FEATURE The “New Normal” FOR FUNDING AT COMMUNITY BANKS


Allen North, Assistant Vice President, Safety and Soundness Supervision, Federal Reserve Bank of St. Louis, Allen.North@stls.frb.org


Community bank funding has evolved significantly since the financial crisis. Core deposits are now more difficult to attract as declining rural populations and increased competition from the largest and internet banks are putting pressure on community banks’ traditional funding sources. After years of moving away from non-core funding, community banks now say they are experiencing a “new normal” for funding that involves more listing service or brokered deposits, which can be obtained more efficiently than running a local certificate of deposit (CD) special. Indeed, community bank reliance on non-maturity deposits has increased while their reliance on CDs has decreased. This funding evolution has even impacted merger activity as acquiring banks are willing to pay higher multiples for target institutions with strong core funding, which establishes a bank’s franchise value. As more community banks increase their reliance on non-core funding, however,


there are several important factors banks should consider. First, diversification in funding sources is just as important as diversification of balance sheet assets, especially when a bank’s loan-to-deposit ratio is increasing. Banks must be attuned to the differences in the types of non-core funding, and how that funding will behave in times of stress. For example, CDs exceeding $250,000 are typically not viewed as core, but in some cases and in certain communities, they may be less rate sensitive than expected. Conversely, reliance on money market deposit accounts (MMDAs) that pay a high rate of interest could be more rate sensitive and less “sticky.” Second, balance sheet liquidity, which is essentially a measure of how quickly


assets can be converted into cash, cannot be overlooked. A bank’s ability to sell securities, and even loans, without experiencing a significant loss, provides an important backstop in a tight funding markets. Most community banks maintain a securities portfolio, but a material portion of the portfolio might be pledged against public deposits. Bankers should always have a portion of their securities portfolio that can be sold relatively quickly for cash. Third, the composition of non-core funding sources is generally more critical


for banks with concentrated or higher risk loan portfolios, especially for banks with concentrations in agriculture or commercial real estate loans. Maintaining sound underwriting standards and credit administration practices is essential if a bank relies on noncore funding. Furthermore, significant growth should not be solely funded from wholesale sources. Rather, growth should be measured and carefully considered as part of a bank’s capital planning process. Today’s bankers know that wholesale funding carries considerable risk should


a bank’s capital levels deteriorate. Once capital ratios have eroded to “adequately capitalized” under Prompt Corrective Action, the FDIC’s brokered deposit rule restricts the use of brokered deposits and the rates that can be paid on any deposit. Most bankers understand the brokered deposit rule as it applies to obtaining or renewing brokered deposits; however, the rate restrictions can be equally as challenging to manage when the bank is paying higher rates for non-maturity deposits, such as MMDA accounts. There is no question that community banks are experiencing a “new normal” in


funding. For that reason, bank managers must carefully diversify funding sources and their maturities, accurately tracking the sources and uses of cash to ensure the bank maintains adequate liquidity. Risk management is key, helping your bank weather the next financial storm.


The Federal Reserve Bank of St. Louis has a great blog called “On the Economy” with several different categories, such as: banking, housing, output, community development, inflation, trade, financial, labor and the Federal Reserve. This very valuable information can be reached at www.stlouisfed.org/on-the-economy.


Federal Reserve ALERT:


The Federal Reserve recently announced the opportunity for industry stakehold- ers to provide feedback regarding the Fed’s potential involvement in real-time interbank settlement of faster payments. The deadline for responding to this important request for comment is December 14, 2018. It is critical for community banks to personally respond to this request as this may be our final opportunity to let the Fed know they should indeed play an operator role in Faster Payments. (Much like check, ACH and wire transfer) No other entity has the ability, nor the incentive to reach every financial institution regardless of size. Without the Federal Reserve Bank’s involvement, faster payments in the US will undoubtedly con- tinue to be fragmented, at best. The Federal Reserve Bank must be made to feel welcome to the market, so it is up to small banks and credit unions to deliver this very impor- tant message. Mega banks and mega credit unions are largely expected to oppose this. Please take time to respond on behalf of the community bank industry. The Fed needs to hear from you; not just from your banking association(s). Visit the agency web site at www.federalreserve.gov.


MIB Community BANKING 13


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