U.S. banking conditions remained strong overall in the second half of 2021, with robust capital and liquidity, in addition to improved asset quality. That’s the conclusion of the Federal Reserve Board of Governors, which recently released its latest Supervision and Regulation Report (PDF). The semiannual report covers banking system conditions, as well as regulatory and supervisory developments for the institutions under the Fed’s supervisory umbrella.

While the banking industry currently appears to be on solid footing, supervisors are monitoring banks for traditional risk concerns, such as management, liquidity and cybersecurity. Recent events, such as the COVID-19 pandemic and the Russian invasion of Ukraine, have created risks for certain banks, leading to special attention from supervisors. They also are focusing on newer risks related to the increasing use of technology by financial institutions of all sizes.

An Eye on Risks

As the report notes, actual and potential risks related to Russia’s invasion of Ukraine are generally limited to the nation’s largest internationally active institutions. Few direct financial exposures to either country exist, and those that do are considered limited and manageable. Indirect exposure through spillovers such as commodity markets also are limited to date, and supervisors believe solid capital levels and liquidity are sufficient for banks to withstand increased volatility and the potential for losses. Banks have partnered with Western governments to implement sanctions—both here and abroad—and have adopted heightened cybersecurity alert levels.

Of greater supervisory concern is the increasing role of technology—especially artificial intelligence, data analytics and cloud computing—in financial services and banking operations. Banks are developing new technology-based products and services to improve back-office operations. These developments offer benefits to banks and their customers, but also generate risk.

An added wrinkle to technology risk is the reliance of many banks—especially smaller ones—on just a few third-party service providers to maintain “operational resilience”—the ability to keep operating amid vulnerabilities such as cyberattacks and outages. To help supervised institutions keep up with technology and regulatory expectations, the Board of Governors has launched an innovation page on its website that offers resources and information. The Board is also updating its supervisory programs on third-party service providers and reviewing the financial technology (fintech) used by Fed-supervised banks.

Supervision by the Numbers

Although the Fed has supervisory authority over several very large banks and all the nation’s bank holding companies, the vast majority of banks under its supervisory umbrella are community banks—banks with assets of less than $10 billion. Of the 705 state member banks (SMBs) the Fed supervised at year-end 2021, nearly 95% (665 banks) met that community bank threshold and were part of the Fed’s Community Banking Organization (CBO) portfolio. The next largest group—consisting of 27 SMBs—is part of the Regional Banking Organization (RBO) portfolio; banks in this group have total assets of $10 billion to $100 billion.1

At the St. Louis Fed, all our supervised banks fall into the CBO or RBO portfolio. Currently, we have direct supervisory responsibility for 119 SMBs in the two portfolios, representing nearly one-fifth of the System’s supervised banks. Six banks are in our RBO group, and the remaining 113 are in the CBO group. In terms of assets under supervision, the RBO banks have a combined $197.8 billion, or 69% of the total. The combined assets of the CBO banks total $89.3 billion.

At the end of 2021, all RBOs and more than 99% of CBOs System-wide had capital ratios above the “well capitalized” minimums,2 and nearly 97% of them received “satisfactory” or “strong” supervisory ratings.

A Look Ahead

While capital levels are generally good and problem loans are minimal, examiners have noted that credit risks may be increasing at RBOs and CBOs because of exposures to economic sectors hit hard by the pandemic, such as commercial real estate. Smaller banking organizations are particularly sensitive to developments in commercial real estate since this sector tends to account for a significant portion of their loan portfolios. And although the overall liquidity risk is currently low because of economic uncertainty and tepid loan demand, that could change as funds are deployed and stimulus programs continue to wind down.

In addition to these traditional worries, examiners will remain focused on information technology risks and cybersecurity. A lack of robust infrastructure and a reliance on third-party vendors make smaller banks more vulnerable to these risks. Difficulty hiring and retaining qualified information technology and cybersecurity staff could place further strains on these institutions.

There’s an App for That

Finally, while much of the work by examiners has been successfully conducted off-site because of the pandemic, some on-site examinations have resumed this year. But we will continue to use technology to make the supervisory process as efficient and effective as possible. We’re encouraged by the positive feedback generated by Supervision Central, a cloud-based application that allows the secure exchange of information between examiners and SMBs and holding companies with assets of less than $100 billion. The new app can also be used for communication between Fed examiners and their state counterparts, reducing redundant requests for information from supervised institutions.


1 The remaining state member banks fall into one of two large financial institution supervisory portfolios: one for U.S. firms with assets of more than $100 billion (the Large Institution Supervision Coordinating Committee portfolio) and one for foreign banking organizations with combined U.S. assets of $100 billion or more (the Large and Foreign Banking Organizations portfolio).

2 A bank is "well capitalized" if it significantly exceeds the required minimum level for each relevant capital measure.