The Future of Supervision: Lessons from Tocqueville

April 06, 2017
Posted April 07, 2017
F. Christopher Calabia, Senior Vice President
Remarks at the 2017 Community Bankers Conference, Federal Reserve Bank of New York, New York City As prepared for delivery

At the Federal Reserve, we believe strongly in the future of community banking.  We understand that, when you lend to individuals or small businesses, you aren’t simply extending credit: you are building the future.  You are creating homes for families.  You are investing in budding businesses.  Your credit decisions may influence the shape of the local economy, from where people live to the kinds of businesses and even jobs that exist.  When you do your jobs well, your communities flourish.1

In that regard, we know that our supervision influences your actions.  Certainly our regulations must ensure that individual firms are managed prudently so that, collectively, the banking system serves as a source of credit to all sectors of the economy.  But when rules are excessive—or when they no longer serve the purpose we intend—we must revisit them. 

As Kevin Stiroh explained earlier, the Economic Growth and Regulatory Paperwork Reduction Act of 1996 (EGRPRA) requires us to identify rules that are outdated, unnecessary, or unduly burdensome.  The report2 released by the agencies last month outlined a number of changes that we have already made. Many of those changes are meant to tailor our regulations more appropriately to the risk profiles that community banks present.

Yet burdens can stem not just from statutes or regulations, but also from the way we conduct our work.  We need to look carefully at how we plan and conduct our examinations; how we communicate our findings; and how we monitor your responses.  Where our processes and approaches are inefficient, ineffective, or unnecessarily burdensome for you, we need to make changes so that we, too, remain relevant in the future. 

And while it is difficult to predict the future, I’m reminded of one man who believed that he saw the future—and traveled there to experience it. 

Alexis de Tocqueville was a twenty-five-year-old Frenchman when he came to the United States in 1831.  He believed that the old political and social order rooted in aristocracy was giving way to a more egalitarian order—and he felt that this potential future was nowhere else more evident than in the then 50-year-old United States of America.

Tocqueville wanted to experience America so that he could advise his own country on its journey toward democracy.  He attended a Fourth of July celebration in Albany. He visited prisons and churches. For nine months, he spoke with countless Americans, from President Andrew Jackson to ordinary citizens in communities and along the roads and rivers across the country. From these personal experiences, Tocqueville drafted Democracy in America—one of the greatest books on our country and on democracy, with insights that remain valid to this day.

One characteristic that Tocqueville found fascinating about Americans is our ability to adapt our work to meet the changing demands of the time.  He described meeting individuals “who have successively been barristers, farmers, merchants, ministers of the gospel, and physicians.” Tocqueville said that our ability to “job hop,” as we might say today, helped make America “a land of wonders, in which everything is in constant motion, and every movement seems an improvement.”3

We supervisors must likewise keep up with the constant motion of our economy and make continuous improvements to our work.  I want to take just a few of the remaining minutes this afternoon to share how we’re changing our approach to onsite supervision so that we are efficient and effective—and so that we minimize burden.  These thoughts represent my own views and not necessarily those of the Federal Reserve Bank of New York or of the Federal Reserve System.

Two years ago at this conference, I shared with you some of the practical things we were adopting at the New York Fed to keep our supervision up to date, to tailor our approach to supervision to fit the risk profiles of community banks more closely, and to reduce the time we spend onsite at your firms so that we minimize disruptions to your business.4 

  • Some of the measures I mentioned then included doing more “homework” at our own office, such as doing most of our financial analysis in advance, so that when we arrive at your door, we don’t spend several days catching up. Instead, we’re ready to lead more focused conversations on key issues.  
  • We adopted a number of automated tools to simplify our examinations process and make them more efficient. 
  • We also had launched a large review to map our internal processes and identify unnecessary steps, smooth out cumbersome practices, and reduce the time it takes us to share our findings and a report with you. 

As I noted then, taken together we were able to reduce time spent onsite by up to almost 50 percent at some firms that did not have serious supervisory issues.  We’re continuing to enhance these practices.

One experiment that the Federal Reserve proposed in 2015 was to make greater use of electronic loan files so that our examiners could review the files offsite.  When I discussed this idea at our community bankers’ conference in 2015, we did not have any community banks in our District that had scanned enough loan files for us to try this approach.  However, I’m pleased to note that, last year, one firm did propose that we conduct our loan review offsite.  I won’t mention the name of the firm, but I do want to share with you our experience, because it was quite promising. 

How does an offsite loan review work?

The bank had already imaged for its own use a sufficient volume of loan files such that we could conduct an offsite review.  First, the bank sent electronic images of loan files to us online via a secure portal; however, banks can propose other means to deliver loan files to us in a secure manner.  In this case, the online portal automatically transferred the loan file images to the internal repository that our examiners use when conducting examinations. 

Second, our examiners reviewed the files at our office here in downtown Manhattan. They remained in touch with bank management and loan officers via telephone calls and conference calls to discuss the performance of certain credits and any issues arising from our review. 

Finally, after completing the review of loans and all discussions with management offsite, we communicated our findings to the management team.

From our observations and discussions with the bank, we believe that the bank experienced three sets of benefits.

  • First, we didn’t take over conference rooms and cubicles for several weeks.  In total, we were planning to send nine examiners to review the loan files onsite, about the same number as had visited the bank at the prior examination.  However, in this particular case, the bank was not able to accommodate nine additional people in its office because of extenuating circumstances.  Had we proceeded with an onsite review, we would have sent fewer staff but would have stayed onsite an additional two weeks.  Instead, by conducting the review offsite, the bank didn’t have to clear desks and a conference room for us, and we finished the exam two weeks earlier than might have been possible otherwise.
  • Second, we reduced the bank’s need to maintain records in physical form.  Our examiners reviewed scans of the loan files, and the bank didn’t need to devote filing cabinets and other storage space to files that really only we would use. 
  • Third, by working remotely, we reduced the need for bank staff to help us get access to the Internet, secure printers and copiers for us, and print or copy documents for us.  This may have reduced unpredictable disruptions to the staff’s normal work day.

From our perspective, we experienced three sets of benefits as well.

  • First, our examiners were able to work productively at their own desks, with full access to all of the Federal Reserve’s technology and systems, some of which may not be available to us when we are onsite at a firm.
  • Second, our examiners were able to upload their work back to our systems faster than is sometimes possible when they work remotely.
  • Finally, our team was able to consult with our managers and colleagues in-house; we felt that the team experienced greater synergies and was better able to keep everyone up to date on the status of the examination and any issues that might be arising.

Overall, we felt that this pilot of offsite loan review in our District was effective and a success.  In this particular case, it did save some time. But the main goal of offsite loan review is to minimize disruptions to your business by having a smaller footprint at your offices during annual examinations.

I should acknowledge that the bank’s management and staff helped to make this a success through their willingness to respond to questions and requests for additional information by telephone, from the bank president to the lending officers. 

Community banks are not required to scan loan files, and so conducting an offsite loan review requires your consent, cooperation, and coordination.  If you do begin using electronic loan files, we are happy to consult with you on whether we can conduct offsite loan reviews. You can read more about this process and how to make a request along these lines in our Supervision and Regulation Letter 16-8, “Offsite Review of Loans.”5

I would note as well that while we would like to move toward doing more aspects of examinations offsite, we do continue to see value in conducting some work onsite.  Onsite visits are likely to remain an important part of our supervisory approach in the future, if perhaps for shorter periods of time. 

Moreover, some of you have told us that you prefer to have us visit in person—and some of you sounded sincere!  It’s often been said that the strength of the community banking model lies in the energy and time you spend getting to know your customers and building close working relationships with them.  The same should be true for those who supervise smaller firms.

In certain instances it may be necessary for us to be onsite to evaluate the quality of processes and to get better insight into the staff, the management, and the communities that you serve.  That kind of understanding is difficult to develop without being there ourselves.  Tocqueville, for example, could have conducted “offsite research” for Democracy in America—but I would bet his writing would have lacked the sense of wonder he found in his travels. 

In that regard, more than most other staff at the New York Fed, the Regional, Community, Foreign Institution Supervision and Consumer Compliance function has a unique connection to the rest of the District given the amount of time that our staff spend traveling and working in communities across New York, New Jersey, Connecticut, and Puerto Rico.  We’ve celebrated that connection this year through our second “Postcards from the District” staff photography contest that you saw projected earlier on screens.

So let me close by thanking you for traveling to our office to engage us in dialogue today and throughout the year.  We need to hear your views on business conditions, on your performance, and on our work and our approach to supervision.  Like the Americans that Tocqueville encountered, we’re constantly looking for ways to improve.  We welcome your ideas and suggestions.  Through this dialogue, we can work together to ensure that the future remains bright for community banking in America.

1 I would like to thank Anita Awatramani, Jessica Crawford-Eka, and Jacqueline Fenton for their input and advice on these remarks. Any errors are mine.

2 Federal Financial Institutions Examination Council, Joint Report to Congress: Economic Growth and Regulatory Paperwork Reduction Act, July 31, 2007.

3 Alexis De Tocqueville (1835), Democracy in America, Book One, Chapter XVIII, Part X.

4 F. Christopher Calabia, Observations on Community Banking Supervision in the Second District, presented at the Community Bankers’ Conference, Federal Reserve Bank of New York, New York City, May 14, 2015.

5 Board of Governors of the Federal Reserve System, SR 16-8: Offsite Review of Loan Files (April 19, 2016).

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