps as challenging as ever, we'd like to touch for a moment on their place in the larger financial services landscape.

Why community banks matter

Specifically, why does it matter if we have fewer community banks? After all, most Americans would still find ways to save and pay bills in their absence. But this overlooks some important realities.

First, community banks are an important provider of key banking services to niche populations and business sectors. In cities, for example, community banks, including minority-owned institutions, support businesses and households that may not be a focus of larger institutions. Community banks are flexible in making decisions on business loans and nimble with loan requests.

From a sectoral perspective, community banks punch well above their weight in lending for commercial real estate, small business, and agriculture. While community banks account for about 15 percent of the banking industry’s total loans, they make 30 percent of commercial real estate loans, 36 percent of small business loans, and 70 percent of agricultural loans, according to the FDIC’s 2020 study.

Second, and related to the first point, community banks know their communities and how they thrive. Because of their unique histories, they can often know borrowers better than a lender from a larger bank’s branch might, which can be critical for expanding access to banking services in rural, urban, and underserved communities.

Third, though most might still be able to save and pay bills if community banking met its demise, the fact remains that not all will. There are still those who have nowhere else to turn for financial services. They should not be left behind.

In recognition of their critical role, the Fed is committed to helping alleviate the pressure that community banks face today and is taking steps to do so. For example, to help reduce regulatory burden we continually refine our regulatory approach and tailor our supervision to the size and complexity of institutions. Generally speaking, in 2018 we began examining smaller, less complex institutions less frequently. We also conduct significant portions of our examinations remotely, from our offices, something that we were doing even before the pandemic. And we are committed to communicating proactively with the industry through our various outreach channels and venues such as our website, to be as transparent as possible about our tailored supervisory initiatives and expectations affecting community banks.

We would like to close by offering thanks to community banks for their strong support of the communities they serve, particularly during the pandemic. Early in the crisis, the Fed and other financial regulators made allowances and extended forbearance to banks, paused examinations, and issued supervisory guidance that made it clear that we would not criticize or take public enforcement actions against a bank that was taking prudent steps to help customers and making good faith efforts to comply with regulations. Our hope was that the banking industry would be an important part of the support to bring us through the pandemic with as little permanent damage as possible.

Well, community banks—and banks more generally—clearly stepped up. We have already noted the strong community bank role in distributing PPP funds and are grateful for that and other efforts community banks made during this time. And the evidence is clear that they did this in a safe and sound manner. Consider that nationwide, only three banks have failed since February 2020, when the pandemic began to significantly affect the United States. This compares very favorably with the roughly 300 failures in 2009 and 2010 in the wake of the financial crisis and Great Recession. Our faith in community banks was definitely rewarded.

Community banks face difficult challenges, but the industry and regulatory agencies can and must devise creative ways to support them. These institutions bring unique economic benefits to the communities where they operate, particularly in rural areas and underserved urban neighborhoods. Our economy and communities need them.

Doris Quiros

Senior vice president of the Atlanta Fed’s Supervision, Regulation, and Credit Division

Raphael W. Bostic

The Atlanta Fed’s president and chief executive officer