Key Takeaways for Regional and Community Banks from the Federal Reserve’s April

Twice a year — once in the spring and then again at the end of the year — the Board of Governors of the Federal Reserve System (Federal Reserve) publishes a report on banking conditions in the United States. Typically, the spring report summarizes the Federal Reserve’s supervisory and regulatory posture for the next twelve months and is released to coincide with testimony by the Federal Reserve’s vice chair for supervision before Congress. As such, the report serves as a good barometer for the Federal Reserve’s perspective on three key areas: (1) banking system conditions, (2) regulatory developments, and (3) the supervisory environment. On April 30, the Federal Reserve released its 2021 Supervision and Regulation Spring Report. Below is a brief summary of the portions of the Federal Reserve’s 2021 Spring Report that are of special importance for regional and community bankers.

Banking System Conditions

The pandemic continues to present challenges for families and businesses nationwide, regardless of geography or economic sector. But, as we regain our balance at the end of COVID-19’s first year, it is clear that regional and community banking organizations have played a critical role in supporting customers and the broader economy. This is due in large part to the financial skill and operational resilience of the American banking system. Several factors identified by the Federal Reserve reflect our banking system’s key strengths as of the second quarter of 2021:

• Capital and liquidity positions remain robust, with capital ratios well above regulatory minimums and significant deposit growth providing a buffer to absorb losses and support continued lending.

• Rapid investment in and deployment of technology has helped regional and community banks continue to engage with customers in a remote, digital environment.

• Profitability — measured by return on equity (ROE) and return on average assets (ROAA) — has rebounded to pre-COVID-19 levels.

• Bank involvement in the Small Business Administration’s Paycheck Protection Program (PPP) has played a vital role in sustaining main street businesses.

Despite these strengths, however, the Federal Reserve is careful not to declare the economic recovery complete. Several unresolved issues give the Federal Reserve cause for concern, including:

• Overall bank lending activity remains low, with reduced demand and tighter lending standards, particularly at smaller banks (notwithstanding the success of the PPP).

• Net interest margin declined sharply in the first three quarters of 2020 and only recovered slightly by year-end 2020.

• Borrower delinquency rates slightly increased, and loan modification activity continues — particularly in residential and commercial real estate — despite the flexibility afforded by banking regulators.

• Expanded reliance on technology has presented a corresponding increase in cybersecurity vulnerability, which affects all banks regardless of asset size or technical sophistication.

Regulatory Developments

During the first year of the pandemic, the Federal Reserve issued 60 notices of proposed or final rules and statements on policy actions to support the economic recovery. The Federal Reserve also worked to improve regulatory transparency and efficiency and cooperation with other financial regulators — particularly in its approach to new risks related to operational resilience and the supervision of new technology (such as artificial intelligence or AI).

Since the onset of the pandemic in early 2020, many regional and community bank balance sheets have grown unexpectedly, which — absent intervention — would subject those banks to new and unfamiliar regulatory requirements. To support operational resilience during this time, the Federal Reserve — along with the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency — granted temporary regulatory relief to…