Economic Review
Second Quarter 2003 

Community Banks and the Federal Reserve
By Thomas M. Hoenig

In a speech given at the Federal Reserve Bank of Chicago’s conference, "Whither the Community Bank?" Federal Reserve Bank of Kansas City President Thomas Hoenig gave his perspective on the role community banks play in key sectors of the economy and in the Federal Reserve’s mission.

Mr. Hoenig’s central theme was that while community banks hold only a small share of the nation’s banking assets, they provide important financial services to some key sectors of the economy. Their importance in the economy, in turn, supports the Federal Reserve’s interest in and oversight of community banks. In fact, community banks play significant, though perhaps not equal, roles in each of the Federal Reserve’s three missions—monetary policy, banking supervision and regulation, and the payments system. Thus, the Federal Reserve has a strong interest in understanding issues facing community banks and in helping to make possible their continued participation in the nation’s financial and payments systems.

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The Role of Community Banks in the U.S. Economy

The U.S. banking system is unusual in consisting not only of some very large banks but also a large number of relatively small community banks. This bifurcated banking system in the United States has served the economy well. Over time, with regulatory change and financial innovation, large banks have become complex organizations engaged in a wide range of activities. They provide a variety of services to their customers, but often rely on hard financial information, computer models, and centralized decision-making as the basis for conducting business. In contrast, small banks have focused more on "relationship banking," basing decisions on personal knowledge of customers’ creditworthiness and a keen understanding of business conditions in the communities they serve.

The bifurcated banking system has served the needs of a diverse U.S. economy composed of businesses of all shapes and sizes and consumers with diverse needs and preferences. But despite the clear role that community banks play in the U.S. banking system, some analysts have questioned whether they play a sufficiently important role in the overall economy to warrant public interest and oversight.

This article examines the role of community banks in the U.S. economy and concludes that the Federal Reserve has a strong interest in understanding issues facing community banks. While community banks hold only a small share of the nation’s banking assets, they provide important financial services—for which there are few, if any, substitutes—to some key sectors of the economy. Moreover, community banks will continue to play an important role in the banking industry, even as technology and market conditions change.

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A Closer Look at Jobless Recoveries
By Stacey L. Schreft and Aarti Singh 

Most analysts believe the U.S. economy is now recovering from the recession. Yet businesses continue to lay off workers, prompting The New York Times to dub this "the worst hiring slump in 20 years." Market analysts and economists have a different name for what is happening. They call it a “jobless recovery.”

The only other jobless recovery in postwar U.S. history occurred following the 1990-91 recession. In the early years of that recovery, forecasting models based on data from past business cycles predicted that the observed pickup in output would be accompanied by employment growth. Those forecasts were consistently wrong and left policymakers puzzled by businesses’ continued trimming of payrolls.

Today, policymakers are trying to understand the unexpected joblessness of the past two recoveries. Will employment be stagnant in future recoveries? This possibility makes understanding the behavior of employment in recoveries, especially jobless recoveries, a priority.

Schreft and Singh take a closer look at jobless recoveries and find that they have many common features that distinguish them from the typical recovery. Understanding job growth, an important variable for evaluating economic activity, may enable policymakers to more accurately forecast the pace and strength of recoveries and to develop more effective policy responses to weak employment growth.

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