By David Lawder and Douglas Gillison

WASHINGTON (Reuters) -The brewing U.S. banking crisis seems far removed from the northeastern Vermont town of St. Johnsbury, but local Passumpsic Bank executive Daniel Kimbell grew concerned when he heard U.S. Treasury Secretary Janet Yellen’s congressional testimony last week.

Yellen told a U.S. Senate hearing on March 16 that uninsured deposits would only be guaranteed in banks deemed a contagion threat, raising fears that banks like Passumpsic, with $900 million in assets, might see business deposits above the $250,000 insurance limit flee for perceived safety to far larger institutions.

“A lot of us were kind of offended at what had come out, that the Treasury was going to guarantee all of the deposits for the larger banks — the too-big-to-fails — and us smaller banks were going to be on our own,” Kimbell told Reuters at an American Bankers Association conference in Washington.

While big banks have dominated headlines, the country’s 4,258 community banks, which are more risk-averse, account for more than 90% of all chartered banks.

They held just 11% of the $23.6 trillion in U.S. banking assets at the end of 2022, but nearly half are chartered in counties with populations of 50,000 or less, making them a key source of capital for small-town America and minority urban communities alike.

Yellen, President Joe Biden and the Federal Reserve and Federal Deposit Insurance Corp boards had invoked “systemic risk exceptions” after the failures of California’s Silicon Valley Bank and New York’s Signature Bank that allowed them to protect uninsured deposits, including those of wealthy technology executives and cryptocurrency investors.

Yellen on Tuesday shifted her emphasis, vowing to safeguard deposits at smaller banks and saying that the Treasury and regulators were prepared to intervene if further deposit runs threaten more banking contagion.

On Wednesday, she clarified that this would not include a swift government move to grant “blanket insurance” on all U.S. bank deposits without Congressional approval, but said that depositors in community banks, just like those in larger institutions, may qualify for systemic risk protections if those banks’ failures could spark contagious bank runs.

Her comments marked a shift in emphasis to include community banks that were not mentioned in her earlier testimony.

“The community banks in this country, we know, are strong and resilient. And I think banks need to reassure their customers, that they are strong and resilient, and the government needs to do exactly the same thing,” Yellen said.

Kimbell, who heads wealth management at Passumpsic Bank, said her reassurances “took the anxiety out of the room” over deposits, which was shared by banks large and small.

The chairman of the Independent Community Bankers Association said that member banks have not reported widespread withdrawals in response to the SVB and Signature failures, partly because the institutions are closely tied to their local markets.

“The community banks we’re talking to just aren’t seeing the negative reaction from our customers,” said Derek Williams, CEO of Century Bank & Trust Co in Milledgeville, Georgia.

Yellen’s shift to include community banks “was certainly better, it was an attempt for her to kind of restate what she was saying and acknowledging the importance of the community banks,” Williams said. She “gave the impression” that the government would step in to protect depositors, he added.

Community banks play an important political role. There are often dozens of such institutions in every congressional district, and the Biden White House is concerned about further consolidation in financial services. They were a key pillar in COVID-19 pandemic programs to keep small businesses afloat and their employees paid during health lockdowns.

(Reporting by David Lawder and Douglas Gillison; additional reporting by Pete Schroeder; Editing by Heather Timmons, Jonathan Oatis and Leslie Adler)

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