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AN AWALYIIfl 07 MDBRAL MSERVB
DISCOOKT WINDOW LOANS TO TAILED ZH8TZT0TZ0M8

Jun« 1 1 , 1991

by th« staff of
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BACRgRQTOB
The Committee on Banking, Finance and Urban Affairs is
currently considering legielation (H.R. 2094) which would reform
the proceee by which banking regulator* handle troubled and
insolvent insured depository institution*. With the collapse of
the savings and loan industry estimated to co«t the taxpayers $500
billion and bank failures increasing, auch refer* i* considered a
top priority. The proca** oust ensure, that insolvent institutions
are resolved in a manner which strictly results in the least
possible cost to the insurance fund and the taxpayers.
There are two dimension* to implementing a least aost
resolution program,
Tha first i* the pre-failure or takeover
stage, which is the period prior to the formal declaration of
inaolvency and takeover by the regulator; the second is the postintervention stage, which involves the process of liquidating or
selling the inatitution and its asset*. The least coat resolution
program contained in H.R. 2094 altero the latter stage by revising
the coat test contained in the Federal Deposit Insurance Act to (1)
ensure that all institution* are in fact resolved in the leaat
coetly wanner, (2) prevent the insurance coverage of uninaured
depoaits, and (3) abolish the too-big-to-fail doctrine.
The pro-failure stage i* modified by curtailing excess
regulatory discretion to keep open insolvent institutions long
beyond the point of viability*
The program require* prompt
regulatory action, as set forth in h\R. 2034, to proaots the
rehabilitation of a failing inatitution. But if the institution
beaomee insolvent, then th* regulator must act in a timely manner
to place the institution in conservatorship or reoeivership so that
additional losses are limited,
The <{U«vlJLuu t h « n « r i « « « a * t h « «x%ent *« w h i c h t h « l « « « t <">•*

resolution program is circumvented by the lending practices of the
Federal Reserve discount window. The. discount window serves an
important stabilising function by satisfying the short term
liquidity needs of viable depository inatitution*.
Under the
Federal Reserve Act the discount window can be used for seasonal,
adjustment or extended credit need*. Our analysis shows that when
a nonviable or insolvent depository institution receives openended extensions of credit at tha di«oount window in order to
r*Tn«*n o M n lona bevond the point of viability, then the Federal
Reserve 1* effectively increasing the coet of tfiximateiy resolving
the institution.
Since discount window loans are at least 100% collateralized,
tha Federal Reserve a**umes no risk of lo*s and ha* no incentive
to shut the window and contain the insurance fund*' losses. The
« O 1 1 * * « Y « I i» in H\« f/ina ii.s. Treasury notes, other government
securities, commercial loan* and other asset*.




1

The borrowed, funda can bo used by the institution during the
pre-takeover period to allow uninsured depositors to withdraw their
funda, Tha insurance fund must than absorb the loss that these
account holdara would have otherwise bean forced to share«
m
addition, th« d+iay in olo«<ng the institution causes operating
losses to escalate and increases losses from tha decline in asset
values.
In order to batter understand the practice and pattern of
Federal Reserve discount window lending and its impact on the
regulatory treatment of insured depository institutions, the
Banking Committee requested and received from tha Federal Reserve
extensive data on tha scope of discount window lending to Insured
depository institutions.

The Committee requested data on all insured depository
institution* which borrowed funda from the discount window from
January 1, 1985 through May, 10, 1991. the information was divided
into two groups: Group 1 consisted of institutions which had been
placed into conservatorship or receivership, or received assistance
under Section 13(c) of the federal Deposit Insurance Act, and Group
2 consisted of all other institutions. The requested information
included a schedule of the type and amount of loans extended, the
CAMEt, ratings of each institution, and the amount and type of
collateral taken. A copy of the letter requesting the Information
is attached as Exhibit A.
An analysis of tha data supports the following findings:
1.

90% Qf ALL IMflTITUTIONl WHICH RBCSIVBD "IXTBNDKD" CKEDIT
S0B81QU1NTLY FAILED.

ft,

TBI flOlIAL AB8BAV8 ROUTXMBLY WXTBHDS
IMiTXTvTIOMB WITH A CAK8L f RATtMd.

9.

A QAMBL S RATIO XM8TXTUTXOH WHICH BOAAOWBD FROM THB
DX8C0TOT WINDOW RBJCAIMJD OPBW FOR AM AVBRAOS FIRIOD 07
10 - 13 MOUTHS.

4

BORROWIWa FROM THB 0X8CO0MT WIKDOW XMCRBA0H8 DRAMATICALLY
M AM IMSTITtJTIOW'S FIKAHCIAL COKDXTXOM BITBRIORATII.

1.

THB FIDBAAL MfliRVH TAKJ0 THB HIQHliT QUALITY ASSBT8 OF
THB XMiTITTOIOM IM A t AKOTOTflUBSTAMTIALLYIK 8XCH88 OF
l
THB LOAM AMOUMT Ad COLLATIAAL.




2

CABDXT

TO

STATISTICAL ANALYSIS

Group 1, the insured depository institutions which borrowed
from th« di«cotjnt window within three years of failure, consisted
of 530 institutions.
Group 2, a n otner institution* which
borrowed for five or more consecutive days, consisted of 2,460
institutions, of the 530 Group 1 institutions, 67 (or 16%) had
assets greater than or equal to $100 million, and 443 (or 04%) had
assets lees than $100 million.
Diacount Window Loans.
The Federal Reserve categorises
discount window loans into three types: seasonal, adjustment, and
extended. A Federal Reserve description of each one is attached
as Exhibit B, A summary of the use of each by the failed
institutions followsi
320 (or 60%) of the Croup 1 Institutions were borrowing
at the time of failure.
292 Croup 1 institutions were borrowing extended credit
at tho time of failure.
26 Group l institutions were borrowing ad-iuatment credit
at the time of failure.
2 Group l institutions were borrowing seasonal credit at
the time of failure.
Extended ctvAL±.
The borrowing patterns of Group 1
institutions reveal that prior to failure, many insolvent
institutions will enter into a period of continuous or intermittent
extended credit borrowing veil beyond the short term periods viable
institutions will need to borrow for liquidity purposes. The
outstanding amount increases daily as the balance due is rolled
over with now borrowings. 418 (14%) of the 2990 institutions
studied received extended credit. 377, or 90%, of these 418
institutions subsequently failed.
Thus, the extended credit
offered by the Federal Reserve appears te operate ia praotioe as
« for* of open assistance or forbear anas.
C A M E L Bstincs.
The term "CAMEL" represents the following
performance standards; capital adequacy, Asset quality. Management,
Barnings and Liquidity. The ratings given to an institution range
from a high of 1 to a lev of 8. A description of what each level
of CAMEL rating represents as far as the health of an institution
is contained in Exhibit C-

The reported CAMEL ratings of Group 1 institutions at the time
of failure were as follows*



3

CAMEL 51 437 (82%)
41
51 (10%)
3:
11 (2%)
2:
5 (1.1%)
1:
1 (0.2%)
not available .15 (4,9%)
Total1 530
The length of time an institution with a CAMEL 5 rating was
allowed to remain open ranged from less than a month to at long a«
56 months;
Manilla

w m ^ r of Tnatitutlona

0-3
4-6
7 - 9
10 - 12
13 - 15
16 - 18
1$ - 21
22 - 24
25-27
28-30
31-33
34-36
56-58

74
53
62
92
58
37
28
16
2
5
3
7
1

Tha average langth of time that an institution with a CAMEL
5 rating v&a allowed to remain open vai 10 - 12 Months.
Amount..Pt_ Cyadlt.

Regarding the amount of credit extended:

320 Croup l institution* had a total of M . M B billion
in Federal Reserve loans outstanding at the timo of
failure*
A7.343 billion of this credit was extended when the
institutions were operating with a C A M E L S rating.
According to one Federal Reserve Bank document, the Banks
normally receive notice of composite CAMEL l, 2 and 3 ratings with
a 4 to d month lag from the time of examinationi however, composite
CAMEL 4 and S ratings are normally known with little lag tin* ae
a result of simultaneous holding company inspections or
conversations with regulators. Peak borrowing for all 530 Group
1 institutions in the three months prior to failure totaled 818.1

frllllnn-




4

REPRBBBqyATiVB CAflH A T O P I E S (Summaries, see Appendix for detailed
information)
F}rnt ifopubllcBank Dallaa, N.A. fOallaa, TX1 . With aaaeta of
$16,379,600,000, thia was the largest institution in Group 1. its
borrowing from the discount window began on March IS, 1988, with
an extended credit loan in the amount of $2.6 billion. The loans
continued uninterrupted for 4 1/2 mc:>nh«t until First Republic was
closed on July 29, 1988, Peak borrowing during this period was
$3,278 billion and its last CAMEL rating was a 3 on September 30,
1986.
The collateral taken was customer notes, and commercial and
industrial loans with a book value of $6.4 billion and Federal
Reserve estimated "lendable* value of $4.0 billion. The book value
of the collateral represented 39% of the bank's assets.
Boston T,rade Bank (Boston, MA). Boston Trade Bank was a
»«<aium-«i«4k/* institution with asaets of $352.9 million, which
failed on May 3, 1991. It illustrate* Uia « ; o o a u «^n«rlo of A
financially deteriorating institution which begins borrowing from
the discount window at the same time the regulator gives it a CAMEL
5 rating. The uninterrupted borrowing increases for five straight
months until it is finally closed with outstanding loans of $53.6
million, representing 15% of its assets.

First State ..Bank; cX-Blffln' fElgin, OR). The majority of the
institutions using the discount window to delay closure wera small,
such as this one with assets of $17.3 million. It operated at a
CAMEL 5 rating for two years and was borrowing extended credit from
the discount window every day during its last 12 months of
operation.
Bank of New England rBoafon. MAI. BNE was the second largest
in Group 1 with assets of $13.9 billion whon it was doolared
inuolvant on January 6, 1991, Peak lending reached $2,263 billion
over a six ttonth period before a plan 'of major asset sales and
borrowing from affiliates was implemented to replace discount
window borrowing. Also, the Institution4* liquidity position was
aldad by Department of Treasury deposits of tax receipts.
Lincoln Savings and Loan Association /Irvine, CA). Lincoln
S6L had assets of $2,752,800,000 at the time of receivership and
was responsible for en estimated $2 billion loss to the taxpayers.
Since the institution was placed in conservatorship on April 14,
1989,
rather than receivership (whlah was done 4 months later),
uninsured depositors were allowed to withdraw their funds without
taking a loss. Federal Reserve loans as high as $98 million over
the
four
month
conservatorship
period
facilitated these
withdrawals.
The First National Bank and Trust Co. /Oklahoma city, om .
This la another example of the discount window being used to keep
open insolvent institutions.
The bank obtained uninterrupted



9

credit for over one year with peak lending of $344 million, all the
while operating with a CAMEL 3 rating.
The peak loan amount
represented 22% of the banks $1.6 billion in assets when it failed
on July 17, 1986.
First StatA Rank fAbilene. TXl. This bank received three
consecutive CAMEL S ratings and was kept open for 17 months before
it was placed in receivership on February 17/ 1989. Consecutive
discount window borrowing began with « $4 million extended loan on
May 12, 1986 and ended ten months later with a balance of $95.2
million, or 35% of the bank** $262,3 million in assets.
ATTACHMENTS
Exhibit A:

Letter from Chairman Gonzales to Chairman creenspan,
dated May 9, 1991.

Exhibit B:

Overview description (excerpt) of the types of
credit extended by the Federal Reserve, from T i l
jf

r«deral Rtgqrvfl Discount Window (I9?g),.
Exhibit C*

Description of CAMEL ratings.

Appendix:

Detailed Information from each case study.




6

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EXHIBIT A

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u.s. HOUSE OF REPRESENTATIVES
COMMlTTtC ON BANKING. HNANCE ANO V«8AN AffAI«S

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Kay 9, 1991

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Tha Honorable M a n Greenspan
Chairman
Tha Board of Governors of tha Federal Reserve system
20th and Constitution Avenue, N.w.
Washington, D . C 20591
Dear Mr, Chairman?
Wa ara writing to you regarding an iaaua of tha utmost concern
and urgency to tha Committee on Banking, Finance and Urban Affairs:
Federal Reserve landing to infured depository institutions.
As you will agree, this Committee and the Congress ara
obligated to maintain the safety and soundness of the banking
industry. We also have a fiscal responsibility to ensure that
insolvent insured depository Institutions are resolved at tha least
cost to tooth tha banking industry which pays premiums into the
insurance funds and to the taxpayers who guarantee tha covorago of
insured deposits.
Federal Reserve loana to insured depository institutions have
a significant impact on both of these goals. Extensions of credit
far liquidity needs, including overnight edvancea, are important
to maintaining the stability of the banking industry. However,
when credit is extended to a failing institution by the Federal
Reserve as the lender of last resort, the insurance funds and the
taxpayers foot the bill*
These Federal Reserve loans, which bear interest, are aade in
exchange for at. leapt 100% collateral end priority creditor status.
The aeaeta being held by the Federal Reserve as collateral are then
unavailable to the institution to Beet its obligations.
This
itwv*ao«« tha coat of resolving the institution by depleting the
institution's assets, when the institution i« finally closed, the
FOXC repays the Federal Reserve in cash before all other creditor A,
and the FOZC then takes back from the Federal Reserve th«
collateral that secured the federal Reserve advances. Thus, those
Federal Reserve loans increase the losses to the insurance fund*
and the taxpayers standing behind then, and allow insolvent
institutions to stay open long beyond the point of viability.



In order for. the Committee to both fulfill ita oversight
responsibilities and legislate in these important areas, we requaat
that you submit the following information to the Committee:
l.

Regarding each insured depository institution that has
been placed in vonservatorahip or receivership, or
received assistance under Section 13(c) of the Federal
Deposit Insuranoe Act, during the period of 1985 to data,
please provide}
(A)

A schedule indicating each time the Federal Reserve
extended oredit, directly or indirectly, to the
institution during the three yea* period receding
the appointment of the conservator or receiver, or
the provision of the section 13(c) assistance; and
include in the schedule:
(1)

the CAMEL rating of the Institution at
the tine the credit was extended;

(ii)

the type of credit extended, inoluding
seasonal credits, adjustment credits, and
and emergency liquidity advances/

(ill) the amount of credit extended;
(iv)

the length of the repayment period;

(v)

the amount and type of collateral taken;
and

(vi) whether repayment was made on tine, late
or not all, and specify whether in any
case an extension of time or rollover
occuredt
(B)

(C)

2.




the date and total of the largest amount or Federal
Reserve loans to the institution outstanding at any
one point in time; and
the aaount of Federal Reserve loans outstanding at
the
time
the
institution
was
placed
into
conservatorship or receivership, or received section
13(c) assistance; together with the book value and
estimated fair market value (if known) of the
collateral taken for each outstanding loan.

Regarding all other insured depository institutions
during the period from 1983 to date that are not included
in the group defined in (1) above, p-lease provide:
(A)

the date(s), aggregate number and amount of loans

extended to those institutions by the Federal
Reserve during the past five years, for a poriod of
0 to 5 days, 6 to IS days, 10 to 30 days, 31 to 60
daya, and 61 day* or longer/
(B) the name of each institution which received a loan,
directly or Indirectly, from the Federal Reserve for
a period of 5 days or longer; and include the type
and purpose of each such loan; and
(C)

the current status and C A M E L rating
institution described in 2(B) above.

of

each

When compiling the information requested include "conduit
loan*" and, when compiling the information requested in (2) above,
exclude non-rolled over loans for e tern of leaa than five
consecutive days.
The Committee** concern over this issue has been heightened
by r«portfl that the Federal Reserve, in a seeming replay of its
lending of approximately §soo m i n i o n to an i*«olvent National Bonk
of Washington, has been extending credit to Kadi son National Bank
even though the officers of the bank have publicly declared that
it is insolvent. Furthermore, ve understand that this has allowed
several large depositors of Madison National Bank to immediately
withdraw their uninsured funds.
The Committee will ttark up legislation very soon which could
affect the lending activities of the Federal Reserve. Therefore,
please devote sufficient resources to complying with this request
so that we receive a complete response by May 30, 1991. Should you
neod Additional personnel, we stand ready to ask the General
Accounting office to assist yvv»,
if you have any questions
concerning this request, please contact the Banking Committee Staff
Director, Xalsay Meek, as soon as possible.
Sincerely,

(WRryBf JfnVaM
Chairman

Oerald D. Kleczkv



Frank Annum io
Chairman
Subcommittee on
Financial Institutions

SJOW^iWto-a

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U.S. HOUSE OF REPRESENTATIVES
C 0 M M 0 7 « ON CANKlNa ftNANC* ANO OMAN AWAWS

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WASHINGTON,

D . c , June 11, 1391—Hous« Banking Committee Chairman Henry

B. Gonzales charged today that tho federal Receive has "expanded billions of
dollars of public monies in backdoor bailouts of failing banks."
Mr. Gonzalez said the Federal Reserve'e loans had kept brain-dead
institutions open for extended periods, increasing losses for the Federal
Deposit insurance funds,
Mr. Gonzalez' comments were based on findingc of a Committee study of
discount window operations between January l, 1985 and Kay 1991.
The findings included:
1, Ninety percent of all institutions which received "extended" credit
subsequently failed.
2, The Federal Reserve routinely extends credit to institutions with *
CAM8L 5 rating—the lowest possible rating,.
3, A CAMEL 5 rated institution which borrowed from the discount windov
remained open for an average period of 10-12 months.
4- Borrowing from the discount window increases dramatically as an
institution*a financial condition deteriorates.
The study revealod that 530 institutions failed within three year* of
borrowing from the Federal Reserve,

some 320 banks were borrowing at the

time of failure and had outstanding loans of $8,325 billion when they wer«
closed.




Mr-

Gonzalez

said

the Federal Reserve's

loans to

terminally

ill

institutions had allowed uninsured depocitors to withdraw funds and had kept
bonk* opeirafcin? with bad tuanagomont »nd risky loan policies.
"This is a massive form of forbearance—granted in secret by the Federal
ft«*erve*«-at a huge cost to the insurance funds and the taxpayers/' th*
Banking Committee chairman said.

"We hear many complaints about the ills of

money brokers who move money into failing inGtitution*, but their operations
pale besido the mega-buck operation* of the Federal Resorve,"
Kr, Gonzalez oaid it is important that controls be placed on the Federal
Reserve's dieoount window operations if the Congr*a« ia "serious about
limiting losses to the insurance fund, ending the too-big-to-fall policies,
and halting the costly practice of extended forbearance for poorly run
banks."





Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102