View from the District: First District Community Bank Supervision and Communication During the Pandemic
by Jim Nolan, Executive Vice President, Supervision, Regulation, and Credit, Federal Reserve Bank of Boston
The Federal Reserve Bank of Boston (FRB Boston) serves as the primary federal regulator for state member banks and holding companies in New England.1 Prior to the outbreak of COVID-19, significant aspects of our community bank safety-and-soundness supervisory work focused on liquidity and funding, with a particular emphasis on changing trends in financial institutions’ funding composition and cost. Another area of supervisory focus in the First District was monitoring growth in commercial real estate (CRE) lending, which included the analysis of market conditions relative to price appreciation, and attention to the underlying strength of borrowers.
The COVID-19 pandemic necessitated short-term modifications to our community bank supervisory approach. We continue to engage with the management teams at state member banks to assess their ability to operate in a manner that ensures the safety of employees and customers while providing liquidity and credit to their communities. Community banks serve an important economic role, and the current environment has created unique challenges in terms of day-to-day operations and meeting the critical credit needs of individuals and small businesses. The services provided by community banks will be instrumental in supporting our local economies through the pandemic.
First District Community Banking in a COVID-19 Environment
Like most of the country, we have significantly changed the way we work this year with added emphasis on safety and health. In mid-March, with the exception of staff needed to provide essential services, FRB Boston transitioned most of the staff to full-time work-at-home status. FRB Boston examination staff worked closely with management teams at banks and with state banking agencies to inform relevant stakeholders of the changes to our examination approach and to coordinate completion of our examinations in process. Our examination teams transitioned from collaborative office or onsite working environments to remotely working from home. As a result, we have more intensively and more broadly incorporated a variety of technologies and tools into our day-to-day work to help us adapt to this new environment.
As conditions rapidly evolved through March and April 2020, the Federal Reserve System (System) adjusted its supervisory approach.2 FRB Boston examination staff remained in contact with impacted bank management teams and coordinated with the state agencies in New England. Our supervisory program through the months of April and into May focused on monitoring rather than traditional examination work. In particular, we monitored modified bank operations; customer and state member bank liquidity needs, particularly in light of changes to the discount window borrowing programs;3 and how banks are working with borrowers and modifying loans.4 We also answered questions related to small business lending and banks’ participation in the Small Business Administration’s Paycheck Protection Program (PPP) and Economic Injury Disaster Loan Program. Most recently, we began to design and implement monitoring tools and processes to guide the First District’s supervision program for the remainder of 2020.
The First District’s community bank supervision unit established a weekly information exchange with senior management teams at state member banks. This communication platform provides a forum to discuss common challenges and shared successes and address questions from state member bank chief executive officers, such as new regulatory developments. The participation rate has remained high, which suggests the benefits of continuing this exercise. This outreach has provided us, as supervisors, with a better perspective on issues impacting community banks as well as needed information to discern which issues are pervasive and need to be addressed programmatically.
Federal Reserve System Communication Tools for Community Banks
Since the beginning of this pandemic, the Federal Reserve has issued various statements and guidance that are relevant to community banks. This heightened flow of information has emphasized the benefits of staying in contact with management teams at community banks in the District and responding to their questions in a manner that is consistent for all state member banks. Three tools in particular have been especially helpful for supervisors and banks in the First District.
The Federal Reserve guidance portal organizes Supervision and Regulation (SR) letters and other issuances by year and by topic, and it can be found on the Federal Reserve Board’s (Board) public website.5 The COVID-19 topic page6 is particularly helpful, as well as the Business Continuity and Disaster Recovery subtopic page.7
The second tool is the “Contact Us” portal on the Board’s website.8 A separate section was added specifically for coronavirus-related questions. Bankers from across the nation have submitted questions covering a variety of topics such as capital, credit, accounting, operations, and other areas of interest in the COVID-19 environment. These submissions are sent to appropriate subject matter experts to answer.
Ask the Fed sessions represent the third communication vehicle that is popular with District community banks.9 These sessions have covered a number of important topics related to banking during this pandemic, including working with borrowers, troubled debt restructuring guidelines, and the PPP program from the bankers’ perspective. In addition, the sessions give bank management the ability to hear directly about any new guidance and ask questions from subject matter experts at the Board.
Community Bank Risk Areas in COVID-19 Environment
In mid-March, the first calls FRB Boston examination staff received from bankers centered on operations, specifically branch operations and reductions in service hours. Despite initial technical and logistical challenges, communications with supervised institutions remain effective. The bankers asked for guidance about providing services while simultaneously keeping employees and customers safe. Innovative operational strategies included expanded use of the drive-through window for a number of transactions that typically take place in a branch and commencing branch hours by appointment only. The use of electronic signatures was another topic of great interest in a socially distanced world. In general, community bankers found creative solutions to meet customer needs and protect the health of customers and employees.
Cybersecurity risk is elevated in the current environment because routines are disrupted and attention distracted. Changes in operations and greater reliance on technology tools contribute to an increase in risk events. Awareness and preparation are important elements of any bank’s cybersecurity program, especially during unprecedented times. The Federal Financial Institutions Examination Council’s Information Technology Examination Handbook describes elements of a sound information security program for financial institutions.10
As mentioned earlier, liquidity and funding were an important pre-pandemic area of supervisory focus within the First District and remain so in the current environment. During the initial stages of the pandemic in the United States, bankers were understandably concerned about having sufficient cash on hand to meet customer needs. The Federal Reserve’s FedCash Services ensured that bankers were able to access the level of cash needed for operations to meet customer demand. The announcements from the Board regarding changes in the terms of discount window loans spurred discussions with bank management about the importance of the discount window as a source of community bank funding. To date, with inflows from both the PPP and stimulus checks, community bankers within the First District are generally demonstrating solid liquidity positions. Going forward, it will be important to track and monitor deposit flows by customer type — commercial, consumer, and municipal — and size. Bank management should continue to monitor collateral and secondary liquidity availability through the Federal Home Loan Bank and the discount window as outlined in interagency liquidity guidance.11 This will be particularly important if banks experience COVID-19–related credit deterioration.
Credit risk generally represents the most prominent risk for community banks. Over the past several years, both nationwide and in the First District in particular, we observed an increase in lending as a proportion of the balance sheet, particularly CRE. Guidance issued by federal banking agencies to date stresses the importance of working with borrowers for loan modifications.12 These efforts are necessary to support the flow of credit for households and small businesses. For newer loan originations and for borrowers participating in businesses or industries that are particularly affected by COVID-19, the ability of the bank to understand a borrower’s cash flows and ability to repay the loan takes on greater importance. For commercial lending, this could include practices such as monitoring changes in a borrower’s monthly revenue to understand the resilience of the business. It is likely that the coming months will bring a variety of credit challenges as banks strive to prudently work with borrowers to continue to provide needed credit to local businesses.
Capital planning is always an essential element of balance sheet management, but it becomes even more important during times of uncertainty or stress. It is reasonable to presume that there will be some degree of pressure on First District bank earnings and, by extension, capital related to the pandemic environment. Guidance issued in 2009 during the prior crisis remains highly relevant to capital planning for community banks with holding companies.13 The guidance focuses on capital actions at the holding company and discusses special considerations for the supervisory review of dividend payments, capital redemptions, and capital repurchases by bank holding companies (BHCs).The guidance also highlights sound practices for a BHC to consider when assessing capital adequacy. Factors outlined in the 2009 guidance include the quality and level of current and prospective earnings, inclusive of earnings capacity under a number of plausible economic scenarios; balance sheet risk, particularly relative to credit concentrations; potential losses that a BHC may incur from the need to increase reserves; and current and prospective cash flow and liquidity. A BHC’s board of directors is also encouraged to consider other risks that affect the BHC’s financial condition and the ability to serve as an ongoing source of financial and managerial strength to depository institution subsidiaries.
Community banks play an important role in serving the banking needs of their communities, and the pandemic highlights this point. Community banks in the First District and across the System have worked tirelessly and demonstrated great innovation, flexibility, and adaptability in meeting customer needs and facilitating the flow of credit to businesses and consumers in their communities.
As we continue to work through the current environment, our goals of promoting a banking system that is vibrant, safe, and sound and meeting the needs of customers are as important as ever. We appreciate community bank innovation, flexibility, and communication on this effort. The past few months have reinforced the importance of functional working relationships and effective communication between regulators and bankers. Stay safe.
- 1 The First District covers Maine, New Hampshire, Vermont, Massachusetts, Rhode Island, and Connecticut (excluding Fairfield County).
- 2 See the Board’s March 24, 2020, press release, available at www.federalreserve.gov/newsevents/pressreleases/bcreg20200324a.htm .
- 3 See the Board’s March 19, 2020, press release, available at www.federalreserve.gov/newsevents/pressreleases/monetary20200319c.htm .
- 4 See the Board’s press releases, issued April 7, 2020, and March 22, 2020, available at www.federalreserve.gov/newsevents/pressreleases/bcreg20200407a.htm and www.federalreserve.gov/newsevents/pressreleases/bcreg20200322a.htm , respectively.
- 5 The Guidance Portal is available at www.federalreserve.gov/supervisionreg/srletters/srletters.htm .
- 6 See the COVID-19 Supervisory Policy and Guidance Topics, available at www.federalreserve.gov/supervisionreg/topics/covid-19.htm .
- 7 See the Business Continuity and Disaster Recovery subtopics, available at www.federalreserve.gov/supervisionreg/topics/information-technology-guidance.htm .
- 8 Comments and questions can be submitted using the Contact Us form, available at www.federalreserve.gov/apps/ContactUs/feedback.aspx .
- 9 The Ask the Fed sessions are available at https://bsr.stlouisfed.org/askthefed/Auth/Logon .
- 10 See SR letter 19-13, “FFIEC Information Technology Examination Handbook,” available at www.federalreserve.gov/supervisionreg/srletters/SR1913.htm .
- 11 See SR letter 10-6, “Interagency Policy Statement on Funding and Liquidity Risk Management,” available at www.federalreserve.gov/boarddocs/srletters/2010/sr1006.htm .
- 12 See the Guidance Portal, available at www.federalreserve.gov/supervisionreg/srletters/srletters.htm .
- 13 See SR letter 09-4, “Applying Supervisory Guidance and Regulations on the Payment of Dividends, Stock Redemptions, and Stock Repurchases at Bank Holding Companies,” available at www.federalreserve.gov/boarddocs/srletters/2009/SR0904.htm .