Right-Sizing Standards for Community Banks

This article was developed using publicly available responses submitted to Requests for Information issued by banking regulators. It summarizes and synthesizes themes, perspectives, and information reflected in those public submissions for informational purposes only. The article does not represent the views of any regulator, respondent, institution, or the Firm, and should not be interpreted as legal, regulatory, or compliance advice.

Executive Summary

Question 22 asks whether agencies should tailor the framework for community banks and, if so, whether different standards should apply by size and complexity. The record shows a minority explicitly supporting proportionate, risk-based tailoring, with several submissions urging calibration by size, complexity, risk profile, and business model. Others caution that ‘tailoring’ can dilute oversight if not bounded by clear guardrails. The core challenge is balancing proportionality for community banks with supervisory rigor and consistency.

Key takeaways:

• One respondent advocated “right-sizing” so expectations reflect community banks’ lower complexity and system risk.
• A risk-based approach that tailors to size, complexity, and business model was explicitly supported by multiple submissions.
• Some evidence supports calibrating materiality so capital/liquidity declines material for large banks are not automatically material for community banks.
• Stakeholders warned that a broad “tailoring” mandate could invite softer supervision when stronger oversight is warranted.
• Calls for clarity, transparency, and consistency in supervisory definitions and applications recur across submissions.

Bottom line:

Agencies should tailor the framework for community banks using a proportionate, risk-based approach that scales expectations to size, complexity, risk profile, and business model, with calibrated materiality thresholds and clear guidance. Guardrails are needed to ensure tailoring does not weaken necessary supervisory escalation.

The Question (Ref #22)

How should the agencies tailor the framework for community banks? For example, should there be different standards for institutions of different sizes and complexity? Please explain.

Direct Response to the Catalog Question

Introduction

How should the agencies tailor the framework for community banks? For example, should there be different standards for institutions of different sizes and complexity? The submissions reflect a clear debate: some urge proportionate, risk-based tailoring for community banks, while others warn of unintended leniency absent clear constraints and consistency.

Historic Lessons in the Evidence

Respondents’ reasoning points to three lessons: proportionality improves fit when institutions differ in size, complexity, and risk; clarity via illustrative guidance reduces ambiguity and variability in application; and over-broad tailoring risks under-supervision, so frameworks should preserve the ability to escalate when conditions demand stronger oversight.

The Challenge

Inputs reveal a practical tension: while many call for right-sized, multi-factor tailoring, others stress the need for clarity, consistency, and durable safeguards to prevent diluted oversight. Implementing differentiated materiality thresholds and articulating when a practice is “unsafe or unsound” for a community bank versus a larger institution are recurring pain points.

Evolving Metrics

Respondents assessed tailoring through factors such as size, complexity, risk profile, business model, and context-specific materiality. Examples include a higher bar for finding an unsafe or unsound practice at community banks and an expectation that certain capital/liquidity declines deemed material at large banks need not be so for community banks.

A Framework Inspired by the Inputs

An implicit pattern emerges: a risk-based, proportionate framework anchored in size, complexity, risk profile, and business model, supported by illustrative guidance and calibrated materiality. This approach aims to keep supervision right-sized and durable while preserving examiner discretion to escalate when risks exceed a community bank’s capacity to manage them.

Case Study

Across submissions, a representative pattern is clear: trade associations and banks urge right-sizing supervision to community banks’ lower complexity and system risk through multi-factor tailoring, banks ask regulators to explicitly consider their business models and risk profiles in assessments, legal analysis contemplates materiality thresholds that differ by bank size, and public-interest commenters caution that such tailoring must not erode the ability to intervene decisively when risks intensify.

Recommendations

1. Codify proportionate, risk-based tailoring that scales to size, complexity, risk profile, and business model.
2. Right-size expectations for community banks to reflect lower complexity and system risk while maintaining supervisory rigor.
3. Calibrate materiality for capital and liquidity impacts so thresholds for large banks are not automatically applied to community banks.
4. Publish illustrative guidance and examples to clarify how tailored expectations apply across common community bank scenarios.
5. Preserve examiner discretion to identify, escalate, and remediate risks to address concerns about overly soft supervision.
6. Specify the factors used in tailoring (e.g., complexity, activities, asset size) to enhance transparency and consistency across agencies.
7. Periodically review tailored standards to ensure they remain right-sized and durable as risk profiles evolve.

Conclusion

The record supports a tailored, risk-based framework for community banks that scales expectations by size, complexity, risk profile, and business model. Calibrating materiality and publishing illustrative guidance can make tailoring both practical and consistent. At the same time, agencies should preserve robust escalation to address the concern that ‘tailoring’ could invite softer supervision. In short, proportionate standards with clear guardrails best answer Question 22.

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