WASHINGTON (MNI) – The following is the third and final section of
the text of the prepared remarks of Cleveland Federal Reserve Bank
President Sandra Pianalto Friday, to the Community Banks Association of
Ohio Annual Convention in Columbus:

Based on what we learned, we have discussed the interview results
with our supervision staff at the Cleveland Fed to remind them about the
importance of frequent, clear, and open communication during the exam
process. It’s a two-way street; we expect bankers to ask questions about
findings they don’t understand, or disagree with, and we expect our
examiners to provide factual support for their supervisory findings.

Our supervisors are well-trained and take their responsibilities
seriously. They know that their actions have consequences. I do not want
to have situations where bankers deny loans to creditworthy small
businesses, especially in this slow-growth economy in which every good
loan counts.

I can tell you that the bankers we spoke with were very
appreciative of the opportunity to discuss these supervisory issues
outside their examination cycle. They also took advantage of the
opportunity to share some opinions about the ongoing process of
regulatory reform. So let me now turn to that topic.

Impact of Regulations on the Financial Services Industry

The Dodd-Frank Wall Street Reform and Consumer Protection Act is
just over a year old. As you know, the Federal Reserve and other
financial regulators are in the process of developing and implementing
hundreds of new rules. The reforms will affect nearly every aspect of
the financial services industry, including how regulators operate. For
example, the Federal Reserve recently assumed responsibility for savings
and loan holding company supervision. While savings and loan holding
companies are similar to bank holding companies, they are not identical,
so we are working to deepen our knowledge about the savings and loan
industry.

Let me by point out that the bulk of Dodd-Frank is aimed primarily
at the very large, complex banks and financial services providers, some
of whom were less tightly regulated before the financial crisis-in other
words, the shadow players. Nevertheless, I hear from community bankers
that you are concerned that the expectations being set for the largest
institutions will ultimately be imposed in a burdensome manner on
smaller institutions, adversely affecting the community bank model. I
understand your concerns and recognize that well-intentioned legislation
can sometimes lead to unintended consequences.

In the past, you may have heard me talk about a regulatory and
supervisory framework called “tiered parity.” In this framework,
financial firms would be placed into a particular category, or tier,
based on their complexity and the level of risk they pose to the overall
financial system. The regulatory and supervisory approach applied to
each tier would be consistent within each tier-resulting in parity of
treatment for firms with similar risk profiles. However, the regulatory
and supervisory approach would differ between the tiers. They would
become less restrictive from one tier to the next as the risk to the
financial system decreases.

I am pleased that the provisions of the Dodd-Frank Act embody the
spirit of this tiered parity framework-that is, the most restrictive
regulatory requirements are imposed on the riskiest, systemically
important firms. That means that the riskiest firms receive the highest
degree of supervisory scrutiny. At the same time, the Act also clearly
seeks to minimize the regulatory burden on banks with assets of less
than $10 billion. So there is no “one size fits all” formula for
regulations or supervision.

To be realistic, though, all players in the financial services
industry will face a number of challenges as they adapt to the new
regulatory environment. While Dodd-Frank is not fundamentally aimed at
community banks, your institutions will also have to adjust to this new
environment.

An important and relevant example involves enterprise risk
management. The Dodd-Frank Act requires that large, complex financial
organizations establish risk committees and risk management processes.
But truthfully, financial firms of all sizes would benefit from an
effective enterprise risk management program that is scaled to the
nature and complexity of the risk found in that institution.

Let me provide a specific illustration. One component of enterprise
risk management is managing concentrations of credit. I have no doubt
that all of you know the importance of managing the risks posed by
credit concentrations within your organizations. However, with the
benefit of hindsight, it is clear that poorly managed concentrations in
commercial real estate and construction lending made many small and
mid-size institutions highly vulnerable to a real estate downturn. In
fact, such concentrations have been at the heart of many of the bank
failures we have seen across the country.

These failures punctuate the need for an effective risk management
program to go beyond traditional audit, compliance functions, and loan
review. These programs should look broadly and holistically at the many
places where risks can build up in an institution, and to mitigate
excessive exposures such as concentrations of credit. I realize that
small banks have limited resources to engage in this sort of effort, but
even a modest program that uses key personnel to develop internal checks
and balances and to develop effective management reports can pay big
dividends.

I could make similar observations about many other topics–such as
stress testing, capital planning, and incentive compensation– that
financial regulators are working to overhaul. The point is, as new
regulations and supervisory practices are developed, it is important
that the regulatory agencies remain sensitive to the burden that new
regulations will place on all banks. The supervisory demands must be
calibrated to the risks we see.

I assure you that the Federal Reserve Bank of Cleveland is
committed to ensuring that our supervisory practices are appropriate to
the size and risk profile of the institution. We will continue to strive
to be fair, balanced, and consistent supervisors.

Conclusion

As community bankers, you are on the front lines of our nation’s
battle to emerge from the recession. You are out there in the
neighborhoods and understand the challenges brought by layoffs and
foreclosures, stressed government budgets, and nervous business owners.
These are your customers, your depositors, and your friends.

But we all have to keep moving forward with a positive attitude.
Remember that even in a slow-growth economy, people will continue to buy
homes and cars and finance their children’s educations. The question
then becomes, who will help them fund these purchases? Business will
always need a trusted financial partner to help them grow; who will be
that partner? With your deep knowledge of your customers, your
commitment to your community, and your back-to-basics approach to
banking, you can position yourselves to be that partner.

(3 of 3)

** Market News International Washington Bureau: 202-371-2121 **

[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$]