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DOCUMENT '$SUME
00278 - [A0751124]

Federal Supervision of State and National Banks
Body of Report]. OCG-77-1; B-114831; B-118535; [Vol. II: Eain
B-168904# January
31, 1977. 1 vol. (various pagings).
Report to the Congress; by Elmer B. Staats, Ccmptroller
General.
Issue Area: Federal Regulatory Activities (30C0);
Accounting and
Financial Reporting (2800).
Contact: Office of the Comptroller General.
Budget Function: Miscellaneous: Financial Management
and
Information Systems (1002); General Government:
Central
Fiscal Operations (803).
Organization Concerned: Federal Deposit Insurance
Corp.; Federal
Reserve System; Department of the Treasu-y; Cffice
of the
Ccoptroller of the Currency.
Actnlority: National Banking Act (12 U.S.C. 21-27).
Federal
Depeosit Insurance Act (12 U.S.i. 1816).
Several congressional committees requested
evaluation of the effectiveness of the supervisory the
the three Federal agencies involved in monitoring efforts of
operations, because of the increasing instability banking
of banks. The
study objectives were to evaluate the agencies'
efforts to
identify unso'nd conditions ard violations of laws
cause bank management to take corrective actions. in banks, and
reports and correspondence files on more than 900 Examination
superviad by FDIC, Office of the Comptroller of banks
the Currency,
and the Federal Reserve Boards were examined,, including
30 of 42
banks that had failed, 294 of 787 problem barks,
and a general
sample of 600 of the banks in the United States.
Findings/Conclusions: Adverse economic conditions
contributed to
some bank failures, but generally embezzlement
and
management ot loans were the causes. Problems were poor
because: (1) the regulatory agencies were reluctant not corrected
to use their
lega' .uthority to force the banks to change, (2)
the agencies
did not consult with bank boards, (3) examinations
on a time basis rather than a problem solving basis,were set up
and (4)
recommendations were not generally made as to how
to
solve
problems. Examiners have enforcement tools they
informal and formal: (1) informally request that may use, both
changes, (2) formal written agreements to ccnfirt banks make the
:orrection
plans, (3) cease and desist orders, (4) remcval
of
management,
(5) financial assistance, (6) cancellation of deposit
insurance,
(7) cancellation of Federal Reserve membership,
and
(8)
revocation of charter. Federal Reserve Board surveillance
of
bank holding companies is not adequate. Training
of
examiners
is
not adequate. Major imsrovements of bank supervision
include
organizational changes, closer bank surveillance,
self-dealing
and insider transaction monitoring, consumer protection
law
enforcement, new examination procedures, closer
contact
with
bank bcards, problem solving monitoring, more use
of formal

poweers, experiemeuts on relying on state examinations, and
better training of examiners. The agencies involved are not
working as closely as they shculd. Recorfendaticns: The
agencies should revise their examination practices and
frequencies to better identify problems. Bxamination reports and
Featings with bank boards should follow all examinations. More
aggressive policies should be developed for the use of formal
actions against problem banks. Better training and screening or
potential examiners should be implemented. The three agencies,
either through their own initiative or legislaticn, should
coordinate their efforts more closely. bore strigent procedures
for handling charter applications should be devised. (SS)

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COMPTROLLER GENERAL OF THE UNITED STATES
WA.HINGTON. D.C. 2t051

B-114831
B-118535
B-168904

To the President of the Senate and the
Speaker of the House of Representatives
This report is the :esult of our unprecedented study of
the effectiveness of State and national bank supervision
by the Federal Deposit Insurance Corporation; the Federal
Reserve System; and the Office of the Comptroller of the
Currency, Department of the Treasury.
This study was made at the request of several congressional committees concerned ove: large bank failures in
recent years and public disclosure that supervisory agencies'
lists of "problem banks" had lengthened.
Our Office does not have legislative authority to audit
the operations of the Federal Reserve System or the Comptroller
of t e Currency. Also, our access to the bank examination
reports of the Federal DeposeL Insurance Corporation has long
been a matter of dispute.
In light of the heavy congressional interest in the
area, the agencies allowed us to make the study. They agreed,
ill April 1976, to give us unlimited access to their bank
examination reports and other related records,
provided
we would not disclose any information about specific banks,
bank officers, or bank customers.
The focus of this report is on evaluating the agencies'
bank examination functions and their efforts to get banks to
correct problems identified. Several recommendations for
improvements are made.

B-114831
B-118535
B-168904

The three agencies have reviewed and commented on a
draft of the report. Their comments are presented, in
full, as appendixes to the report. In view of the time
constraints placed on us for completing and releasing
the study, we have not been able to fully evaluate their
comments.
In the past we have supported proposals before the
Congress to give this Office continuing legislative
authority to review the operations of the bank regulatory
agencies and report to the Congress. With such authority,
we could be more helpful to the Congress in carrying
out its legislative and oversight responsibilities for
bank insurance and regulation. In view of the very important
part that the three agencies play in the Nation's system
of money and credit, we feel that the Congress should
provide for GAO audits of the agencies.
We are sending copies of this report to the Secretary
of the Treasury; the Comptroller of the Currency; the
Chairman, Board of Governors of the Federal Reserve System;
and the Chairman, Board of Directors of the Federal Deposit
Insurance Corporation.

Comptroller General
of the United States

- 2 -

Contents
Page

CHAPTER
i

INTRODUCTION

1-1

ENTRY INTO THE NATIONAL BANKING SYSTEM

2-1

CONVERSIONS OF CHARTERS--CHANGES IN
SUPERVISORY AGENCIES

3-1

BANF EXAMINATIONS: 1971-75

4-1

BANK PROBLEMS IDENTIFIED BY EXAMINATIONS

5-1

REPORTING PRACTICES: 1971-75

6-1

EFFORTS TO IMPROVE BANK EXAMINATION

7-1

EFFECTIVENESS OF AGENCIES IN RESOLVING
PROBLEMS

8-1

AN ANALYSIS OF BANKS THAT FAILED I1N THE
LAST 5 YEARS

9-1

9
10

EXAMINER CAPABILITY AND INDEPENDENCE

10-1

POTENTIAL FOR BETTER INTERAGENCY COOPERATION

li-1

SCOPE AND APPROACH OF GAO STUDY

12-1

APPENDIX
I

III

Letter dated January 14, 1977, from the
Comptroller of the Currency, to the
General Accounting Office
Letter dated January 16, 1977, from the
Chairman, Federal Reserve Board, to the
General Accounting Office
Letter dated January 17, 1977, from the
Chairman, Federal Deposit Insurance Corporation, to the General Accounting Office

I-1

II-1

III-1

IV
V

Survey of commercial bankers
Principal officials responsible for administering activities discussed in this report
ABBREVIATIONS

CSC

Civil Service Commission

EDP

Electronic data processing

FDIC

Federal Deposit Insurance Corporation

FRB

Federal Reserve bank

FRS

Federal Reserve System

GAO

General Accounting Office

NBSS

National Bank Surveillance System

OCC

Office of the Comptroller of the Currency

IV-1
V-1

CHAPTER 1
INTRODUCTION
Pagq

Purpose of this study

1- 1

The banking industry
Changes in th, banking industry: 1971-75

1- 3
1- 3

Government involvement in banking--a
historical perspective
Initial Federal and State involvement
State involvement only
Reemergence of Federal. involvement
The bankers' view of Faderal supervision

1- 8
1- 8
1-. 8
1- 9
1-10

Regulation and supervision of banks today
The agencies' responsibilities and finances
Federal Deposit Insurance Corporation
Federal Reserve System
Office of the Comptroller of the Currency

1-11
1-13
1-13
1-14
1-15

The cost of Federal bank supervision

1-16

CHAPTER 1
INTRODUCTION
PURPOSE OF THIS STUDY
The Congress is concerned with the soundness of the
commercial banking system. In the past 3 years, several
large U.S. banks have failed. The public has become aware
that a number of major banks are on supervisoryr agencies'
lists of problem banks 1/. The supervisory agencies' power,
capability. and independence to pLoperly supervise the
banks are being questioned.
In early 1976, several cor7ressional committees asked
us to evaluate the effectiveness of the supervisory efforts
of the three Federal agencies involved:
Federal Deposit
Insurance Corporation (FDIC); Federal Reserve System (FRS);
and Office of the Comptroller of the Currency (OCC), Department of tne Treasury. Specifically, the study was requested
by the Chairmen of
-- the House Committee on Banking, Currency
and Housing;
-- the Domestic Monetary Policy Subcommittee, House
Committee on Banking, Currency and Housing;
-- the Financial Institutions Supervision, Regulation
and Insurance Subcommittee, House Committee
on Banking, Currency and Housing;
-- the Commerce, Consumer, and Monetary Affairs Subcommittee, House Committee on Government Operations;
and
-- the Senate Committee on Banking, Housing and Urban
Affairs.

I/In the context of this report we use the term "problem
banks" to refer to banks requiring special supervisory
attention. FDIC and FRS also commonly refer to them as
problem banks, but OCC considers problem banks as a i:ortion of banks requiring special supervisory attention.

1-1

Our study was possible because the agencies granted us
access to their bank examination reports and related records.
We do not have statutory audit authority at FRS or OCC, and
our right of access to bank examination records at FDIC has
long been contested. The agencies supported out efforts and
provided the cooperation essential to completing the study.
The objective of our study was to evaluate the agencies'
efforts to (1) identify unsound conditions and violations cf
laws and regulations in banks and (21 cause bank management
to take corrective actions. Our effort was directed to determining whether:
--OCC considers applications for national bank charters
on a fair and consistent basis.
-- Bank examinations are of sufficienit scope to identify
banks which are likely to run into serious managerial
or financial difficulties.
-- Supervisory agencies' efforts to improve their operations are satisfactory.
-- Supervisory agencies can and do follow through on
their findings of problems in banks to see that corrective actions are taken by bank managers.
-- Examiners are qualified and trained to counduct reliable bank examinations.
We reviewed examination reports and correspondence
files on over 900 banKs supervised by the 3 agencies. These
included three sample groups:
-- 30 of the 42 banks which failed from 1971 to mid-1976.
-- 294 of 7R7 "proble. " banks (those identified by the
agencies as needing special supervision) as of December 31, 1970, and December 31, 1975.
--A general sample of 600 of the over 14,030 banks in
the United States.
The scope of our study is described more fully in
chapter 12.

1-2

THE BANKING INDUSTRY
About 14,700 commercial banks are chartered to do
business in the United States and its possessions. Of these,
about two-thirds are chartered by the 50 States and one-third
by the Comptroller of the Currency.
Banks range in size from a general-store-post-office
bank in the mountains of Colorado to a multibillion dollar
institution with over 1,000 domestic and foreign branches.
Half of the industry's assets are teld by less than
2%0 banks.
Banking in its simplest form is a straightforward business. Funds received as deposits are invested primarily as
loans to commercial and individual enterprises, and to Federal, State, and local gover.nuits. Bank profits result
from investing funds at interest rates greater than the
rates paid to depositors.
Banking entails risk, and these risks become greater
in periods of general economic decline. To lessen the
effects of possible economic declines, banks have engendered
a host of strategies to reduce risks while still assuring
reasonable profits. Diversifying loan and security portfolios and balancing demand and time deposits are perhaps
the most basic strategies for dealing with risk.
The changing needs of consumers have also influenced
the marketing strategies of banks. Today commercial banks
must serve the needs of governments, multinational corporations, small businesses, farmers, and individual consumers.
Changes in the bankin g indutry: _1971-75
During 1971-75, the commercial banking industry underwent significant change. Much of the change is reflected in
the following comparative statistics for December 31, 1971
and 1975.

1-3

General Statistics

Number of commercial banks
Number of large banks (assets
over $100 million)
Number of small banks (assets
under $10 million)
Number of domestic branches
Number of bank holding companies
Number of multibank holding companies
Number of banks controlled by
holding companies
Assets of banks controlled by
holding companies (billions)
Number of foreign branches of
U.S. member banks
Assets of foreign branches of
U.S. member banks (billions)
Foreign loans of U.S. domestic
banks (billions)

Percent
increase

1971

1975

13,804

14,657

640

920

7,367
23,370
1,567

5,661
30,262
1,821

-23
29
16

177

311

2,420

3,674

$362

$661

577

762

$ 61

$176

189

$ 27

$ 60

122

Several trends are apparent from the preceding statistical data:
-- The number of banks with assets over $100 million
increased 44 percent, while banks with under
$10 million in assets decreased 23 percent.
-- The number of banks controlled by holding companies
increased 52 percent and their assets increased 83
percent.
-- Assets of foreign branches of FRS member banks increased 189 percent. (Nonmember banks hold less than
1 percent of foreign branch assets.)
·-Foreign loans of domestic banks and branches increased
122 percent.
The following tatles describe all commercial banks, excluding their foreign operations.

1-4

Balance Sheet Data

1971

1975

Percent
increase
(note a)

(billions)
Cash
Securities:
Federal, State, and local
government
Other
Federal funds sold
Loans:
Residential real estate
Automobile
Other personal
Comntercial and industrial
Banking and financial
Agricultural
Other real estate
All other
Bank premises and equipment
Other assets

$100

$135

166
4
20

222
9
39

34
108
97

57
25
41
120
22
17
30
19
10
15

92
34
59
181
42
26
53
25
16
42

62
36
42
51
96
59
75
29
52
185

Total assets

$646

$975

$264
279
24
25

$326
467
54
49

23
68
122
96

7
3
32
12

9
5
43
22

41
50
33
80

$646

$975

Demand deposits
Time deposits
Federal funds purchased
Other liabilities
Reserves for losses on loans and
securities
Capital notes and debentures
Capital stock and surplus
Undivided profits and reserves
Total liabilities
and capital
a/Based on amounts before rounding.

1-5

Income and Ex2ense Data

1971

1972

1973

1974

1975

------------- (billions)------Income:
Interest
Other
Expenses:
Interest
Compensation
Provision for
losses
Other
Income taxes
Net income

$32
5

$35
5

$47
6

$61
7

$58
9

14
8

16
9

25
10

35
12

30
13

1
7
2

1
8
2

2
10
2

4
11
2

$ 5

$ 7

Dividends paid

$2.23

$2.20

$2.43

$2.77

$3.03

Losses charged
to reserves
RecoveLies
credited to

$1.41

$1.26

$1.55

$2.42

$3.80

-. 32

-.37

-. 39

-. 46

-. 55

Net loan and
securities
losses
$1.09

$0.89

$1.16

$1.S6

$3.25

reserves

1-6

From our analysis of the financial data, the following
observations can be made about the banking industry:
-- Total assets of the commercial banking industry grew
by over 50 percent. The number of banks increased
only 6 percent.
-- Less than 19 percent of the asset growth was financed
by demand deposits (checking accounts), while
74 percent came from more costly time deposits (such
(The remainas savings certificates) and borrowings.
ing 7 percent came from an increase in capital.)
-- Loans secured by residential and other real estate
increased over 66 percent.
Included were
-- Other assets increased 185 percent.
real estate holdings resulting from foreclosures,
or taken in lieu of foreclosure, which increased
380 percent, (from $0.4 billion in 1971 to
$1.9 billion in 1975).
-- Reserves for potential losses on loans and securities
increased 41 percent, 7 percentage points less than
the overall growth in loans and securities.
-- Total capital increased 46 percent. Approximately
half of the growth was the result of profits being
retained; half, the result of new capital being
added.
-- Capital declined slightly in proportion to assets,
from 8.36 percent in 1971 to 8.10 percent in 1975.
-- The relationship of profits to assets also declined
slightly (from 0.77 to 0.72 percent).
-- Income and expenses for 1975 were about 82 percent
greater than for 1971, due mostly to the rise in
interest rates.
-- Net losses from loans and securities for 1975 were
approximately 200 percent greater than for 1971.

1-7

GOVERNMENT INVOLVEMENT IN BANKING-A HISTORICAL PERSPECTIVE
Government involvement in the American banking industry
has consisted of recurring attempts to balance the need for
healthy competition among banks with the need for a sound
banking system. As history shows, these objectives are not
easily reconcilable. Attempts to balance them have led to a
banking system which is unique in the contemporary world;
Government involvement in the Nation's 14,700 commercial
banks is dispersed among 50 States and 3 Federal agencies.
The historical path to the present system followed three
stages of governmental supervision:
involvement initially
by both Federal and State governments, then by State governments alone, and again by both levels of government,
Initial Federal and State involvement
The first bank in the United States--the Bank of
Pennsylvania--was chartered in 1781 by the Continental Congress. Until 1790 there were only three commercial banks in
the country--the Bank of North America (successor to Bank of
Pennsylvania), which held both Federal and State charters,
and two other State-chartered institutions.
In chartering the first "Bank of the United States" in
1791 and the second "Bank of the United States' in 1816, the
Congress attempted to establish a "central" bank to regulate
the money supply in the economy. Both banks were chartered
for a specific time period and, although both banks were
considered successful, their charters were not renewed for
political reasons.
President Jackson's veto of its application for charter
renewal in 1836 closed the second Bank of the United States
and temporarily resolved two controversies--should the Federal Government charter banks, and should it regulate the
money supply?
State involvement only
From the demise of the second Bank of the United States
until 1863, State governments chartered banks. The Federal
Government made no attempt to regulate the supply of Statebank-issued promissory notes. The Federal Government from
1836 to 1863 was out of the banking business.

1-8

With the demise of the second Bank of the United States,
the era of "wild cat" banking began, under State banking laws
which were often rather lax. The number of State banks grew
from only 88 in 1811, to 713 in 1836, to 1,466 in 1863.
The price of increased competition was the disruptive
effect of numerous bank failures. The resulting instability
in the banking system led for a time to a complete ban on
banking in some of the States.
During that period, entry into banking was regulated by
charters granted by State legislatures. To get a charter,
one needed a majority vote in the legislature.
Such "political" chartering was opposed by proponents
of "free" chartering; they favored entry for anyone who could
meet certain objective criteria specified by statute. The
New York "Free Bank Act" of 1838 was the pioneer; it specified less subjective requirements for acquiring a bank
charter.
Similar free-banking laws were enacted by other
States.
Reemergence of Federal involvement
The return of the Federal Government to banking supervision came in three major steps:
the National Currency Act
of 1863 (superseded by the National Bank Act of 1864) which
created OCC; the Federal Reserve Act of 1913 which created
FRS; and the Banking Act of 1933 whic. created FDIC.
Under the 1863 act, the Federal Government again became
involved in bank chartering.
The act created a new type of
bank--a national bank.
This bank could issue its own bank
notes secured by Federal bonds.
The act also created a
"Comptroller of the Currency," with authority to charter and
supervise national banks.
In many respects, the act extended the basic concepts
of the various State free-banking acts to a national scale.
National banks offer an additional avenue of entry for persons unable to secure State charters.
The effect of the act
was to increase competition.
While some may have intended that national banks would
supplant State banks, the actual result was a dual FederalState banking system. Attempts to force State banks to convert to national banks by taxing State bank notes reduced

1-9

the number of State banks from 1,089 in 1864 to 325 in 1870.
Eventually, however, the tax caused the elimination of State
bank notes, but not State banks.
The advent of deposit banking (use of checking accounts)
and the realization that less stringent State laws gave State
banks a competitive advantage over national banks stimulated
State banking. By 1892 State banks had increased to 3,773-outnumbering national banks, which they have continued to
do, although for many years after 1892 and consistently since
the bank moratorium of 1933, total assets of national banks
have exceeded those of State chartered banks.
With the Federal Reserve Act of 1913, the balance
between competition and soundness was struck differently.
Central banking powers of the Federal Government were reconstituted, but dispersed in a system of 12 Federal Reserve
banks administered by a 7-member Federal Reserve Board
While national banks automatically became members of the new
Reserve System, State banks had to apply for membership.
Supervision of State member banks by the Board presumably
increased State bank soundness through reserve and other
requirements.
The Banking Act of 1933 which established FDIC, increased Federal involvement in banking. Bank soundness was
promoted because the Federal Government would now supervise
those State banks which were not in the Reserve System and
which subscribed to the Federal insurance program.
Except for 286 State banks not covered by Federal Deposit Insurance, all commercial banks were supervised by one
of the three Federal agencies at the end of 1976.
The bankers' view of Federal supervision
As the historical record shows, banks in the United
States have always been regulated by some level of government. At a minimum, establishing a bank has always depended
on a government "blessing" in the form of a charter.
The
power to grant a charter carries with it the inherent power
to revoke it.
Further, the authority to charter establishes,
ipso facto, a government interest in the soundness cf the
chartered entity. Protection of this interest has led, historically, to bank supervision.
Chartering, examination, and followup actions are
central aspects of the State and Federal Government relationship to commercial banks.
1-10

Bankers, responding to our survey 1/, endorsed
government intervention in the banking Industry. Almost
90 percent indicated that "elimination of bank regulation
entirely" would be, to some degree, "detrimental." Other
aspects of Government intervention received similar endorsements. For example
--70 percent felt elimination of Federal chartering
would be detrimental,
-- 72 percent felt elimination of State chartering
would be detrimental, and
-- 88 percent felt elimination of bank examinations
would be detrimental.
Approximately 80 percent of bankers responding to our
questionnaire opposed any bank regulatory arrangement which
did not include States. Bankers clearly favored the dual
banking system over a solely Federal system.
REGULATION AND SUPERVISION OF BANKS TODAY
Government regulation is one of the strongest influences on the banking industry today. The primary regulators
are the States and the three Federal agencies--FDIC, FRS,
and OCC.
The Federal agencies, as well as agencies in
50 States, all have some responsibility for bank regulation
(the process of interpreting banking legislation and issuing
rules and regulations for the ban.gs) and bank supervision
(the process of monitoring, examining, and advising individual banks).
The Federal agencies influence the .. ructure and operation of commercial banks by granting national bank charters,
FRS membership, and FDIC insurance and by approving bank
holding companies, foreign branches, and other bank structural changes.
1/Our survey of commercial bankers is described on page 12-6,
and the results of the survey are summarized in appendix IV.

1-11

All banks--both State and national--are also influenced
to some extent by State law. Most noteworthy are State
laws which govern trust operations and branching. Twenty
States permit statewide branching; 18 States permit limited
forms of branch banking; and 12 States require unit banking.
Individual State laws on the formation of bank holding
companies also influence the structure of the banking industry. In 8 of the 12 unit-banking States, holding companies
may own more than one bank. The result is that very few
States can be considered true unit-banking States. Only
Illinois, Kansas, Nebraska, and Oklahoma are fairly consistent in prohibiting branches (except auxiliary teller facilities) as well as multibank holding companies.
Some of the important regulations issued and administered by the Federal agencies are in the following areas:
-- Equal credit opportunity.
-- Standards for security devices and procedures.
-- Interest on deposits.
-- Securities issuance.
-- Bank holding companies.
-- Interlocking relationships.
-- Truth in lending.
--Fair credit reporting.
-- Home mortgage disclosure.
The process of promulgating a regulation is much the
same at each agency. Briefly, it entails determining the
need for a regulation, drafting it, publicizing it, receiving comments on it, revising it, and issuing it. Need may
be determined as the result of new legislation, or it may
arise from changing circumstances or the desire to correct
an abuse which has surfaced during bank examination. Regulations are proposed and issued in the Federal Register.

1-12

re resnsibilities and finances
Theaencies'
FDIC, FRS and OCC have similar supervisory responsibilities. Their structure is also similar, however, FRS is
less centralized. The agencies receive no congressional
appropriations, but rely essentially on the banks they supervise and their investments in U.S. Government securities for
operating funds.
Federal Deposit Insurance Cor£oration
The Federal Deposit In"lrance Corporation was created
-ontained in the Banking
June 16 1933, under the authori;
1811). The act estabAct of 1933 (48 SLat. 168; 12 I1.
inment corporation. to
lished FDIC, as an independent ,,
insure small depositors against losses resulting from bank
failures. FDIC is authorized to:
-- Approve or deny a bank's eFplication for deposit
insurance currently of up to $40,000 for each private
depositor and up to $100,000 for savings and time
deposit accounts of Federal, State, and local governments. National banks and State banks that belong to
FRS receive FDIC insurance with their charters and do
not require FDIC approval.
-- Approve or deny applications for structural and other
changes, such as branches, mergers, and relocation of
State nonmember insured banks.
-- Act as receiver for closed insured banks.
-- Operate special "deposit insurance national banks'
for up to 2 years to provide limited banking services
to communities where banks have closed.
-- Purchase assets from, make deposits in, or extend
loans to, insured banks which have closed or are in
danger of closing.
-- Administer securities registration requirements
(under the Securities Exchange Act of 1934) that
apply to St -e banks not belonging to FRS.
-- Supervise State nonmember insured banks and their
affiliates by surveillance, examination, and enforcement activities.

1-13

In 1975, 40 percent of FDIC's revenue came from premium
assessments; the remaining 60 percent came from investments
of the Deposit Insurance Fund in U.S. Government securities.
Net income amounted to $592 million in 1975. The fund comprises FDIC's accumulated net income since inception. As of
December 31, 1975, it amounted to $6.7 billion, or
1.18 percent of the insured deposits at 14,714 banks. In
the event the fund should prove inadequate, FDIC can borrow
an additional $3 billion from the U.S. Treasury.
Federal Reserve System
The Federal Reserve System was created on December 23,
1913, by the Federal Reserve Act (38 Stat. 251; 12 U.S.C.
221). The act established Federal Reserve banks, supervised
by a Board of Governors to carry out monetary policy and
improve the supervision of banking in the United States, as
well as provide various central banking services for banks
and the U.S. Government. FRS has been entrusted with many
supervisory and regulatory functions:
-- Approving or denying various applications, such as
for branches, mergers, bank holding companies,
capital stock or debenture issues, and membership
in FRS.
-- Determining margin requirements, i.e., the amount
of credit that may be extended to purchase or hold
equity securities.
-- Establishing maximum interest rates that member banks
may pay on savings and time deposits.
-- Regulating the foreign activities of all member banks.
-- Regulating the activity of bank holding companies.
-- Administering securities registration requirements
(under the Securities Exchange Act of 1934) that
apply to State member banks.
-- Establishing rules for all lenders of consumer credit
to disclose interest cn loans and terms of repayment
("truth in lending").
-- Examining State member banks, bank holding companies
and their nonbank subsidiaries, and Edge Act and
agreement corporations.
1-14

FRS is financed mainly by in'erest on its holdings of
U.S. Government securities, which it acquires in the process
After FRS operations have been
of creating bank reserves.
is returned to the Treasury.
over
financed, interest left
FRS does not exercise its authority to charge banks -or
examinations.
Office of the Comptroller of the Currency
The Office of the Comptroller of the Currency was established by the National Bank Act of 1864 (12 Stat. 665 (1863),
The act provides that
as superceded by 13 Stat. 99 (1864)).
operate soundly and
will
which
chartered
be
national banks
banking services.
commercial
for
fulfill the public need
As the administrator of the national banking system,
the Comptroller:
-- Approves or disapproves structural changes in the
system, including applications to (1) organize new
national banks, (2) establish branches of existing
national banks, (3) merge or consolidate banks into
national banks, and (4) relocate national bank
offices.
-- Determines when national banks become insolvent
and appoints FDIC as the receiver for closed banks.
-- Issues rules and regulations governing the corporate structure of national banks and their lending
and investment practices.
-- Administers securities registration requirements
(under the Securities Exchange Act of 1934) that
apply to national banks.
-- Examines each national bank periodically to ascertain if it is being operated soundly and in accorEach bank is required
dance with Federal statutes.
each calendar year.
twice
examined
by statute to be
be waived every
may
examination
one
except that
2 years.
About 88 percent of OCC's $59 million income in 1975
came from semiannual assessments against national banks;
7 percent from charges for special examinations and investigations; and 5 percent from investments and other sources.

1-15

The co~ ' of Federal bank supervision
Salaries and travel account for most of thR agencies'
bank supervision costs.
Their 1975 c )sts follow:

Number of bank examiners
1975 cost

FDIC

FRS

OCC

1,700

700

2,00C

$22b/

$69

(millions)

$68a/

a/Includes supervision of mutual savings banks which
accounts for approximately 8-10 percent of FDIC's bank
supervision costs.
(FDIC is the only Federal supervisor
of mutual savings banks.)
b/Estimated cost of bank supervision and regulation, exclusive of occupancy and other indirect costs not allocated
by the district banks.
These functions account for about
3 percent of FRS tctal operating costs.

1-16

CHAPTER 2
ENTRY INTO THE NATIONAL BANKING SYSTEM
Page
Overview

2- 1

The survival pattern of national banks

2- 4

OCC's chartering criteria and procedures

2- 6

Chartering by State banking authorities

2- 9

Adequacy of OCC's chartering criteria
and procedures
How did the Comptroller decide?
Haskins & Sells study noted
similar weaknesses

2-10
2-14
2-18

Time required for processing applications

2-19

Conclusions

2-20

Recommendations

2-21

Agency comments

2-21

CHAPTER 2
ENTRY INTO THE NATIONAL BANKING SYSTEM
OVERVIEW
The Comptroller of the Currency must approve the formation of all national banks and, thus, entry into the national
banking system. This chartering responsibility is one of
the Comptroller's major functions. The chartering process
is intended to provide a sound national banking system
without unduly restricting entry into that system. Thus,
under present law, the Comptroller is vested with a great
public trust. Through his decisions on chartering, he plays
a vital role in structuring banking markets.
To instill the fullest public confidence in the chartering of national banks, the Comptroller needs to develop
more definitive criteria and provide better documentation
for his decisions to approve or disapprove applications
for bank charters.
National charters may be granted to groups of organizers
seeking to form new banking associations or to operating
(See ch.
State banks seeking to convert to national banks.
3.) OCC's goal, as stated in its recent policy statements,
is to insure a healthy, competitive banking system that
offers the public maximum convenience and choice and stimulates economic growth and efficiency. It is OCC's policy
to charter only banks which cakn be economically supported
and profitably operated.
From .January 1, 1970, to April 30, 1976, OCC considered
865 applications for establishing new banks. As shown below,
the Comptroller approved 57 percent of the applications.

2-1

Decisions on New Bank Applications
Year
1970
1971
1972
1973
1974
1975
1976

Approved
Number Percent

Rejected
Number Percent

Total

42
55
84
134
92
70
13

48
50
58
66
57
53
45

46
54
60
68
70
61
16

52
50
42
34
43
47
55

88
109
144
202
162
131
29

490

375

865

In evaluating a charter application, OCC primarily
considers the proposed bank's capital structure, future
earnings and management, and the convenience and needs of
persons in the area to be served. State banking authorities
consider similar factors.
Under OCC's application review process, five individuals
independently review applications and make recommendations
to the Comptroller, who decides whether to approve or reject
an application.
The agency, however, has few definitive criteria for
evaluating applications. The policies established on
November 1, 1976, prescribe essentially general criteria.
Definitive criteria were provided to measure only one factor
that the agency considers--capital structure. Considerations
of charter applications are highly judgmental, and OCC reviewers often had different opinions of the action that
should be taken on individual applications.
Furthermore, OCC reviewers about half the time did not
clearly indicate which factors they considered favorable
and which unfavorable. The Comptroller himself rarely
stated why he approved or disapproved a charter application.
Under new policies established in November 1976, OCC will
in the future furnish disapproved applicants a written
statement of the reason.; for disapprovals.

2-2

In ruling on the applications we reviewed, the
Comptroller apparently relied on what the majority of his
five reviewers recommended. The lack of definitive criteria
and complete documentation for the decisionmaking process
prevents us from evaluating whether OCC has considered applications fairly and consistently.
On the basis of a 1975 study conducted under its auspices, the Administrative Conference of the United States
proposed that OCC state its policy objectives and decision
standards so that cases could be understood and evaluated
on their merits. The Conference recommended that OCC (1)
fully state its objectives in approving or denying applications and (2) concretely define the standards to be applied.
The Conference said its recommendations for policiej
and standards did not result from any trend of public dissatisfaction, but rather from a general distrust of decisionmaking based on undefined discretion. In its March 1976
report, the Conference stated:
--The statutes governing approval of entry into
banking contain sketchy or no standards defining how the agencies should exercise judgment.
-- The agency has not filled this statutory
void with comprehensive policy statements or
meaningful rules of general applicability.
OCC has recently taken several actions to improve the
processing of applications and to make charter decisions
more consistent. Even with these changes, however, we believe that more definitive criteria and documentation are
still needed.

2-3

THE SURVIVAL PATTERN OF NATIONAL BANKS

On the premise that banks which continue to operate
for several years after chartering are evidence of the
effectiveness of the chartering process, we collected data
on:
-- How many new national banks were chartered during
the 15-year period, January 1958 through December
1972?
-- How many of these banks were no longer operating
as national banks on April 30, 1976?
-- What happened to the banks which were no longer
national banks?
indicated in the following table, most national
banks Lhartered over this 15-year period are still ope,ating as individual national banks.

2-4

C 41
u

4- C

Go I

Ca
a

o,*UY~C4J

a'
I 4LL

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-

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uU
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i~
c4-G,.

2-5f

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U' 41 0 4-'
cu..iL n0D
-~'02
05
o~

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-..

a a-.

b~~~~~~~~~~~N~Nlbm

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t

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_

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0)~~~1
.0m~m
4-'~O~r5~(u

Of the 813 new banks chartered during 1958-72, 172, or
21 percent, were no longer operating as individual national
banks at the end of April 1976. However, about 76 percent
of these operated for 3 or more years before ceasing to operate as national banks. Thus, of the 813 newly chartered
banks, only 5 percent did not survive as national banks for
at least 3 years.
Of the 172 which were no longer operating at April 30,
1976, 80 had merged with other banks, 57 had converted to a
State charter, 30 were voluntarily liquidated, and 5 were
declared insolvent. Thus, of the 813 banks chartered during
the 15-year period, less than 1 percent ceased operations
because they were declared insolvent.
The survival rate of national banks in this period is
almost the same as the rate noted in a similar analysis of
a sample of national and State banks chartered between 1948
and 1966.1/
Exits from the national banking system cannot always
be considered a sign of weak operations or poor chartering
decisions. For example, many banks converting to a State
charter may still be operating as sound State banks. On the
other hand, the mergers and voluntary liquidations may have
occurred because of normal market changes in local banking
structure or because of banks' i capability of continuing to
operate. For the 14 percent that merge- or were liquidated,
we did not attempt to determine whether exits were actually
voluntary or forced by financial difficulty.
Nevertheless, national banks' high rate of survival
indicates that OCC has at least tended to charter banks
that can be economically supported.
OCC'S CHARTERING CRITERIA AND PROCEDURES
The National Bank Act (12 U.S.C. 21-27) provides OCC's
chartering authority and requires the Comptroller to base
his charter decision on facts reported in the application
and

1/ Alhadeff, David A. and Charlotte P. "Growth and
Survival Patterns of New Banks, 1948-70," Journal
of Money, Banking and Credit, May 1976.
2-6

"any other facts which may come to [his] knowledge
* * * whether by means of a special commission appointed by him for the purpose of inquiring into
the condition of such association, or otherwise."
The act specifies the minimum number of persons needed
to organize a national bank (five) and the minimum amount
of initial capital required in a city of a given population.
The Comptroller, however, requires substantially more capital
than the legal minimum. OCC will normally not approve an
application to organize a national bank with less than
The National Bank Act provides
$1 million initial capital.
to consider in acting
Comptrolier
the
for
criteria
other
no
to
OCC regulations, the
According
applications.
on charter
of applicants as he
investigations
Comptroller may conduct
deems necessary or proper.
The Federal Deposit Insurance Act (12 U.S.C. 1816)
gives OCC additional chartering guidance. Because national
banks are rcquired to have deposit insurance, before granting a charter the Comptroller must certify to FDIC that he
(1) the bank's finanhas considered the following factors:
structure, (3)
capital
its
(2)
condition,
and
history
cial
its future earnings prospects, (4) the general character of
its management, (5) the convenience and needs of the community it is to serve, and (6) whether its corporate powers
are consistent with the purpose of the act.
OCC has assigned to its regional offices the primary
responsibility for reviewing and processing charter appliPotential applicants usually discuss their procations.
After the regional
posal with a regional administrator.
office accepts an application and the information the applicant supplied to support the proposal, the applicants publish
a notice of filing in a newspaper of general circulation.
The regional administrator advises area banks and other bank
regulatory agencies of the filing and assigns an examiner
to conduct a field investigation.
The examiner visits the proposed bank site and interAlso, the
views the applicants, who are called organizers.
examiner usually confers with opponents to the application
With the inand local business and professional persons.
formation developed, the examiner evaluates the data furnished by the organizers and prepares a report of the
investigation.

2-7

The examiner's report provides the essential information for evaluating a charter application. The examiner
answers questions such as:
-- Is the strength of management adequate?
-- Is the proposed capital structure adequate
for the estimated volume and character of
operations?
-- Is there a public need for the proposed bank,
or do existing banks and branches serve the
area reasonably well?
-- Is it reasonable to expect that the available
banking business will be adequate to support
the proposed bank, together with existing
competitive banks and branches, or will an
"overbanked" situation be created?
-- Are the applicant's 3-year estimates of income
and expenses reasonable?
In the report the examiner summarizes his or her findings in an unstructured narrative format and recommends
The regional
approval or disapproval of the application.
his
or her
narrative
form
writes
in
also
administrator
conclusions and makes a recommendation.
The information gathered at the regional level, plus
the two staff recommendations, are forwarded to OCC headquarters. At the time of our review, the director of the
Bank Organization Division and a senior economist also evaluated the application, wrote brief remarks, and recommernded
The deputy comptroller responsible
approval or disapproval.
for new charters usually wrote a memorandum setting forth
his comments on capital, management, convenience and needs,
Finally, the Comptroller reviewed
and competitive factors.
the file and approved or rejeczed the application, usually
without written comment.
If the application was approved, the organizers were
usually allowed 1 year (now 18 months) to incorporate the
bank; that is, complete the sale of stock, acquire a building, and hire officers acceptable to OCC. Wnen the bank
is ready to open, the Comptroller issues a charter certificate authorizing the bank to begin business.

2-8

CHARTERI., BY STATE BANKING AUTHORITIES
The 50 States also have authority to charter new banks.
The States have vested their chartering authority in a State
supervisor (29 States), a banking board (14), or a combination of the two (4); a commission (2); or a board of
trust (1).
To gather information on State chartering criteria,
policies, and procedures, we contacted all State bank
supervisors in July 1976.
Of the 24 State bank supervisors
responding, 15 said that they investigate the same factors
as OCC: the proposed bank's capital structure, its earnings
prospects, the convenience and needs of its community, and
the general character and the banking ability of its organizers and prospective directors.
The remaining nine State
supervisors who responded investigate at least three of the
same factors.
The majority of the States responding also said that
State statutes set forth the factors used to evaluate charter applications.
Some indicated that to receive a charter,
applicants must satisfy all criteria.
Unlike OCC, however, most States require, either by
statute or as a matter of practice, a public hearing before
they take final action on charter applications.
The Comptroller conducts public hearings for national bank applications only if he considers it necessary or an opponent
to the application requests it.
Of the 24 States responding, 14 also provided
information on the standards used to evaluate the factors
they consider.
For the most part, the information provided
translates into general criteria similar to that OCC uses.

2-9

ADEQUACY OF OCC'S CHARTERING
CRITERIA AND PROCEDURES
To assess OCC's fairness and consistency in evaluating
applications for new bank charters, we randomly selected
50 of the applications approved and 25 of the applications
rejected by the Comptroller from January 1, 1974, through
More than half of the 75 applications
April 30, 1976. 1/
were received from applicants in 3 States--Florida (20),
The.e three are "unitTexas (14), and Illinois (5).
banking" States which prohibit branch banking; therefore,
new banking offices require new bank charters.
tle could not judge OCC's fairness and consistency,
because:
-- OCC has few definitive criteria for
to use in evaluating applications.

its staff

-- Considerations of charter applications are
highly judgmental, and there were differences
of opinion by OCC reviewers regarding the
action that should be taken on individual
applications.
-- OCC reviewers about half the time did not
clearly indicate which factors were considered
favorable and which unfavorable.
-- The Comptroller rarely documented the basis
for his final decision on charter applications.
The professional judgment of the examiner and the
other four reviewers was a key factor in considering charter
applications. But the reviewers generally did not (1) document in the files the degree to which the various factors
were considered or (2) clearly indicate whether they conThe
sidered individual factors favorable or unfavorable.
for
provided
reviewers
headquarters
the
three
form used by
each to state whether capital, earnings, management, and

1/Of the 75 applications, 12 were reconsiderations, that
is, applications considered and acted on by the Comptroller more than once.
Reconsiderations are initiated
The Comptroller ruled
by previously rejected applicants.
Therefore, our
case.
on
1
twice on 11 cases and thrice
for 75
decisions
88
charter
included
actually
review
banks.
2-10

"convenience and needs" were adequate or inadequate. The
reviewers did not, for the most part, provide this information. When an application reached the Comptroller for
his final decision, he usually hid a recommendation from
each of the five reviewers. He documented the reasons for
his decisions in only 7 of the 88 cases we reviewed.
Selected cases shown below illustrate the diversity
of reviewers' opinions on specific applications. Throughout this report black borders have been put around case
studies to distinguish them from the text of the report.

Case 1
Examiner--Recommended disapproval because of the lack
of demonstrated need and the potential to damage existing
banks in the area.
Regional administrator--Recommended disapproval
because there was little reason to believe that the banking
needs of the public were not being met fully, effectively,
and on a strongly competitive basis. The prospects for the
proposed bank, in this atmosphere and under the guidance of
an inexperienced board of directors, would be uncertain at
best.
Director, Bank Organization Division--Recommended
disapproval because he thought that there was no real
public need for another bank in this market.
Economist--Recommended approval because the proposed
bank would probably be a marginally successful entry into
a highly competitive market. However, the bank would not
be a serious competitor for some time, and thiz new entry
through the addition of competition could accentuate the
problems of three local banks.
Deputy Comptroller--Recommended disapproval
even though the new bank would bring competition because
of a certain type to this market and provide another choice of
banking for the public, the application was marginal insofar
as the directorate's net worth and business representation
were concerned.
The Comptroller approved the application, stating that
the new bank could be Justi-led on competitive grounds.
2-11

Case 2
Examiner--Recommended aEproval because even though
there did not appear to be a strong need for a new bank, it
was believed that applicant's loan and deposit projections
were attainable and that profitable and successful operations could be achieved without providing detrimental
competition to any existing banks.
Regional Administrator--Recommended apEproval because
"* * *applicant does not contend that existing banking
office3 are not adequately serving the banking needs
of the public." Rather the applicant intended to provide
the service area with a new competitive banking unit.
Further, a sampling of local public opinion indicated
moderate support for the bank, and it should not have
a serious adverse affect on existing banks.
Director, Bank Organization Division--Recommended
because sufficient banking alternatives
disapprova
already provided adequate service. Also, there was no
strong public support and the record showed no need.
Economist--Recommended appropval because the area,
probably support
-would
while served by established anks,
modest competprovide
would
bank
the
and
the proposed bank
itive benefits.
Deputy Comptroller--Recommended disapproval because,
although from the competitive standpoint it was possible
this group could inject healthy competition in this market,
there were a number of alternative banking offices and the
convenience factor was minimal. He concluded that, on
balance, a strong case was not made for this bank.
The Comptroller disapproved this application.
not document the basis for his decision.

He did

Case 3
Examiner--Recommended approval because it would appear
that the needs of the community might be better served by
a bank based on the concept of concentrating on new or
growing small or medium-sized business. He commented that
it would be difficult to visualize this group of organizers
falling short of any goal they set for themselves.
2-12

Regional Administrator--Recommended disapproval
because, although he agreed with the examiner that the
proposed bank would ultimately achieve satisfactory operations, he was unable to conclude that there was a distinct
unfulfilled public interest or need. Also, he thought that
the banking record of about half of the proposeC directorate, plus the competition in the area, suggested that the
ultimate future of the bank would be a sale to a bank hold
ing company. The application was predicated on this speculation, and it would not serve any particular public
interest.
Director, Bank Organization Division--Recommerlded
approval because (1) the proposed directorate was strong,
(Tt2area banks were well established and had performed
well, and (3) no real arm would be done to existing
banks.
Economist--Recommended approval because he thought (1)
there was room for another bink, (2) it would provide convenience to the public, and (3) the proposed directorate
appeared strong enough to ensure success.
Deputy Comptroller--Recommended aeeroval because he
thought that the business and professiona--market was
sufficient to provide a profit, and it would provide
healthy competition in the area.
The Comptroller apiroved the application without comment.

Case 4
Examiner--Recommended disapproval . He stated that,
although the area was experiencing economic growth aad the
population was increasing, relatively little development
had actually begun, and the application was premature. He
said'also that there was no real need for a new bank at that
time, as the other area banks serviced the community well.
Regional Administrator--Recommended approval because
there was a reasonable public need for the bank in the
future, even though he thought the application might
be slightly premature. The new bank would provide healthy
competition; public opinion slightly favored the need
for another bank; and a fair degree of usage was indicated.
2-13

Director, Bank Organization Division--Recommended
disapproval because (1) during the last year the existing
local bank recorded no asset growth, (2) public reaction
was mixed, and (3) no strong case had been made for
added competition or service.
Economist--Recommended approval because, although the
community offered a limited opportunity at that time, its
proximity to the city had produced modest growth which
Further, there was considerable
was likely to continue.
was not meeting the needs of
bank
evidence that the local
the community. The comapetitive factors, convenience and
needs, and holding company affiliation were favorable.
Deputy Comptroller--Recommended approval because the
new bank would bring healthy competitio-nand there appeared
to be an adequate base to support this new entry.
The Comptroller approved the application without
written comments.

As can be seen, the staff members based their recomThe
mendations on whatever factors they thought relevant.
differand
uniformity,
lacked
application review process
ences in reviewers' opinions were left unresolved.
How did the Comptroller decide?
Judging from written comments by the five staff
reviewers, approval of applications appeared to have been
mainly related to the "convenience and needs" factor,
broadly interpreted to include need for competition, new
or better services, or service to a special clientele.
Rejections included in our sample seemed to be based
largely on lack of need for a new bank or on expectations
of newly approved State banks opening in the community.
As previously mentioned, the Comptroller rarely
documented why he approved or disapproved a charter application. He apparently relied on what the majority of his
five reviewers recommended. OCC officials told us, however,
that the Comptroller considers staff recommendations on
charter applications as advisory because he alone has the
legal power to approve or reject a charter application.

2-14

The following table shows that the Comptroller
agreed with all five staff members in 44 percent of
the cases we reviewed and with the majority of his
staif in 91 percent of the cases.
Extent of Staff Agreement With the
Comtrolier-s Charter Decisions
Staff recommendations
against Comptroller's
eventual decision

Total

None
One
Two
Three
Four
Five

39
28
13
3
4
1

Percent
44
32
15
4
4
1

The Comptroller disagreed with his regional office
staff--the examiners and regional administrators--more often
than with his headquarters staff. The table below notes the
frequency with which ::.e Comptroller disagreed with the
recommendations of each of the reviewers.
Staff Pecommendations Compared to the
ComptrolieL'_

Staff member

Charter Decision

Number of
recohmendations

Examiner
Region.J. a'mi,iins'rator
Director, Balk
Organizaticn
Division
Economist
Deputy comptroller

Recommendations
contrary to
final decision

Percent of
disagreement

85
88

25
21

29
24

85
85
86

10
16
12

12
19
14

2-15

In some cases there was considerable disagreement
among reviewers. The Comptroller, as shown above, disagreed with the examiner's recommendations in 25 cases
and the regional administrator's in 21. However, only
8 of the regional administrator's cases of disagreement
with the Comptroller are included in the examiner's 25.
Likewise, when the Director of the Bank Organization
Division, the economist, and the deputy comptroller
disagreed with the Comptroller, those cases were not
complete subsets of the examiner disagreements. The
following tables illustrate the extent of staff disagreement on cases where the Comptroller disagreed
with more than one staff member. The tables further
illustrate that for the 12 applications which the
Comptroller approved, he tended to agree with th3
majority of the reviewers more so than he did when
he rejected applications.

2-16

Extent of Staff DiLantreent n Approved Applicatione
(note a)

Examiner

Regional
administrator

Director, Bank
Organization
Division

IEconist

Deputy
comptroller

Comntrollor

Re iect

Reiect

Re iect

Reject

Approve

Reiect

Reject

Reiect

Re ect

Approve

Reject

Re iect

Approve

Re ect

Approve

Reject

Approve

Reject

Approve

Reject

Approve

Reject

Approve

Aptrove

Approve

Reject

Approve

Reiect

Arprove

Approve

Reject

Approve

Reject

Approve

Reject

ect

Approve

Reiect

Reject

Approve

Appi ve

Approve

Reject

Approve

pprove

Rejet

Reject

Approve

Care
number

For 18 applications only 1 staff member made a reccomendation uoyitrary to the Comptroller'e
charter decision. The examiner accounted for 8 of them; the ,e3io.,nal administratcr, 6;
the economist, 2; end the deputy comptrolle;, 2.
Extent of Staff Diaeereement on Relected Applictions
(note a)

Examiner

Regional
achniniutrator

Director, Bank
Organization
Division

Approve

Reject

Approve

Case
number

Deputy
colptroller

Crqtrollor

Approve

Reject

Approve

Reject

Approve

Reject

Approve

Reject

Re ject

Approve

Reject

Appgrce

Reject

Approve

Reject

Appro'e

Reject

Approve

Reject

Approve

Reject

Approve

Reject

Approve

Reject

Approve

Reject

Approve

Aprove

Approve

Reject

Econi

For 10 applications only 1 staff member made a recomaendation contrary to the Comptroller's
charter decision. The examiner accounted for 5 of 'hem; the regional administretor, 2; the
economist, 1; and the deputy comptroller, 2.

2-17

Haskins & Sells study noted
ea-nesses
w
sTim-ia7r
A May 1975 Haskins & Sells report noted that OCC
lacked formal guidelines for processing applications and
making decisions. The report states:
"Past practice, precedent, and policies of
the present Comptroller as interpreted by
key staff provide the informal guidelines
on which the OCC functions. The result is
considerable flexibility in the making of
* *.
decisions on specific applications
Policy thus tends to be formulated on an
ad hoc basis and the decisionmaking process
is affected by some uncertainty about the
turn."
factors on whicha decision wli
(Underscoring suppTie.T
The public accounting firm recommended that OCC write
(1) policy statements setting forth the conditions under
which applications will be received and considered and
(2) decision guidelines setting forth the specific facHaskins &
tors to be considered in the decision process.
grouped
be
factors
pertinent
the
that
proposed
Sells
into three categories: (1) major factors for which
a negative finding on any one factor would ordinarily
result in rejecting the application, (2) factors for
which a negative finding on one or more factors would
not necessarily result in rejection but which would
need to be weighed in the aggregate, and (3) factors
which may significantly benefit the public.
In response to the Haskins & Sells recommendations,
policy statements on November 1, 1976. The
issued
OCC
statements include decision guidelines, but no grouping
of factors as recommended. OCC officials said groups
of pertinent factors would not be applicable to every
possible market situation and hence to every application
considered. OCC's policy statements do provide, however,
that when a charter application is rejected, the applicant
will be furnished a written statement of the reasons
for rejection.
In response to other Haskins & Sells recommendations,
OCC took further actions which should help standardize
the review process and provide a better documented record:

2-18

-- In February 1976, OCC reorganized the headquarters
division responsible for reviewing charter applications. To supplement the regional offices' evaluation of applications, staff reviewers of the
newly organized Bank Organization and Structure
Division are required to comment on capital,
management, competition, and the market area.
-- A new investigation report form was instituted in
November 1976 for regional office reviewers. The
comments, conclusions, and recommendations
section provides space for specific comments
by the examiner and regional administrator on
the factors involved in arriving at their recommendations for approval or disapproval of
the application.
TIME REQUIRED FOR PROCESSING APPLICATIONS
The time OCC took to process applications seems
excessive. The processing time for the sampled applications is shown below.
Average
Approved applications
Rejected applications

10.8
10.2

Months in process
Medi an
Range
10.0
8.8

5.5 to 26.8
4.0 to 25.5

OCC took an average of 10-1/2 months to initially
decide on the applications. The headquarters office
accounted for 5-1/2 months, and 4-1/2 of these were
taken for reviews by the deputy comptroller and the
Comptroller. The headquarters review time appears
to be excessive, since the examiner's field investigation
and any necessary public hearings are conducted by
the regional office.
Of the 24 States responding to our information
request on chartering, 7 said that their statutes
require them to approve or reject charter applications
within a certain time frame. The required time frames
for the sever. States are as follows:

2-19

Months

Number of States

2
3
5
6
12

2
1
1
2
1
We do not know whether
limits.

the States were meeting these

In response to a Haskins & Sells questionnaire,
31 percent of 180 recently chartered national banks indicated that the processing time for their applications
The accounting firm made several recomwas excessive.
mendations which should help diminish the processing
These included revised application forms, streamtime.
lined information requirements, and a manual on proceOCC impledural guidelines for processing applications.
1,
1976.
November
on
mented these recommendations
CONCLUSIONS
The high survival rate for national banks indicates
that OCC's chartering process has at least tended to
charter banks that prove to be economically supported-thus contributing to a sound national banking system.
However, there is no practical way to determine
whether OCC has been fair and consistent in approving
or disapproving new banks because the agency lacks
(1) definitive criteria for its staff to use in evaluating applications and (2) an Adequately documented
decisionmaking process.
The differing opinions of the staff reviewers
suggest that more definitive criteria are needed to
provide for uniformity in the application review process
and to insure that all factors are considered and resolved
either favorably or unfavorably. Although definitive
criteria that would apply to every application may be
difficult to develop, we believe the matter warrants
further study by OCC.

2-20

The Comptroller has considerable latitude in deciding whether to approve or reject an application, and
for the most part, gives no reason for ruling a particular way. While he is not legally required to make
a determination on each of the factors considered, he
must certify to FDIC that he has considered the six
required factors. We believe reviewers' conclusions
on these factors should be completely documented during
the application review process.
RECOMMENDATIONS
Accordingly, we recommend that the Comptroller of
the Currency (1) develop more definitive criteria for
evaluating charter applications and (2) thoroughly
document the decisionmaking process, including an identification by reviewers of each factor as either favorable or
unfavorable.
AGENCY COMMENTS
OCC in its letter dated January 14, 1977, stated:
"The OCC is the only federal agency with the
responsibility for chartering banks. It charters
banks in all of the 50 states and in Puerto Rico
and the Virgin Islands. The widely differing
banking environments found in the U.S. make it
almost impossible to develop definitive criteria
which can be universally applied such as in
states like Arizona, which has 6 National Banks,
and in Illinois which has over 400 National Banks.
The diversity of criteria therefore, is a function
primarily of the differing political, social
and economic environments in which the OCC must
operate. The OCC's chartering criteria, of
necessity, must be somewhat flexible. That is
only to be expected since the OCC does not
charter in one environment. Also, under the terms
of the McFadd,:n Act, the OCC's actions are
often affected by applicable state law.
"The new corporate guidelines, development of which
began in September 1975 and which became effective
on November 1, 1976, answer many of the criticisms
of the GAO. Written opinions containing reasons
are now sent to applicants receiving denials.
2-21

As examples, we quote from three recent letters
sent to applicants denying their charters. One
letter in part, states:
'Based upon the population and the median
income per household, it would appear
difficult for many individuals in the
priv!ary service area to qualify for a
loan. Furthermore, income levels are inadequate to provide a sufficient deposit
base for the proposed bank to become a
viable institution.'
In
'In another case, we quote in part:
in
decision
Court
view of the Supreme
Whitney and the Federal Reserve Board's
decision in InterMountain Bank Shares,
it would be an exercise in adminstrative
futility for this Office to approve the
present charter application...Should West
Virginia change its statutes or should the
statute be successfully challenged, then
this Office could consider a new application in light of these changed citcumstances.'
'In still another case, the denial letter
to the applicants stated: The new guidelines state that a new banking office will
not be approved, if its establishment would
threaten the viability of a newly chartered
independent bank. Such protection will
typically not exceed one year. As you are
aware, the new bank opened on September 27,
It is the opinion of this Office
1976.
that this newly chartered independent state
bank is entitled to the protection set forth
in the Comptroller's policy statement.'
"Every attempt is now made to document thoroughly
the decision-making process. Further efforts will
be made by our Office to identify each factor as
favorable or unfavorable.
"Our decisions have been suject to judicial review
for many years. In the long series of court cases
covering our chartering process, the Comptroller's

2-22

decision on a charter application has never been
finally overturned by a reviewing court. See
annotations to 12 U.S.C. 21 et seq.
"Our Department of Research & Economic Analysis
has undertaken a market study of 35 national
banks chartered between 1969 and 1971. The
economic study attempts to identify, statistically,
those factors which can be identified with the
growth or lack of growth of these new banks.
The results of that study, if positive, will
be incorporated into our decision-making process. We are hopeful that quantification of a
sufficient number of pertinent factors applicable to a majority of cases will result."

2-23

CHAPTER 3
CONVERSIONS OF CHARTERS--CHANGES
IN SUPERVISORY AGENCIES

Overview

3-1

Criteria and procedures

3-3

State-to-national conversions
Many State banks convert to change supervisors
Condition of banks applying to convert
General OCC agreement on applications

3-3
3-4
3-6
3-7

Recent changes to OCC's conversion process

3-7

National-to-State conversions
State conversion policies
National banks convert to withdraw from FRS

3--8
3--8
3-9

Conclusions

3-10

CHAPTER- 3
CONVERSION-OF-CHARTERS--CHANGES
IN SUPERVISORY AGENCIES

OVERVIEW
With the Comptroller of the Currency's approval,
State-chartered banks are allowed to convert to national
banks.
By changing charters in this way, banks become
subject to supervision by the Comptroller, instead of
by a State authority and either by the Federal Deposit
Insurance Corporation or by the Federal Reserve System.
Because such banks are already in operation and
usually subject to Federal supervision, the impact on
the total banking industry of whether to approve requests
to change charters is not as important as initial charter
decisions.
From OCC's viewpoint, however, approval
means entry into the national banking system; therefore,
decisions to change charters are equally as important to

it as initial charter decisions.
In November i976, OCC began requiring an applicant
to give reasons for wanting to convert to a national
bank. It also established policy statements which say
that it will ordinarily approve conversions that are
consistent with maintaining a sound national banking
system but that conversions should not be motivated
by supervisory pressures from other bank regulators.
We reviewed the 71 State-to-national conversion
applications OCC acted on from January 1972 through
April 1976.
Sixty-four were approved, four were rejected,
and three were withdrawn.
Many banks applied for conversion either to receive
favorable decisions on corporate structural changes, such
as branches and mergers, or to change their image or
obtain the prestige of national banks. According to OCC
files, few banks applied to avoid supervisory action
from another banking agency.
Before deciding on the conversion applications, OCC
either examined the bank itself or reviewed earlier
Federal or State bank examination reports. Most banks
3-1

converting to national banks were judged by OCC or their
previous supervisors as sound in every respect. Only one
bank was receiving special supervisory attention when it
converted.
With the approval of its State agency, a nationally
chartered bank may also convert to a State charter (12
OCC has no authority over a national-toU.S.C. 214-214c).
State conversion, except to require a percentage of stockholder approval and to protect the rights of dissenting
From January 1972 through April
minority shareholders.
According
1976, 79 national banks switched to State banks.
to FRS, the major reason national banks convert their
charters is to avoid maintaining assets in the noninterest-bearing reserves required for FRS membership.
All national banks are required by law to be members
of the Federal Reserve System; State banks are not.

3-2

CRITERIA AND PROCEDURES
The National Bank Act (12 U.S.C. 35) permits any
State-chartered bank to become a national bank, if it
has sufficient capital and the approval of OCC, unless
conversion is prohibited by State law. The application
for conversion must be authorized by owners of at least
51 percent of the bank's capital stock.
The law does not provide specific criteria for
evaluating applications for charter conversions. The
agency has established regulations allowing it to conduct
any examination or investigation necessary, but until
November 1, 1976, it had no written regulations or policy
statements of criteria for approving or rejecting such
ccnversions.
Applications include information on the bank's present
and proposed capital structure and number of branches,
whether it is a member of FDIC or FRS, proposed names for
the converted bank, and names and addresses of bank
directors. The applications are processed in generally
the same way as new bdnv charter requests. An examiner
at the regional office usually examines or visits t.e
bank and prepares a written report recommending approval
or disapproval. Reviews and recommendations are also
made by the regional administrator and various OCC
headquarters personnel. The Comptroller makes the final
decision.
If OCC grants anproval, the bank completes certain
corporate documents (equired by statute and OCC issues
a charter certificate authorizing it to commence business
as a national bank on a specific date.
STAME-TO-NATIONAL CONVERSIONS
From January 1972 through April 1976, OCC considered
71 conversion applications. Of these, 64 were approved,
4 were rejected, and 3 were withdrawn. Of the 71 State
banks and financial institutions applying for conversion,
23 were members of FRS, 45 were nonmember banks insured
by FDIC, and 3 (a savings and loan association, a credit
union, and a trust company) were not commercial banks.
As shown in the table below, most of the applicants
were small in terms of deposits.

3-3

Number of banks

Deposits
(000,000 omitted)

62
6
2
1

$100
Under
$500
$100 to
$1,000
to
$500
$1,000
Over

Many State banks convert
to cha!Me supervlsors
During the period covered by our review, OCC did not
require applicants tD disclose their reasons for wanting
a national charter. Nevertheless, files for 53 of the 71
cases contained either stated or implied reasons for
the requests. Reasons were given by some applicants; in
other cases motives were discussed by the OCC reviewers.
Summary of Reasons for
Conversions-to Natlonal-Banks
Reasons related to supervisory agencies:
Seeking to avoid supervisory pressure
fur corrective actions
Seeking favorable decisions on desired
structural changes
Generally dissatisfied with former
regulator

4
22
5
31

Reasons unrelated to regulatory disagreements:
Seeking same type of charter as
affiliated banks
Changing image or obtaining
prestige of national bank
Miscellaneous

7
10
5
22
53

3-4

F)r the four banks which applied for conversion
to avoid supervisory action, OCC
-- rejected one application, knowing the bank's problems and its desire for a structural change which
probably would be rejected even if the conversion were approved,
-- approved one conversion but required the bank to
correct the problem identified by the previous
supervisor,
-- approved a second conversion, was aware of the
problems identified by the previous supervisor,
but took its own actions to correct the problems,
and
-- approved the other application but did not
take the same action as the previous supervisory
agencies.
In the last case, the bank obtained a more
decision from OCC than it had from FDIC and the favorable
State
supervisory agency1 which had told the bank to increase
its capital. In a letter to OCC, the applicant explained
its disagreement with the amount of the directed increase.
After examining the bank, OCC required additional capital
as a condition of approval, but less than FDIC and the
State agency had asked for. Except for undercapitalization,
the OCC examination disclosed that the Lank was in sound
condition.
For tne 22 conversion applications which were related
to a bank's desire for structural changes, OCC
-- rejected 2 applications,
--approved 15 and later approved branches. mergers,
and other structural changes, and
-- approved 5 others, but either has not acted on or
has not received their requests for structural
changes.

3-5

Of the 15 requests for structural changes approved
by OCC, 4 had been rejected by the previous supervisory
In the rev: ining 11 cases, the banks implied that
agency.
structural change r 'uests were the reasons for conversions
but did not indicate whether they had actually been turned
down by another agency. Since this information was
readily available in the files we reviewed, OCC apparently
was aware of the banks' motives for conversion. OCC investigated the merits of applications submitted by the converted
banks for branches, mergers, and other structural changes.
These investigations apparently satisfied OCC that the
corporate structure requests should be approved.
Condition of banks applying to convert
An OCC examination or investigation was performed for
54 of the 70 conversion applications we reviewed. 1/
Fifty-one had deposits under $100 million and three had
deposits over $100 million. OCC reviewed earlier bank
examination reports or contacted the applicant's previous
Federal or State agency for about half of the 70 banks,
including the 16 which OCC did not examine firsthand. Thus,
in all 70 cases, before deciding on the conversion applications, OCC either did its own examination or investigation,
or reviewed previous examination reports.
Although several banks accepted for conversion had some
weaknesses, most were rated by OCC or their previous agencies as sound in every respect. Two banks with weaknesses
were approved because they were affiliated with bank holding
companies which OCC believed would improve their condition.
A third bank had been designated a problem bank by
FDIC, which was considering issuing a cease and desist
order to prevent the diversion of profits through a manageAfter examining the bank, OCC gave
ment service contract.
preliminary approval for conversion, without knowing about
FDIC's proposed action. OCC believed the bank had no
serious problem and had been assured by its president that
the contract's objectionable provisions would be rescinded.
Before OCC gave final approval for conversion, FDIC notified OCC of its proposed action, and OCC granted final
approval with the understanding that the bank agree to
Because
correct problems in the management contract.
1/ One applicant withdrew before any OCC evaluation.
3-6

the problems were not fully corrected after conversions
OCC entered into a formal written agreement with the
bank about 7 months later to confirm the bank's planned
actions to correct the problems.
Another bank with known problems was also accepted
for conversion. Memos in the files indicate that OCC was
aware of this bank's problems, had met with FRS before
approving the application, and took its own actions to
encourage the bank to correct the problems identified by
that agency.
All four apDnpiCrts £Lur 6tate-to-national charter
coizversions that OCC rejected from January 1972 through
April 1976 were very small banks with deposits ranging
from $800,000 to $3.6 million. One bank was turned down
because OCC's examination revealed a poor overall condition. Two other banks had sought a relocation which OCC
believed should not be approved; one of these also had
not obtained the additional capital recently recommended
by its State and Federal supervisors. The final application was disapproved because the bank appeared more interested in expanding through branching than in correcting operating weaknesses.
General OC_agreement on applications
OCC reviewers at the regional office and headquarters generally agreed with one another on conversion
applications. The Comptroller disagreed with more than
one staff member on only 1 of the 68 conversions from
January 1972 through April 1976. Single recommendations
were contrary to the final decision on only two other
applications. Reviewers thus agreed much more often on
conversions than on new charter applications.
RECENT CHANGES TO OCC'S CONVERSION PROCESS
The Haskins & Sells study addressed OCC charter conversion policies and procedures. The public accounting
firm said OCC should (1) require an applicant for conversion to a national charter to give reasons for the
conversion and (2) assure itself the conversion is not
the result of supervisory pressure from other bank regulators because of illegalities or unsatisfactory banking
practices. Several of the study's general recommendations

3-7

about OCC's handling of applications for new banks and
structural changes also apply to the conversion process.
These include (1) policy statements and decision guidelines,
(2) better application forms, and (3) better guidelines
for receiving, verifying, and reviewing applications.
OCC addressed the recommendations about conversions
with a set of policy statements and revised application
forms and procedures. OCC began using the policy statements and forms on November 1, 1976.
According to OCC's policy statements, it will ordinarily approve conversions which are consistent with a
sound national banking system. Conversions should not be
motivated by supervisory pressures from other supervisory
agencies. The bank's general condition should be satisfactory and managers should have demonstrated ability to
supervise a sound bank. Serious problems will normally
preclude approval. Disapproved applicants will be told
the reasons for rejection.
OCC's new procedures do not, however, define the method
of obtaining information on the factors to be considered.
Certain procedures should be part of the process; for example,
contacting the applicant's current Federal and State regulatory agencies. By reviewing recent bank examination
reports and talking with the appropriate regulators, OCC
will have all current supervisory information and will be
better able to evaluate a bank's condition and its motives
for conversion. OCC officials intend to closely monitor the
implementation of the new procedures and, as they gain
experience in using them, make changes to insure their
effectiveness.
The new conversion application now requests a bank's
reasons for applying for conversion. The new procedures
require an examination of the applicant unless specifically
waived by a regional administrator. If the examination
is waived, the region must provide a written justification
to be reviewed by the Comptroller.
NATIONAL- 20-STATE CONVERSIONS
State conversion policies
Of the 24 State agencies responding to our survey,
15 provided information on their policies, criteria, or

3-8

procedures for reviewing national-to-State charter conversion applications. Several respondents stressed they have
had little or no experience with bank charter conversions.
Five states indicated they use the same or similar
procedures and criteria as for new bank charter applications. Nine States fully examine a bank before deciding.
Of these nine, two also apply the same criteria applied
to new bank charters. The remaining State explained that
statutes require an investigation to assure that depositors
are protected and legal requirements are satisfied. California, Michigan, and New York review OCC examinations
of applicants as part of their conversion review process.
Only California indicated it would waive its own examination if satisfied with a recent OCC examination.
Few States presented their policies regarding
acceptance of national-to-State conversions.
Michigan
and Georgia stated conversion requests should not be the
rcult of supervisory pressure and, along with Oklahoma,
specifically indicated that converting banks should be
in sound condition.
National banks convert to withdraw from FRS
National-to-State charter conversion applications
are not evaluated by OCC, and the agency's files do not
contain information on banks' motives for such changes.
However, according to FRS, the major reason that banks
have given up national charters is to avoid maintaining
assets in the non-interest-bearing reserves required
for FRS membership.
National banks are required by law to be members of
FRS, but State banks are not.
According to FRS, only 2
of the 73 national banks converting to State charters
from 1972 to 1975 retained membership. Also, stockholder
proxy statements available for 11 converting banks
indicated that 10 gave up national charters to withdraw
from FRS.
The other bank converted to a State charter
to prepare for a planned merger with a State bank,
Even though some national banks have convected
apparently to avoid FRS reserve requirements, other
factors have influenced national banks not to convert
and State member banks to maintain FRS membership.

3-9

State reserve requirements for nonmember banks offset some of the disadvantages of the FRS requirements.
Forty-nine States have asset reserve requirements, and
over half of these States specify that the reserves are
to be maintained as vault cash or non-interest-bearing
demand deposits at other banks. These balances can
also be used to compensate for various correspondent
banking services. Only 3 States allow all the reserves
to be maintained Ln selected interest-bearing assets,
and 18 other States permit part of the reserves to be
invested in certain short-term assets.
Member banks also receive advantages such as access
to the FRS discount window, free shipment of coin and
currency, and use of FRS safekeeping facilities. In
addition, FRS membership helps banks attract interestfree demand deposits from banks that are seeking correspondent bank services.
A recent study by the Conference of State Bank Supervisors quantified the benefits and drawbacks of FRS membership, concluding that some banks profit more from membership and some from nonmembership. Apparently, most of
the banks which converted from national-to-State charters
had determined that they were not receiving net benefits
from their membership.
CONCLUSIONS
Before OCC had policies governing conversion requests,
several banks appear to have converted to national charters
to avoid supervisory action by another regulatory agency.
Supervision was usually consistent because OCC addressed
the problems identified by the previous regulators.
Other banks converted to obtain more favorable consideration of requests for branches, mergers, or other structural changes. OCC approved many of these requests after
separately considering their merits.
State banks also converted for reasons unrelated to
supervisory disagreements, such as to have the same type of
charter as affiliated banks or to obtain the prestige and
Federal Reserve-related banking powers of national banks.
OCC's recently established policies and its requirements that State banks explain their reasons for wanting
a national charter should help it make better informed
3-10

decisions about whether a bank should be allowed to change
supervisors. More importantly, they should help OCC to
accomplish its basic objective--maintaining a sourd national
banking system.

3-11

CHAPTER 4
BANK EXAMINATIONS:

1971-75

Overview

4-1

Objectives of examination

4-4

Examination responsibilities

4-4

Types of examination

4-5

Scheduling and planning of commercial
examinations
Examination patterns
Conclusion
Recommendation
Agency comments
How often are banks examined?
Conclusion
Recommendations
Agency comments
How are Federal examinations coordinated
with State examinations?
Conclusion
Recommendation
Agency comments
Planning and preparing for examinations
Determining examination scope
Conclusion
Recommendation
Agency comments
Procedural guidelines
Documentation standards
Conclusion
Recommendation
Agency comments

4-6
4-6
4-7
4-7
4-7
4-8
4-9
4-9
4-9
4-11
4-13
4-13
4-14
4-15
4-15
4-16
4-17
4-17
4-18
4-18
4-18
4-19
4-19

How examinations were performed

4-20

Specific areas covered by commercial examinations
Classification of assets
Review of loans
Evaluation of securities
Real estate
Deposits
Borrowing by banks

4-21
4-21
4-21
4-23
4-23
4-24
4-24

Adequacy of capital
Income and dividends
Liquidity
Compliance with banking laws
and regulations
Management, management practices,
and internal controls

4-25
4-26
4-26
4-27
4-27

Bankers' views on examination coverage

4-28

International operations examinations
Evaluation of foreign credit
Conclusion
Recommendation
Agency comments
Onsite versus home office examinations
of foreign branches and subsidiaries
Conclusion
Recommendations
Agency comments

4-30
4-31
4-32
4-33
4-33
4-34
4-35
4-35
4-35

Electronic data processing examinations
Conclusion
Recommendation
Agency comments

4-38
4-39
4-39
4-39

Trust department examinations

4-40

Compliance with consumer protection laws
How violations are discovered
Unaggressive examinations
Action on violations
Conclusions

4-40
4-41
4-41
4-43
4-43

Bank affiliation with holding companies
Snme holding companies caused problems for
subsidiary banks
Unsound holding companies' expansion
applications approved
FRS surveillance and inspection policies
Review of financial data
Onsite inspection
Time spent on inspections
Holding company inspections did not discover
weaknesses
Reserve Board oversight of FRBs' holding company
surveillance and inspection activities
Interagency coordination
Conclusions
Recommendation
Agency comments

4-43
4-44
4-44
4-45
4-45
4-46
4-47
4-47
4-49
4-50
4-50
4-51
4-51

CHAPTER 4
BANK EXAMINATIONS:

1971-75

OVERVIEW
Bank examinations have placed great emphasis on analyzing the bank's condition at the time of the examination.
This approach has been reasonably effective in
identifying problems in banks.
However, in many cases
examiners do not address the underlying causes which
have existed for some time, such as the bank's basic
management practices, operations, and controls.
The
examination approaches have also emphasized financial
ratios and comparisons.
The agencies had not established
absolute agency-or industry-wide criteria or levels of
acceptability for these ratios and comparisons.
Their
views of the condition of banks depended largely on
individual judgment.
The Federal agencies do not examine the same banks.
The Office of the Comptroller of the Currency examines
national banks, the Federal Reserve banks (FRBs) examine
State banks which are members of the System, the Federal
Deposit Insurance Corporation examines insured State banks
which are not members of FRS.
State banking authorities
also examine State banks.
The agencies examine banks' commercial departments,
trust departments, electronic data processing operations
or service bureaus, and international operations.
The National Bank Act requires that each national
bank be examined twice each calendar year, but allows the
Comptroller of the Currency to waive one examination for
each bank in each 2-year period.
During the 1974-75 cycle,
OCC examined 75 percent of the national banks the required
3 times.
FRS policy is to examine each State member bank
at least once a year.
In 1975 it examined 97.5 percent
of its banks.
FDIC, in practice, attempted to examine
each of its banks once every 12 months.
In 1975 it
examined 88 percent of its banks.
In our view, the number of times a bank is examined
should not be based upon a rigid frequency requirement.
Rather, the agencies, using the results of the previous
examination and information from reports by the bank,
should schedule examinations based on an evaluation
of the bank's soundness and the quality of its policies,
procedures, practices, controls, audit, and management.

4-1

under this approach, banks in poor condition would
be examined more often than those in good condition.
Each agency should have policies to allow it to consider such factors and exercise discretion in determining
when to examine banks.
FDIC and FRS sometimes conducted their examinations at the same time as the State banking agencies.
Both agencies have started very limited experimental
programs to rely more on the work of State examiners
instead of examining banks in those States. We believe
that the agencies should expand these efforts to as many
States as possible; of course, the quality of the State
examinations must be considered in such programs.
The examination procedures followed by the agencies
were much alike. They looked at the same things and did
essentially the same types of analyses and evaluations.
The major emphasis of the agencies' examinations efforts
was on evaluating asset quality, adequacy of capital,
and quality of management. The examiner-in-charge set
the scope of each examination within general guidelineprovided by agency manuals, standard report formats, anr
agency training and tradition.
Of the several factors which influenced the scope
of an examination, the primary one was the bank's asset
size. To some extent, the scope was also influenced by
the condition of the bank and the quality of its internal
controls and audit. However, we found no evidence that
the examiners first evaluate the bank's internal controls,
its internal audit, or its policies and procedures, co
determine what the examination's scope should be. They
did not attempt to identify areas of operational strength
or weakness before beginning the detailed examination
steps. Thus, the same things were usually looked at
from bank to bank.
In our opinion, examiners should identify and then
concentrate on weak bank operations which could cause
serious problems. Also, the examiners should forego
certain steps that have been done satisfactorily by the
bank's internal auditors, an independent accounting firm,
or State examiners.

4-2

FRS and OCC are the primary examiners of international
operations because few FDIC-examined banks are internationally involved.
International examinations are similar
to commercial examinations, in that loan quality, controls,
and management are evaluated. However, these examinations
are complicated because special risks are involved in
foreign loans and foreign currency trading and because
the operations are conducted in foreign countries.
The different approaches used by FRS and OCC to evaluate certain loans to foreign businesses or countries may
have resulted in inconsistent treatment of U.S. banks.
Also, we believe that the agencies have not conducted
onsite examinations of foreign branches and subsidiaries
frequently enough.
While the agencies reported some violations of consumer protection laws and regulations, they acknowledged
that they have not aggressively monitored consumer protection law compliance, and they have begun revising their
approaches.
(See ch. 7.)
According to the examiners, affiliation with a holding company caused problems for 22 of the 344 sampled
banks so affiliated. 1/ With 15 of these 22, the bank
examination was the first indication of such problems,
although the FRBs had inspected 7 of the controlling
holding companies within the previous 2 years.
Had
these inspections been adequate and had the other eight
been inspected, the problems might have been resolved before
they affected the banks.
17As
agre-ed-with the Board of Governors of the FRS, we
confined our evaluation of holding companies to
FRS actions with regard to holding comipanies affiliated
with banks in our samples.

4-3

OBJECTIVES OF EXAMINATION

Bank examination is the agencies' primary tool for
bank supervision. An examination is intended to provide
the supervisory agency and the bank with an evaluation
of the bank's soundness. It also discloses problems
which the bank must rectify with advice and sometimes
pressure from the supervisory agency.
Unlike auditors, examiners are not expected to
evaluate banks' ac.(unting practices or systems, nor
do they attest to tbe accuracy and fairness of financial
statements. Howe, examiners are expected to check
the accuracy of t.ie various financial reports which the
banks are required to file with the agencies.
The disclosure of fraud is not a primary objective
of an examination, although some examination procedures
uncover defalcations in banks. Examiners, however, do
evaluate the banks' systems of internal control.
EXAMINATION RESPONSIBILTIES

OCC and the State agencies have legal power to examine
the banks they charter. FRS has authority to examine
banks which are members of the System. FDIC has authority
to examine banks which subscribe to Federal deposit insurance. State banks are also examined by their State
banking supervisors. The result is a system of
?rlapping
supervisory responsibilities. However, the thrL, Federal
agencies have agreed to allocate bank examination responsibilities. Thus, national banks are subject to only one
examining agency (OCC); State banks, to two (FRS or FDIC
and their State agency).
As the chart on the following page indicates, the
Federal agencies have different examination workloads.
FDIC examines about 60 percent of all commercial banks,
but these banks account for less than 23 percent of total
deposits and the majority are small or medium sized. OCC
and FRS examine most of the large banks in the Nation,
as well as many small and medium-sized banks; therefore,
their workloads are less homogeneous.

4-4

Bank asset size
(000,U00

Number of banks examined by:
FDIC
FRS
and
and
States
States
OCC
Total

omitted)

Over
$1,000
$500 to $1,000
$100 to
$500
Under
$100
Total
Percent of total

11
15
259
8,309
8,594

28
18
97
903
1,046

59.7

7.3

78
117
64
97
468
824
4,134
13,346
4,74 a/1-4,384
33.0

100.0

a/An additional 273 banks had no Fede al deposit insurance
and, therefore, were not federally supervised.
Percent of deposits of banks supervised by Federal_aqencies

Bank asset size

FDIC
and
States

FRS
and
States

OCC

Total

1.5
1.2
5.0
14.8

12.9
1.4
2.3
2.4

32.0
4.8
10.1
11.6

46.4
7.4
17.4
28.C

22.5

19.0

58.5

100.0

(000,000 omitted)
Over
$1,000
$500 to $1,000
$100 to
$500
Under
$100
Total
TYPES OF EXAMiNATION
The agencies devoted most of their resources to
examining the commercial departments of banks. These
departments encompass the primary operations of most banks:
accepting deposits, making loans, investing in securities,
etc.
The agencies have also developed examination
policies, procedures, reports, and sometimes staffs
for four other areas:

4-5

--Trust departments.
-- International departments.
-- Electronic data processing services.
-- Ccnsumer protection laws and regulations.
These areas have been given special attention because
they are complex and can greatly affect a bank's overall
condition.
SCHEDULING AND PLANNING
OF COMMERCIAL EXAMINATIONS
All three agencies scheduled examinations at the
field office or regional level. The frequency with which
schedules were prepared varied. Because their banks were
also examined by State examiners, FDIC and FRS coordinated
their schedules with State agencies. The agencies' schedules
were based on
-- agency policy on examination frequency,
-- bank asset size,
--the availability of examiners, and
-- travel considerations.
Examination patterns
Agency officials said they tried to preserve the
element of surprise in scheduling examinations so banks
would not hide adverse conditions or wrongdoing. Therefore,
as a matter of policy, they did not disclose examination
schedules to banks or outsiders (other than State examiners)
and they tried to avoid establishing predictable patterns.
However, to avoid delays once the examination started, the
agencies sometimes rsked for information from a large
bank's computer-based files juist before starting an
examination.
Nearly all of the bankers responding to our questionnaire said they received no advance notice of an examination. However, in some cases the agencies had established
definite examination patterns. FRS examined 70, FDIC

4-6

examined 56, and OCC examined 78 of the banks in our samples
in the same month of 2 or 3 consecutive years. A 1976 OCC
internal review concluded that examinations of 16 banks in
8 regions were so regularly scheduled that they could
easily have been predicted by the banks.
Upon entering the bank, the examiners were to take
control of assets such as cash, securities, loan portfolios and collateral, etc. This procedure was int,,sded
to prevent employees from substituting assets to cover
shortages or misuse of assets. Thus. the agencies considered the element of surprise to be important to the examination process, especially when they examined banks with
poor internal controls or inadequate internal or external
audit programs.
Conclusion
Because the agencies view surprise as an important
element of an examination, they should be scheduling their
examinations to avoid obvious patterns.
Recommendation
Therefore, we recommend that the Board of Directors,
FDIC, the Board of Governors, FRS, and the Comptroller
of the Currency establish scheduling policies and procedures which would avoid setting examination patterns.
Agency comments
FDIC in its letter dated January 17, 1977, stated:
"We believe that our recently adopted General Memorandum #1, which has been under consideration and
extensively tested for several vears prior to adoption, largely satisfies this recommendation. For
more extensive comments on our General Memorandum,
please refer to our comments on the recommendations contained on page 4-9 of the GAO Report."
FRS in its letter dated January 16, 1977, stated:
"This recommendation is based upon t'he premise that
the agencies view surprise as an important element
of an examination. The Board believes that, in
many cases, there is serious doubt as to the

benefits to be gained aiid hence the desirability
of surprise examinations. In those instances
where surprise is considered important, it has
been, and will continue to be, our practice
to schedule examinations so that they cannot
be predicted in advance."
OCC in its letter dated January 14, 1977, stated:
"Historically, the OCC has viewed surprise as an
important element of an examination. However, a
primary feature of our new examination approach
entails the pre-examination analysis wherein the
examiner will determine the adequacy of internal
control and audit activity. The OCC feels the
best deterrent for fraud is not periodic unannounced visits by examiners but rather the
existence of sound bank policies, procedures,
internal control and audit activity on a continuing basis. The element of surprise is
necessary only in those cases where such factors
are suspect."
How often are banks examined?
Although FDIC had no policy, in practice it examined
most of its banks at least once every 12 months.
In
1975, it did not examine 12 percent of its banks. All of
those banks, unless new, had been examined in 1974.
FRS policy is to examine each State member bank at
least once a year. It did not examine 2.5 percent of its
banks in 1975. These banks had all joined FRS in 1975 or
had been examined in 1974.
OCC is the only agency of the three subject to a
statutory examination frequency requirement.
The National
Bank Act requires that each national bank be examined at
least twice each calendar year but allows the Comptroller
to waive one examination at each bank once in 2 years.
According to its own reports, OCC has not examined national
banks as frequently as required by the National Bank Act.
During 1974-75 about 1,200 national banks were not examined
the required 3 times. Some banks with poor composite
ratings (see ch. 6) were examined only twice during those
years although some banks with better ratings were examined
three times.

4-8

OCC, since early 1975, has been using a "bobtailed"
examination for national banks in good
abbreviated
or
recently, FRS has adopted a "compacted"
And
condition.
ch. 7) for State member banks in good
(see
examination
1976, FDIC established a policy
November
In
condition.
based upon the bank's
examination
bank
a
to schedule
(See ch. 7.)
condition.
Conclusion
Although the agencies did not examine all of their
banks as frequently as their policies or the law required,
they may have been examining some banks more often than
necessary and others not often enough.
Using the results of previous examinations and information from reports by the banks, the agencies should
base the liumber of times a bank is examined on an
evaluation of the bank's soundness; policies, procedures,
and controls; and management quality. Thus, banks in
known poor condition or with major weaknesses in policies,
procedures, or controls would be examined more often than
banks with good policies thought to be in good condition.
Recommendations

We recommend that the Board of Directors, FDIC, and
of Governors, FRS, adopt flexible policies for
Board
the
examination frequency which would allow them to concentrate their efforts on banks with known serious problems.
We recommend that the Congress amend the National Bank
Act to allow the Comptroller of the Currency to examine
national banks at his/her discretion. We would be glad to
assist the committees in drafting appropriate legislation.
FDIenc

comments

FDIC stated:

"Although it was FDIC's long-standing policy to examine
each bank once a year, it is inaccurate and misleading
to suggest that that time-frame was the only guideline used by the FDIC in scheduling examinations,
or, to state it another way, that examinations were
not scheduled and conducted by the FDIC based upon

4-9

the "bank's soundness; and the quality of
its policies, procedures, practices, controls,
audit, and management.
"During 1975, FDIC conducted 213 follow-up
examinations and a number of on-site visitations
at banks presenting either financial or supervisory problems. Further, those banks which
were not examined in 1975 largely consisted of
banks which would not fall within the one-year
time-frame guideline under General Memorandum
#1. Although General Memorandum #1 was formally
adopted in November 1976 and implemented on
January 1, 1977, the concepts and practices embodied in it are not of recent origin. Those
concepts and practices have been under consideration at FDIC since early 1974. Furthermore, the concepts and practices have been experimented with and tested in five of the FDIC's
14 Regional Offices prior to formal adoption of
General Memorandum #1. We might add parenthetically that FDIC policy is to experiment on a
regional basis with major policy changes before
implementation for the entire Corporation.
"According-y, while the recently issued General
Memorandum #1 expresses more definitively that
scheduling of examinations is not based on timefralne priorities alone, nevertheless, we feel
that the criticism of past scheduling practices
expressed in the GAO recommendation is misplaced.
The FDIC has followed and continues to follow
a policy so aptly stated in the said General
Memorandum #1, namely:
"The first priority has been and will
continue to be, effective surveillance
and supervision of the institutions which
present either supervisory or financial
problems."
FRS said:
"The Board already has established policies that
are flexible enough to allow us to concentrate our
efforts on banks with known serious problems.
Some years ago, the Board adopted the policy, which
was reaffirmed in 1975, that all banks considered
to be in a problem status be examined at a minimum
4-10

of six-month intervals. However, we will continue
to schedule periodic examinations of all banks
under our supervision since a bank may deteriorate with the passage of time. As pointed out in
the GAO report, the Board recently approved the
usage of Asset Quality and Management Performance
Examinations in the case of banks thought to be
relatively free of major problems. If this
limited scope examination detects major changes
or deterioration, a full scale examination is then
commenced. These procedures give us flexibility
while at the same time insuring that problems are
not overlooked."
OCC said:
"We support the recommendation of legislation to
permit OCC discretion in scheduling the frequency
of examinations. The current method uf adapting
the depth cf examinations to the needs of each
bank, based on NBSS data and pre-examination
analysis, fily complies with law. However,
tcry discretion would enhance our
greater sti
effectiveness in this regard."
How are Federal examinations
coordinated-wi-t State examinations?
Since the banks examined by FDIC and FRS were also
examined by State banking authorities, both agencies
tried to coordinate and frequently combine their examinations with those of the States. The arrangements between
the Federal supervisors and State authorities were of two
basic types:
-- The Federal agencies and the States conducted
independent examinations.
---The Federal agencies and the States conducted
joint examinations and wrote either one or two
examination reports.
The examination relationships between the Federal agencies
and the States varied from State to State, from bank to
bank, and sometimes from examination to examination.

4-11

In joint FDIC-State examinations which resulted in
C Ingle report, examiners shared the work. In those joint
FvbC-State efforts which resulted in two reports (called
concurrent examinations), the examiners also sometimes
shared the workload. Similarly, FRS and State examiners
sometimes shared the work during j .nt examinations.
The following table summarizes the predominant examination
arrangements during 1375.
Predominant
examination arrangements

Number of States
FDIC
FRS

In'dependent
a/ 22
Joint--two reports ("concurrent")
8
Joinc--one report
13
Mixed
7
Experimental (see p. 4-13)
Total

15
8
7
12
1
b/ 43

a/Special arrangements existed for some banks in 3 States,
see page 4-13.
b/In seven States, no State banks belonged to the FRS.

4-12

We asked bankers their opinions about the competence of State examiners as compared to Federal examiners.
As shown below, many of the bankers believed the State
examiners to be as competent as Federal examiners.

Type of bank

Percent of responding bankers
who said State examiner competence,
compared with that of Federal examiners, was
Wcrse
The same
Better

State nonmrember
State member

64
61

8
5

28
34

FDIC and FRS were conducting experimental programs
with States which could improve efficiency. In Georgia,
Iowa, and Washington, FDIC was relying completely on State
examinations to replace its own.
The FRB ot Chicago was conducting a similar experiment
in India.a. The State examined the bank with only one
Federal examiner present. The bank and the FPB received
a copy of the State report. For FRS use, the FRB examiner
wrote a report of examination based primarily on the work
of the State examiners.
Conclusion
In our opinion, these approaches are reasonable
If
attempts to eliminate needless duplication of work.
?DIC
enable
to
expanded
be
should
they
found acceptable,
and FRS to concentrate their efforts more on banks with
By relying more on State examinations
serious problems.
FDIC and FRS could free their own examiners from relatively
routine examinations of "good" banks to examine, reexamine,
The Federal
visit, or monitor banks with major problems.
examinations
States'
the
on
agencies, of course, should rely
only if they are of acceptable quality.
Recommendation
We recommend that the Board of Directors, FDIC,
-bend their current
ari, the nBord of Governors, FRS,
etfforts to use State examinations and, if they do, we
also recommend that they
-- develop minimum standards for State
examiner training and examination procedures and
4-13

-- use only reports of State examinations meeting
those standards.
Agency comments
FDIC said:
"The FDIC has determined that the Experimental
Withdrawal Program conducted in three states
during the past three years will not be continued in its present form. However, agreement
to examine nonproblem banks on an alternateyear basis has already been consummantad with
one state and the possibility of entering into
similar arrangements with other states is being
explored.
Furthermore, termination of the Experimental Withdrawal Program should not be
construed as a decline on the part of the
FL)IC to cooperate to the fullest extent possible
with the various states or to place less reliance
on the efforts of the state supervisors. The
guidelines set forth in General Memorandum #!
provide a workable framework for increased
cooperation with the states. Thus, almost by
definition, if the program expressed in General
Memorandum #1 proves workable and if a state
banking department performs in an acceptable
manner, the frequency and scope of FDIC examinations in that state will be reduced."
FRS said:
"The report recognizes our cuLrent extensive
efforts to eliminate unnecessary duplication by
utilizing State examiners and State examination
reports.
If experience with our existing program in Indiana should indicate that expansion
of this program is desirable, GAO's recommendations regarding standards would be appropriate.
Indeed, the purpose of the existing experimental
program is to develop such standards. In this
connection, however, it should be recognized
that written standards alone will not insure
the success of any program."

4-14

Planning and preparing for examinations
The examiner-in-charge typically prepared for an
examination by reviewing the previous report of
examination and related workpapers. Just before entering
the bank, the examiner-in-charge usually met with his/her
staff and assigned specific tasks. In many districts,
workload, geography, and travel difficulties precluded
extensive preparation. However, some FRBs gave
their examiners-in-charge a period of time, usually a
week, to study the report, workpapers, and related
correspondence from the previous examination.
Determining examination scope
The scope of an examination is the extent to which
the examiner reviews and analyzes the bank's financial
condition, operations, and management. Included in scope
is the depth of the examiner's coverage; e.g., how many
loans and securities were analyzed.
The areas of examination coverage were reasonably
well defined and about the same at each agency. Each
-- evaluated assets,
-- analyzed capital structure,
-- analyzed income and changes in capital,
-- evaluated loan policies,
-- analyzed concentrations of credit,
-- analyzed "insider" loans,
-- evaluated investment policies,
-- reviewed the bank's premises and other real
estate owned,
-- analyzed borrowing,
-- evaluated management,
-- evaluated internal contr.,ls, and
--reviewed compliance with laws and
regulations.
4-15

How thoroughly hese areas were reviewed and analyzed
varied, largely according to the examiner's judgment.
The standari report of examination (see ch. 6)
established the basic scope of an examination. Procedural manuals, whether agencywide or local, also provided
some scope guidance to the examiners. Beyond these guides,
examination scope was left to the discretion of regional
officials and the examiner-in-charge.
Agency officials said problems in the bank's
internal controls or internal or external audit programs
discovered during the previous examination could have
influenced the extent to which certain records were verified or whether cash was counted.
The examiner might have expanded or reduced
coverage of some areas because of the results of the
previous examination. However, we found no evidence
in examination reports that the examiner reviewed
the bank's internal controls, policies, or procedures
before setting the scope of the examination. Unless the
examination was a special, limited-scope reexamination,
it usually closely resembled the last examination.
Conclusion
When planning the examination and defining its
scope, the examiner-in-charge should pay close attention
to the bank's system of internal controls, its policies,
and the audit or verification work already done by internal
and external auditors. We believe that, by examining
electronic data processing operations and by reviewing
the system of controls and policies, the examiners
could identify areas of weakness upon which to focus their
commercial examinations.
The first step of the examination should be a review
and evaluation of policies, procedures, controls, and audit
and the scope of the remaining work should be adjusted
accordingly. Thus, the examiners would not spend time
reviewing areas in which problems are unlikely. Explanation for scope modifications should be included in the
workpapers or the report.

4-16

New examination approaches and procedures being
implemented by the agencies are described in chapter 7.
OCC's new approaches and procedures should eliminate the
weakness discussed above.
Recommendation
We recommend that the Board of Directors, FDIC, and
the Board of Governors, FRS, establish procedures to base
the scope of each examination on the examiners' evaluation
of the quality of the bank's controls, policies, procedures,
and audit.
Agency comments
FDIC stated:
"With respect to FDIC examinations, the findings
and conclusions expressed by GAO are not accurate.
The primary factor influencing the scope of
the examination is not size, but the known history of strengths and weaknesses of the particular institution. Furthermore, FDIC examiners
do pre-plan the scope of an examination, by
studying applicable files and previous examination reports, and noting any material changes
in the management or style of operations since
the last examination.
"FDIC examiners have in recent years reviewed
a bank's internal controls, policies and procedures prior to actual commencement of the
examination in order to establish the scope
of the examination within the minimum standards
prescribed. With respect to smaller banks,
however, such a review tends to be less formal,
hence harder for GAO to detect than with larger
banks. Considerable leeway in this respect is
provided for in the recently adopted General
Memorandum #1, and we reiterate that these
procedures were considered and extensively
tested in five of the FDIC's 14 Regional Offices
for several years prior to formal adoption."
FRS said:
"This recommendation encompasses what we are already doing. We review the policies, procedures,
4-17

and controls in connection with all bank
examinations.
In most large banks, our examiners currently perform a preexamination
review specifically focusing on controls,
nclicies, and procedures.
The results of
such review are used to determine the
amount of scrutiny given to each area.
In
smaller banking institutions, a review of
the controls, policies and procedures in
effect at the last examination is used to
develop the scope of the examination."
Procedural guidelines
Each of the three agencies has a manual describing
the general procedures to be followed during an examination.
However, only the FDIC and OCC manuals were in use during
the period covered by our review.
The FRS manual was issued
in 1976.
Brfore the systemwide manual was issued, the FRBs
followed their own procedures.
Some had examination manuals;
others formally compiled procedural memorandums.
All three
agencies allowed their regional officials and examiners
considerable discretion in establishing examination proceddures.
Beyond the manuals, procedural guidance came from agencywide and regional schools and seminars. (See ch. 10.)
The reports of examination also dictated some procedures.
Documentation standards
The agencies' reports of examination (se
ch. 6) were,
to a great extent, the workpapers for the examination.
The
agencies retained certain forms for recording details about
loans and securities in the files.
However, there were no
guides for what other material--schedules, records of interviews, etc.--should have been available or how it should
have been prepared and organized.
Conclusion
More complete and organized workpaper files would
-- enable the examiner-in-charge to readily determine
if all the required examination steps have been
followed,
-- provide organized and accessible support for
the preparation of the examination report,

4-18

-- i -ble the agencies to streamline their reports
(see ch. 6) by transferring information now in
the reports to the workpapers,
-- enable agency reviewers to determine what work was
done and what information and analyses support the
examiners criticisms, and
-- facilitate review of the workpaperz by the examiner
in charge of the later examinations.
The approaches and procedures being taken by OCC
(cee ch. 7) should result in better documentation
of bank examinations.
Recommendation
We recommend that the Board of Directors, FDIC, and
the Board of Governors, FRS, develop standards for the
preparation, maintenance, and use of examination workpapers.
Agenc _cormments
FDIC stated:
"The standards for the preparation, maintenance,
use and importance of examination workpapers are
included in the course of study at the various
schools operated ¥,ythe Corporation and in our
The examination
program.
on-the-job traininr
workpapers do, in fact, cover a number of items
other than the details relating to specific
loans and securities in support of comments
contained in a Peport of Examination. We believe
ination workpapers will permit a determinour e:
ation that appropriate examination procedures have
been followed, provide support for the preparation
of the Report of Examination, and are utilized at
the next examination."

FRS said:
"We believe that, in the vast majority of examations,
line sheets I spared
the examination workpapers an
The
are adequate to meet the Sysco.. : needs.
manner in vhich examination workpapers should be
prepared and maintained is extensively covered in
connection with the training of our examiners."
'-19

HOW EXAMINATIONS WERE PERFORMED

Examinations were not conducted very differently by
the three agencies. Those variations which existed resulted
from differences in workload and geographical dispersion
of banks.
The examination team consisted of one or more examiners
(one of whom was the examiner-in-charge) and one or more
assistant examiners. Upon entering the banes, the examiners
would take control over assets and request certain information from the banks' managers, usually through a standard
questionnaire.
The actual steps followed during the examination were
established at th? discretion of the examiner-in-charge.
He/she concentrated on evaluating loan quality, while other
examiners or assistants counted cash, listed securities,
and administered policy and internal control questionnaries.
Sometimes the various listings and analyses were consolidated by a senior assistant examiner, but the examiner-incharge checked his/her staff's work and drafted the report.
The time taken for an examination depended on several
things: the bank's size, complexity, and condition; the
numb-r cf examiners available; the skill and experience of
the -xaminers; and the number of examinations to be conducted
during a given period. Specific examination times were fr£quently based on the time taken for the last examination of
the bank.
As shown below, the supervisory agencies generally
spent more effort examining large banks than small banks.
Avera9eStaffdays for
Independent Fede 31 Ex.miinations
FDIC

Bank deos

size

Numter
of
examinations

FRS

oCC

Staff
days

Number
of
examinations

Staff
days

444
316
170
28

1
8
36

188
107
25

Number
of
examinations

Staff
day

(000,000 omitted)
Over
$ ,000
$500 to $1,000
$101 to
$500
Under
$100

1
1
13
99

4-20

62
32
51
55

932
300
117
30

SPECIFIC AREAS COVERED BY COMMERCIAL EXAMINATIONS
The agencies' examinations concentrated on several
major areas, such as asset quality, deposits, capital adequacy, compliance, and management. The agencies were doing
essentially the same things in considering each area.
Classification of assets
s condition was
An important factor in assessing a brPart of an
locins.
the quality of its investments and its
The agencies
assets.
of
quality
examination was to judge the
used three classifications for poor assets--namely (from bad
These
to worst), "substandard," "doubtful," and "loss." of
1949,"
Agreement
classifications conform to the "uniform
National
the
and
signed by the Federal supervisory agencies
Association of State Bank Supervisors. The classifications
were the examiner's judgement of the difficulty converting
assets to full cash value at maturity.
The classifications were used to describe the quality
of the bank's loans, investment securities, real estate
other than bank premises, and other assets.
Review of loans
The examiners looked for low-quality loans, concentrations of credit, insider transactions, and loans outside of the bank's normal trading area (this practice was
cf special concern in small banks).
..
liners did not evaluate the quality of all the
The
loans in a bank's portfolio. Generally, the examiner-incharge was to review all past-due loans, all loans previously classified, and all loans of more than a specified amount.
This amount varied according to the size of the bank, total
loans, and the amount of classified loans found in the previous examination.
Each loan reviewed was judged on risk, collateral,
character, and financial position of the borrower, and
likelihood of repayment. Loan evaluation depended upon the
examiner's knowledge, judgment, perception, and analytical
technique.
Cutoff points and percent of loans reviewed varied
from agency to agency and from region to region. We
were told that FDIC examiners tried to review about 75
4-21

percent of the examined bank's loan volume. FRS examiners
were to establish a cutoff point based on a percent of
capital (each loan of over 1 to 2 percent was reviewed)
and, we were told, usually covered 75 to 90 percent of
the bank's loan dollar volume. OCC's suggested guidelines were:
(1) all loans of at least 0.75 percent of
gross capital were to be reviewed in banks with assets
of less than $25 million and (2) all loans of at least
either 0.5 percent of gross capital or $500,000, whichever
was less, were to be reviewed in banks with assets of
$25 million or more.
In addition to the adverse classifications, the
agencies had a category for loans which required more
than ordinary management attention--"other loan, especially mentioned." FDIC also listed loans with which
examiner had found technical difficulties (inadequate the
documentation of collateral, insufficient credit information).
PRS listed loans not supported by adequate
credit information. OCC used two exception categories:
(1) collateral exceptions and (2) loans not supported
by current and satisfactory credit information.
Examiners were to check all loans and securities to
identify instances where the bank depended on the ability
of a single individual, entity, or industry to repay loans.
The examiners were to group together all large direct and
indirect loans to, and purchases of securities from,
(1) individuals and their families and related interests
(2) business entities and their affiliates, and (3) industries (e.g., agriculture, automobile, real estate). The
examiners were to -eview these concentrations whether or
not the loans or securities were classified or exceeded
the State lending limits.
The examiners were to review and record all debts
(direct and indirect) owed to the bank by its directors,
officers, and employees, and their interests. Federal and
State laws restrict the amounts of such loans, and the examiners were expected to comment on any loans which violated
these laws. Also, examiners were to criticize any such
loans which they considered large and unwarranted.
The examiners were to look for and criticize large
amounts of loans to borrowers outside of the bank's normal
trading area.

4-22

Evaluation of securities
The examiners were concerned about at least three factors affecting securities (stocks and bonds) the banks had
purchased: current value, quality, and maturity. Examiners
Examiners were usually expected to review all securities
using, as guides to quality, ratings provided by various
securities rating services.
The examiners were to group the bank's securites into
special categories. FDIC used four; FRS used a different
four; OCC tsed seven. The examiners were expected to compare the maLket values for all groups of securities to
their book values. If market value was less than book value,
the amount of the difference ("depreciation") would be
class&fied substandard, doubtful, or loss depending upon
the agency's standards for each group. Generally, the
agencies would not classify either U.S. Government bonds
or bonds which received one of the four highest ratings
of one of the securities rating services.
The agencies' approach to New York City bonds shows how
different classes of securities were treated by examiners.
In October 1975 the agencies agreed not to classify certain
New York obligations even though a rating service had lowered
their rating. This was done because the agencies believed
that the "unsettled condition" of the market did not reflect
the truie value of the securities. Ordinarily, bonds with
that rating would have been classified as doubtful by the
examiners. In December 1975, FRS modified its position by
suggesting that New York City obligations of less than investment grade be classified as substandard. OCC similarly
modified its posiLion on New York City bonds in March 1976.
The examiners were also to see whether the bank's investment securities would be redeemed at different times to
provide the bank with a steady flow of funds.
Real estat
The examiners were to review each real estate
holding, other than the bank p.emises, to determine
-- the reason the property was acquired and the
plans for disposing of it,

4-23

-- the book value (the cost to acquire the property)
in relation to the appraised value,
-- the length of time the property had been held
and the reasons it had not been sold, and
-- rental income and maintenance expense.
The examiners were to classify real estate as substandard,
doubtful, or loss if the bank was losing money by maintaining the property or if the market value of the property
w s less than its book value.
Deposits
Examiners were to analyze the bank's deposit trends
both in total and by account type--checking, regular savings,
or time (such as Christmas clubs or savings certificates);
public or private funds; individuals, partnerships, and corporations; etc. The time spans covered differed among the
agencies (FDIC looked at a 5-year span, FRS looked at 4
years, OCC looked at 3 years), as did deposit categories,
but the agencies had similar objectives. The examiners
were to analyze deposit trends and distribution in order
to jude the bank's assets (short-versus long-term, lowversus high-interest), identify changes in its operations,
and identify potential decreases in ready cash.
The examiners were to look at the sizes of
deposit accounts to identify concentrations of deposits which
might be withdrawn quickly, thus decreasing ready cash. To
identify overreliance on public funds or an entrance into a
new field of operations, the examiners were to analyze the
amount of the bank's deposits which were secured by pledged
assets. It was ccnsidered undesirable for a bank to have an
inordinately high percentage of its assets pledged against a
similarly high percentage of its deposits.
The examiners also were to analyze in detail the public
funds deposited in the bank. Particular attention was given
to the types of accounts, interest paid, and any special
terms or conditions, The examiner also compared the current
rates of interest paid to the types of accounts. The rates
could have indicated the bank's competitive position.
Borrowing by banks
FDIC and OCC examiners prepared detailed listings of
loans made to the banks since the previous examination;
4-24

FRS examiners summarized the bank's borrowing in the reports of examination. The examiners were interested in
the amounts of borrowed funds compared
the same things:
to the assets and condition of the bank, frequencies and
types of borrowings, borrowings which had not been approved
by the bank's board of directors or which exceeded legal
limits and the likelihood that the sources of loans would
continue to be available. The borrowing practices were
then evaluated in light of the bank's liquidity, capital,
and profits.
Adequacy of capital
When analyzing the adequacy of a bank's capital,
the examiners calculated a figure for "adjusted capital"-total capital minus (1) losses and estimated losses on
assets and (2) half of the assets classified as doubtful.
If the resulting figure was less than the amount of capital
stock, the bank's capital was considered impaired. If the
figure was negative, the bank could have been insolvent.
When adjusted capital exceeded capita. stock, the
examiner was to determine if the bank's capital structure
was below an acceptable level. During the examination,
the examiner would calculate various capital ratios for
the bank. These would be compared to industry and/or
peer group ratios. The results of such comparisons would
indicate whether or not the bank required further analysis.
Other factors considered in the analysis of capital were
asset quality, liquidity, deposit trends and distribution,
borrowings, income, and management. The bank's capital
would not normally be criticized if, in the view of the
examiner or reviewing agency officials, it was sufficient
to support the bank's operations and protect the bank's
depositors. There was no level of capital, either ratio
or absolute amount, deemed minimally acceptable for all
banks or any particular class of banks.
The agencies indicated that they were studying the concept of industrywide standards for adequate capital. However, these efforts have not produced standards or more
(Case 5 in chapter 8 illustrates this
definitive criteria.
The agencies emphasized that developing indussituation.)
trywide capital standards is extremely difficult and might
even be impossible.

4-25

Income and dividends
The examiners also were to analyze the bank's earnings and dividends to determine whether:
-- Earnings were sufficient to provide capital to
accommodate future growth.
-- Earnings were sufficient to cover current asset
losses.
-- Earnings were adequate in relation to the existing
dividend rate.
-- The bank was sufficiently managed and operated.
-- Dividends were consistent with the bank's condition,
-- Dividends were legal.
The examiners were to analyze income and changes in
capital using data contained in the bank's annual reports
of income and other records. Specific practices for
neriods covered and sources of data varied among the
akencies.
Liquidity
Many of the analyses performed by tIe examiners involved
information important for determining the bank's liquidity
position (its ability to fund probable and possible cash
needs without liquidating assets at substantial losses).
Information about such things as maturity and value of
securities, types oi loans, deposit concentrations, forward
commitments, contingent liabilities, and deposit trends
was considered by cte examiner. The examir'r decided
(subject to the review of agency officials) whether or
not the bank's liquidity was adequate based on the above
information and other factors, such as the economy, management capability, access to money markets, ind asset quality.
The agencies also had liquidity formulas which they used
as screening devices to indicate which banks warrented
further analysis.

4-26

Compliance with banking

laws and regulations

Examiners were instructed to inspect for violations
FDIC and FRS
of Federal and State laws and regulations.
in the
laws
State
of
examiners were to cite violations
reports of examination.
The laws and regulations enforced through the examination process varied in importance and concerned lending practices, including: specific lending limits; securities and real estate investments; dividends; activities
of directors, officers, and employees; deposits and interest rates; stock registration; affiliations; consumer
protection (see pp. 4-42 to 4-45); and bank security.
Management, management practices,
and internal controls
Appraising a bank's management was an important part
of the exyami.ation. The examiners were to consider (1) the
bank's condition, (2) its policies and procedures, (3) the
adequacy and quality of its earnings, (4) the relat:onships among individuals and management levels, and (5) provisions for management succession.
trhe examination was to include analyses of policies
and procedures for
-- loans,
-- credit card and credit-check plans,
-

investments,

-- internal controls,
-- outside :nvolvement of the board of directors,
-- insurance, and
-- emergencies.

4-27

The examiners were to use a questionnaire approach in
identifying and analyzing these policies and procedures.
They were also to review the activities of the board of
directors.
BANKERS' VIEWS ON EXAMINATION COVERAGE
We asked bankers to indicate (1) what they considered
the five most important objectives of bank examinations
and (2) which five objectives they thought were most important to the agencies. (See app. I, pp. I-5 and I-6.) As
shown below, four objectives appear in both lists *of most
frequent answers, though in different order. The bankers
consider the safety of depositors' funds and the quality
of management more important than they thought the agencies
considered it. The agencies' examination policies emphasized
the importance of the evaluation of management, and each
agency's rating system (see ch. 6) included a rating of
management. Yet the bankers had not perceived an evaluation
of management as being one of the agencies' five most
important objectives.

Bankers'
priorities

Area of examination
Safety of depositors' funds
Asset quality
Compliance with laws and
regulations
Quality of management
Adequacy of internal controls
Adequacy of capital

Bankers'
view of
agencies'
priorities

1
2

4
2

3
4
5

1
5
3

Less than 40 percent of the bankers believed evaluation
of capital adequacy and evaluation of liquidity to be among
the five most important.
The following tabulation shows that the bankers generally believed that the examiners were paying enough attention
to the important aspects of examinations.

4-28

Area
Loan assessment
Co..pliance with banking
laws and regulations
Manaqement assessrelit
Internal control
Capital adequacy

Percent of bankers who felt
examiners' attention was
Appropriate Too little
Too much
20

22
8
12
16

74
79
79
81

4
13
9
3

4-29

INTERNATIONAL OPERATIONS EXAMINATIONS
The agencies' international examinations were
similar to their commercial examinations in objective and
scope. However, the special risks involved in international
loans and the risks and complexities of foreign exchange
transactions required specialized knowledge and procedures.
Thus, the agencies used specialists in international
examinations.
Domestic banks may maintain branches in foreign countries or invest in foreign banks or financial institutions.
Today, foreign branches account for most of the international assets of domestic banks.
Investments in foreign
banks or financial institutions may be direct purchases
of foreign bank stock or "Edge Act" or "agreement" corporations--domestic corporations which are chartered solely
for foreign banking or financial activities. Most branches
of foreign banks operating in the U.S. are not subject to
FDIC, FRS, or OCC supervision. 1/
Relatively few domestic banks are engaged in major
international operations. As of December 31, 1975, only
131 of the 5,790 national and State member banks had overseas branches and/or foreign subsidiaries. Foreign branches
of the 20 largest banks had almost 92 percent of total
foreign branch assets.
While international assets as a percentage of total
assets amounted to approximately 15 percent of the banking
industry as a whole, 40 to 50 percent of the assets of
the largest banks were in international operations. For
example, the 30 largest banks in our samples had nearly
$167 billion of foreign assets at their most recent examinations. Of this amount, nearly $81 billion was in loans to
foreign governments, businesses. and individuals. Also;
these banks' international operations are a major source of
income--up to 50 percent in some cases.
The objectives of international examinations were to
determine the condition of the international departments
and to assess their management. Thus, the international
1/

See "International Banking--a Supplement to a
Compendium of Papers Prepared for the FINE Study,"
a staff report for the House Committee on Banking,
Currency and Housing, May 1976.
4-30

examiners, like commercial examiners, evaluated asset
quality, internal controls, policies, and procedures.
The foreign exchange activities of banks, becaus?
of their special risk, were of major concern to the examiners.
The examiners reviewed the bank's net currency positions and
future commitments to identify potential large losses, evaluated the risks involved should customers not fulfill their
parts of the transactions, evaluated the credit of the
bank's trading partners, and evaluated the bank's system
of audit and controls over foreign exchange dealings.
Evaluation

f tor.eign credit

Foreign loans are more complicated to evaluate than
domestic loans because they are often made in different currencies and to foreign governments. A special risk (called
country risk) is taken with loans made in different currencies because the borrower must repay the loan in the
currency borrowed. The borrower's ability to obtain the
appropriate curren-, is affected by the political and
of the borrower's country, including its
economic stabili7
-- balance of trade and of payments,
-- Fxport-import trends,

-- foreign exchange reserves,
-- overall debt and debt-service rates,
-- gross national product growth, and
-- employment and inflation rates.
FRS and OCC took different approaches to evaluating
loans subject to country risk. These different approaches
caused some banks' loans to be classified differently than
other banks' loans to the same country or foreign business.
Within FRS, two approaches were taken. In 1976 an
ad hoc committee of senior examiners in the New York FRB
evaluated the country risks and assigned a general classification to loans to borrowers (including the government)
within some of those countries. All loans to those countries
and their businesses received the classification, unless
the borrower's ability to obtain the repayment currency
was independent of the country's stability or the loan
was made in the local currency. A loan in a local currency
was judged according to the borrower's financial condition.
4-31

At the other FRBs, foreign loans were evaluated
individually. This approach led to inconsistent classifications within the FRS. For example, a loan to one
country was classified by San Francisco examiners, while
examiners from FPBs of New York, Philadelphia, and Richmond did nct classify loans to the same country. Similarly,
examiners from the FRBs of Boston, Chicago, and San
Francisco criticized loans to another country, but New
York examiners did not. As a r:'sult, some State -member
banks may have received more supervisory attention than
others in different locations, even though they had similar
loans subject to the same risks.
In 1974, OCC set up a committee for evaluating country
risk. Each quarter senior international examiners from
headquarters and the Chicago, New York, and San Francisco
offices met to evaluate the risk involved in, and assign
classifications to, certain loans to certain countries. The
loans classified were those for which repayment was as much
dependent on the borrower's ability to obtain the appropriate
repayment currency as on the borrower's financial condition.
The committee classified these loans by using information
from major banks' research dparments and Government sources
available to it. The classifications arrived at by tne
committee were then used throughout OCC for loans to these
countries.
The New York FRB and OCC thus both used "committee"
systems; but with, different results. In July 1976 the
Reserve bank's committee and OCC's committee each developed
ratings for loans to foreign countries. While the OCC
mmittLe concluded that certain loans to five countries
g..ould be classified as substandard, the New York FRB
assigned the substandard classification to loans of only
o,ie of them. Neither committee classified loans to any
other countries. As a result, one bank may have been
subject to more supervisory attention and pressure than
another even though their loans were similar.
Conclusion
Using three country risk evaluation methods has resulted
in different treatment of the banks that FRS and OCC supervise, Further, the method used by the FRBs depends on
.ndividual examiners keeping abreast of economic conditions
a many countries and being able to judge loans in many

4-32

countries. A te.m of experts who evaluate economic conditions in each codntry should produce more accurate and
consistent results than numerous individuals who evaluate loans case by case.
Recommendation
We recommend that the Board of Governors, FRS, and the
Comptroller of the Currency, using all available informatiot,
develop and use a single approach to classify loans subject
to country risk.
Agency comments
FRS said:
'The evaluation of the country risk element in international loans calls for difficult analysis and judgment a. the time lines of credit are established or
loans extended since "country risk" involves an
estimate of a country's political, economic, and
social fortunes over the life of the loan as they
may affect the collectability of such loans. There
is serious question as to the validity of generalized
characterizations of credits based on the country
of residency of the borrower, particularly where
the characteristics of the credit may well vary with
the borrower - private or governmental - as well as
the nature and extent of external resources available to support the loan. For a number of months now,
the Federal Reserve has had underway a review of
country risk problems in international lending as
well as appropriate supervisory treatment of the
problem. This review has included an on-going appraisal of the system employed by th2 Comptroiler
of the Currency. In this regard, we believe that,
while there may be general agreement on the desirability of of uniform evaluation of the country
risk element in individual interrational credits,
there is a real question as to the desirability
of rating individual countries. It might be noted,
for instance, that the ComptrollerCs system focuses
almost exclusively on credits to individual governments. In any event, we believe that we should
strive toward uniform treatment. Of course, as with
respect to many of the recommendations, the Federal
Bank Examination Council proposal would accomplish
this."'
4-33

OCC said:
EThe OCC has a well established procedure using
single approach to the classification of country a
credits. This procedure makes use of information
from many governmental and non-governmental sources
and examiners in all fourteen national bank
regions.
"Copies of the minutes of our committee meetings
and
any resulting classifications have always been
provided to members of the staff of the Board
of Governors.
"The process of country risk evaluation is more
precisely an art than a science. Most of the
evaluation process is judgmental.
However, the
interagency meetings held to date have been
beneficial in determining basic differences in
philosophies."
Onsite versus home office examinations
of foreign branches and subsidiar ie s
FRS and OCC conducted international examinations
at the
home affi.e of the bank or the Edge Act corporation
and
at the foreign branch or subsidiary. The examiners
usually
evaluated foreign loans from information at the
home
office
of the parent bank or corporation.
We reviewed examination reports on 18 national
banks
and 12 State member banks with substantial international
operations. A high percentage rf classified loans,
inadequate
controls over foreign exchlange operations, and inadequate
overall internal controls were the most prevblent
problems
found in those banks' international operations.
FRS examiners stated that two of the State
banks were experiencing some problems which were member
related
to subsidiaries of the banks' Edge Act corporations.
Both
banks' Edge Act corporations had been examined
by
FRS
before the problems were noted in the banks. However,
the
examiners of both had said the information available
at
their home offices was inadequate. The subsidiaries
were
not examined onsite until after the banks had begun
experiencing problems.

4-34

Conclusion
We believe that these subsidiaries should have been
examined onsite as soon as possible, once the home office
files were found inadequate. Early onsite examinations
of the subsidiaries might have disclosed their problems
before parent banks were injured.
The supervisory agencies are sometimes prohibited or
restricted by foreign laws from making onsite examinations
of domestic banks' foreign branches and subsidiaries.
Recommendations
We recommend that the Board of Governors, FRS, and the
Comptroller of the Currency implement proced' .s to examine
(where permitted by the country involved) major foreign
branches and subsidiaries, including subsidiaries of
Edge Act corporations, onsite--periodically and whenever
adequate information about their activities is not available
at the home office.
Also, we recommend that the Board of Governors, FRS,
and the Comptroller of the Currency utilize each others'
examiners to cut expenses when conducting examinations in
foreign countries.
Agency comments
FRS said:
"The development of widespread networks of foreign
branches and subsidiaries by the major banks has
brought the question of the supervision of the
banks' international operations to the forefront
in recent years. We concur with the principle
that examinations, wherever conducted, should
be adequate to provide the necessary supervisory
information. However, one constraint with which
the Board has had to deal is, as noted in the
report, that, in many cases examinations of foreign
subsidiaries are not possible because of host
country laws which preclude direct examinations
by other governmental authorities of banks chartered in those countries regardless of the ownership. The System has not only required that
banks maintain records at the head office adequate
to appraise the risk and exposure of the banks
4-35

through their foreign operations, but the System
has also provided for direct visitations of examiners
to major foreign branches in those cases where
such
visitations have been legally possible.
"The Board believes that, on the whole, this system
has worked well. The information available at
head offices has, in general, been adequate to
assure that the banks were not unduly exposed to
loss or serious financial difficulties. At the
same time, there has been a continual search for
better and more efficient ways of satisfying
the
Federal Reserve's supervisory responsibilities
in the international field.
"Beginning in the fall of 1976, onsite examinations were made of foreign branches of State
member banks where we had previously utilized onsite inspections by State examiners or information at the head office. Moreover, a number of
foreign subsidiaries were directly examined for
the first time with the agreement of the host
government. A full evaluation of those examinations has not yet been completed. One preliminary
result of that exercise Las been to provide assurance that a large portion of the material needed
for proper supervision of foreign branches and
subsidiaries is in the management information
systems at head offices. In this connection,
it should be noted that consultations are continuing with foreign bank supervisory authorities
about the ways in which access to foreign subsidiaries may be broadened to accommodate onsite
reviews. These consultations are part of a wider
effort of international cooperation in bank
supervision."
Regarding onsite examinations OCC said:
"National Banks are required by Regulations K &
M
to provide examiners with whatever credit and
financial information the examiner deems necessary
to evaluate the condition of the bank's foreign
branches and subsidiaries. Those regulations
require such information be transmitted to and maintained at the baink's head office. The OCC has
f r practical purposes defined "head office" to
.zaclude any foreign or domestic office of the bank
4-36

which is readily accessible to its examiners.
For example, all international credits of one
large national bank are examined from two domestic
offices and four foreign offices located in
London, Caracas, Tokyo and Manila. All of
that bank's many branches and subsidiaries
located in E rope, the Middle East and Africa
are examined from duplicate records in London.
"Supplemental examinations to determine the
quality of the bank's operations are made onsite
overseas when necessary. For purposes of performing asset and operational examinations,
the OCC established in 1972 a London office
In fulpermanently staffed by six examiners.
filling its overseas examination obligations,
the OCC in 1976 examined 141 overseas branches
and subsidiaries of 25 banks located in 37
countries; 154 onsite examinations were performned by 215 National Bank Examiners."
Regarding joint overseas examinations, OCC said:
"The GAO recommendation has merit. As a bare
minimum the physical support of the three agencies
could be jointly provided. F..rther arrangements
could be made so that any of the agencies could
jointly commission overseas examiners. In this
regard, the OCC is willing to seek a cooperative
solution with our sister agencies.
"Under present statutes, however, such a sharing
of examiner forces may be difficult. Section 481
of Title 12 (12 U.S.C. 481) directs the Comptroller
of the Currency to appoint examiners who shall
examine every national bank. That same section
empowers the Comptrolle .o make a thorough examination of all the affairs of the banks under
his jurisdiction including the affairs of all
affiliates of National banks 'other than member
in order to disclose fully the relations
banks',
between the bank and its affiliates and the
'effect of such relations upon the affairs of such
(Emphasis added.)"
bank'.

4-37

ELECTRONIC

DATA PROCESSING EXAMINATIONS

Over 85 percent of the country's banks use computers
to process accounting and financial records. At some banks,
computers support every operation. The agencies devote
special attention to electronic data processing (EDP)
operations (whether carried out by the banks or contracted)
because
-- the accuracy of management and accounting reports
depends on EDP,
-- the bank's ability to function might depend on
the continued operation of EDP, and
-- the bank could be vulnerable to large embezzlements
through computer fraud.
Banks are beginning to use more advanced computer
operations, such as computer audio response systems, online
account changes, automatic payment and deposit procedures,
and electronic funds transfer. To keep pace, the agencies
will hare to devote even more attention to EDP operations
and increase the expertise of their staffs.
Many banks did not have enough data processing activity
to justify buying a computer. To meet their data processing
needs, these banks contracted with service centers, which
frequently specialize in standard programs that can be used
by similar customers. Examinations of such service centers
were generally the same in scope as examinations of
banks' in-house EDP departments.
Although each agency had an "EDP handbook," or standardized examination procedures manual, prepared by its
Washington headquarters, the scope of each EDP examination
was determined at the regional level. Examination procedures
at the three agencies emphasized a questionnaire approach.
The time and staff allotted to an EDP examination depended on the size of the bank, its degree of automation,
and the availability of qualified examiners. The average
time spent on an examination varied from agency to agency
and region to region.
TIe OCC and FDIC examination reports had various questioLnnaires on EDP and a comment section summarizing EDP
4-38

matters requiring management attention. The FRS examination report asked for similar information, but the
questions were to be answered in narrative, rather than by
l']es" or "no."
The examination reports of all three agencies contained
more information than required to tell bank managers
of the need for corrective action. The banks received all
questionnaires answered during the examination, whether
a deficiency was disclosed or not.
Conclusion
In our view the EDP examination report, like the commercial examination report, should contain the deficiencies
noted by the examiner and any necessary supporting information.
OCC is developing new procedures for EDP examinations
which should result in a streamlined examination report.
Recommendation
We recommend that the Board of Directors, FDIC, and the
Board of Governors, FRS develop reports of examinations for
EDP operations which present the problems found, corrective
action needed and any necessary explanatory data in a clear
and concise manner.
Agency comments
FDIC stated:
"The summary comments page of the FDIC EDP questionnaire provides clear and concise descriptions of the
In our judgresults of a data center evaluation.
ment, a new evaluation report is not necessary at
this time and our form, if effectively used, is
comparable to the new one recently adopted by the
However, we view our questionnaire as a
OCC.
constantly evolving tool which will be revised
frequently in order to stay abreast of industry
developments and to meet the burgeoning needs of
our field personnel. See also our comments regarding EDP evaluation reports included with our
general comments."

4-39

FRS said:
"The Board wishes to note that it believes its
present EDP examination report adequately presents the major problems found and corrective
action needed. Furthermore, the System has
already undertaken a review of EDP examination
procedures to determine whether there are
possible improvements, particularly in the
review of internal controls, and, in connection with that review, is preparing a
revised examination report."
TRUST DEPARTMENT EXAMINATIONS
Banks operate trust departments to control or manage
clIstoaers' money or property at their request. The agencies
have developed special trust examination techniques to
focus on two issues:
-- Is the trust department complying with laws and
with individual trust agreements?
-- Is the trust department managed so the bank does
not incur any major liabilities?
We reviewed (1) the agencies' trust examination policies
and procedures and (2) examination reports on 30 trust departments. We learned that:
-- The agencies' policies and procedures were similar.
-- Their examination reports differed only in format.
-- They used different trust department rating systems,
all of which emphasized the examiner's judgment.
COMPLIANCE WITH CONSUMER PROTECTION LAWS
The Congress has enacted several laws to protect
consumers. Certain of these laws affect banks' lending
practices, efforts to attract depositors, and billing
discrepancies. The agencies are responsible for enforcing
these provisions.

4-40

How violations are discovered
The agencies learn of violations through consumer complaints and bank examinations. Each agency defines the handling of consumer complaints as a major function of its consumer affairs effort. Both FDIC and OCC keep computerized
records of consumer complaints and their disposition. FRS
records consumer complaints on a card filing system, and
each FRB handles complaints in its district. Each agency
processes hundreds of complaints and inquiries each year.
Until recently, all three agencies reviewed consumer
credit as part of their regular commercial examinations.
FDIC adopted separate compliance reports and consumer credit
reviews in September 1974. In the most recent examinations
of banks in our general sample, FDIC examiners cited violations of consumer credit and truth-in-lending regulations
more often than did FRS and OCC examiners.
Percent of banks in which
violations were found bv
FDIC
FRS
OCC

Law or regulation

Credit discrimination (regulation B) 3
Truth-in-lending (regulation Z)
29

1
17

Unaggressive examinations
Consumer advocates have frequently complained that
bank regulators have been deficient in their enforcement
of truth-in-lending provisions (regulation Z) and other
regulations. Although consumer credit compliance was
being reviewed, agency officials acknowledged that examinations in this area had not been penetrating. Both
consumer protection organizations and the agencies agreed
that the consumer credit regulations are complex and,
therefore, difficult to comply with or enforce. Officials
of each agency stated that most complaints are technical
problems resulting from a lack of understanding of the
regulations by both banker and consumer.

4-41

In addition, some agency representatives pointed out
the poteniL-al conflict between a bank's objective of financial soundness and strict compliance with consumer credit
laws. For example, the financial soundness of a bank may
depend upon its lending selectivity. This selectivity could
violate consumer credit laws if the criteria used discriminate illegally. Also, consumer credit violations disclosed
by examiners may stimulate consumer lawsuits which force
banks to pay large settlements.
Since September 1974, FDIC has used consumer credit
compliance reports which contained questions concerning
consumer credit practices. The current report consists
of four pages entitled "Truth-in-Lending--Fair Credit
Billing," "Fair Credit Reportinc Act," "Advertising of
Interest or Dividends on Deposits," and "Equal Credit Opportunity." Each question required a yes or no response, and
each page allowed space for comments.
FRS was reviewing consumer credit laws as part ot
the regular commercial examination. Several general questions in the regular report of examination referred to
consumer credit laws; however, there was no evidence of
the type or extent of testing done for consumer credit
compliance.
The OCC review of consumer credit laws was also included
in the regular commercial examination. A truth-in-lending
disclosure checklist of 22 items for review was used; however,
forms were not provided for other consumer credit laws.
The forms used by the agencies for reporting on banks'
consumer credit compliance:
-- Did not require specific enough information as to
the extent of noncompliance in cases of possible
or probable violation.
-- Did not ask about lawsuits, other civil claims,
or pending prosecution.
-- Left the real questions of compliance up to the
individual examiner.
Discovery of violation, depended on the examiner's
familiarity with the regulations and persistence in asking

4-42

questions. However, compliance training for examiners has
been limited and inconsistent. Examiner training in consumer
credit regulations, according to agency officials, has
varied from 2 hours at OCC to 10 hours at FDIC and 'RS.
Officials at all three agencies acknowledge that training
has not emphasized examining for consumer credit law compliance other than with regulation Z.
Action on violations
The agencies investigated each complaint.
If they
found it valid, they notified the complainant and the
offending bank. The agencies did not publicly disclose the
violation. When a violation was discovered during an examination, the agency informed bank managers in meetings and
in the examination report. The agencies have statutory
authority to issue cease and desist orders (see ch. 8)
for persistent violations of consumer protection laws and
regulations.
Coiiclusions
The agencies were not devoting enough attention to
monitoring banks' compliance with consumer protection laws
and regulations.
Their procedures were not sufficiently
comprehensive or detailed. Thus, they relied heavily upon
the individual examiners to find violations; yet examiner
training was Insufficient. The agencies have started
new programs to improve their approaches, including more
comprehensive procedures, specialized training, and specialized examination staffs.
(See ch. 7.)
BANK AFFILIATION WITH HOLDING COMPANIES
Bank holding companies are those which own or control
one or more banks. They are a major element in the American
banking system, owning or controlling one-fourth of all
commercial banks in America which control two-thirds of
all assets and deposits.
A holding company may be a source of financial and managerial strength to its affiliated bank or banks, or it may
be a scurce of weakness. In 1956 the Congress passed the Bank
Holding C'ompany Act to control the concentration of financ,e.
resources, and preserve effective competiton. FRS was
assigned responsibility for supervising and regulating
bank holding companies.

4-43

Some holding companies caused
problems for subsidiary banks
The agencies' examiners were expected to review banks'
relationships with their affiliates, including holding
companies, and to criticize any relationship which could
cause or was causing problems for the banks. Examiners said
that 72 of the 344 banks in our samples which were affiliated
with holding companies had problems resulting from that
affiliation. According to the examination reports for 50
of these banks, holding company management was not the
primary cause of the problems. However, for the remaining
22 banks, 20 holding companies' actions were causing the
problems.
According to the examination reports for these 22 banks,
problems were caused by inept and ineffective holding
company management--particularly overexpansion4
unsound
operations of nonbank subsidiaries, and real estate loans
which were unpaid. Holding company actions which harmed
subsidiary banks were
-- transferring loans between subsidiaries and charging
excessive management fees and dividends to
(1) offset weaknesses in nonbank subsidiaries.
particularly mortgage subsidiaries with weak
real estate loan portfolios (nine holding
companies), or
(2) repay loans for either expansion or additional
subsidiary bank capital (seven companies);
-- excessive investment in bank quarters (one company);
-- insisting that a bank make real estate loans which
were subsequently classified as risky (one company);
-- self-dealing and engaging in various unsound
banking practices (one company); and
--fraud (one company).
Unsound holding companies'

2_xansion

applications approved

Through December 1975, FRS approved applications by
15 of the 20 detrimental holding companies to acquire

4-44

additional banking and nonbanking subsidiaries. Such acquisition contributed to problems in two subsidiary banks.
In
1972, FRS approved six of seven applications for purchases
by one holding company with inadequate capital. Serious
problems in the company's lead bank were noted 2 years
later. According to examiners, by the end of 1975 the holding company and its banks were in hazardous capital
positions.
Another holding company's applications to acquire additional subsidiary banks were approved b-t FRS, despite serious
asset problems in one of its subsidiaries. Recently the holding company went bankrupt and its lead .Tank failed. (See
case on p. 4-41.)
FRS surveillance and inspection _clicies
Bank holding companies are supervised by FRBs, with the
Division of Bank Supervision and Regulaeion providing general
policy guidance and oversight from FRS Headquarters.
In 1972, FRS developed a surveillance system
to identify and monitor actual and potential problems
by gathering and analyzing information. The system consists
of
-- reviews of examination reports on holding-companyaffiliated banks, whether national, State member, or
State nonmember,
-- reviews of holding companies' registration statements, annual reports, applications, and other
financial information, and
-- visits to holding companies to review records and
operations.
The aim of these activities is to insure that bank
holding companies are operated in a manner that does not
jeopardize subsidiary banks.
Review of financial data
Reserve bank surveillance rctivity focuses on analyzing
information on each holding company and its banking and
nonbanking subsidiaries.

4-45

All bank holding companies are required to report annually, and the larger companies must also file quarterly and
annual supplementary data. Annual reports are due nout later
than 3 months after the end of a holding company's fiscal
year, but the Reserve Board will grant an extension. FRB
personnel are supposed to study these reports in depth and
appraise the holdingcompanies' conditions in detail. Reserve
bank staff also review registration statements; applications
and related memorandums; bank examination reports by FRS,
OCC, FDIC, and State bank supervisors; Securities and Exchange Commission annual (10K) reports; and all correspondence. Also, FRB officers frequently contact holding company
managers, who yield useful information.
According to FRS officials, they monitor those holding
company activities that are most likely to place a bank in
a difficult financial position. such as loans and other
extensions of credit; capital adequacy, including debt equity,
liquidity, and cash flow; nonbank subsidiary earnings; and
intracompany transactions, including dividends and management
fees. They are specifically concerned with those holding
companies, subsidiaries, and affiliates which engage in
leveraging activities, such as mortgage banking, consumer
financing, and leasing.
Reserve Board officials believe that the information
presently gathered, both oral and written, allows early
identification and monitoring of problems that otherwise
would come to FRS' attention only after they affected the
banks. We found only one instance where the review of financial data disclosed a problem before it was found by a bank
exmination.
Cnsite inspection
FRS inspection guidelines state that the frequency
and scope of holding company inspections should depend not
only on the holding compary's size and complexity but also
on information gained from other sources, such as
registration statements, annual reports, and particularly
examination reports on the company's subsidiary banks.
According to responsible officials, of the 12 Reserve
banks:
-- 9 have no written guidelines detailing the scope
of inspections;

4-46

-- 5 do not evaluate nonbank subsidiaries' assets;
--3 perform limited evaluations of nonbank subsidiaries;
--4 do not meet with holding company boards of
directors to discuss findings;
--2 do not submit inspection reports to holding
company managers or directors; and
--7 restrict supervisory activities, including
inspections, due to bucgetary restraints which preclude hiring additional personnel.
Time spent on inspections
The average time for an inspection by each Reserve bank
ranged from about 4 staff-days to about 150 staff-days.
Some of the variance can be attributed to differences in
the average size of holding companies supervised by each
FRB.
Many of the FRBs did not begin formal holding company
inspection programs until 1974. FRBs had made 527 inspections through Decembe. 1975, as follows:

Year
1971
1972
1973
1974
1975

Number of
inspections

Percent of all
holding companies
1
5
6
8
13

13
69
89
128
228

Three FRBs made approximately 55 percent of these inspections. Six others together accounted for only about
20 percent. One of these made only six inspections in this
5-year period.
Holdingcompany inspections
did not discover weaknesses
FRS did not detect weaknesses in 15 of the 20 holding
cumpanies until after they had damaged subsidiary banks.
Problem in the 20 holding companies were first identified by

4-47

-- examinations of subsidiary banks of 15 companies,
-- the review of financial data of 1 company,
-- 2 simultaneous bank examinations and holding company
inspections, and
-- inspection of 2 holding companies.
Nine of the 20 holding companies had not been inspected
before problems appeared in their banking subsidiaries.
Seven holding companies had been inspected before problems
were found in the banks, but these inspections did not discover the potential for problems. Four of the seven had last
been inspected 1 to 2 years before the problems were identified in the banks. In one case the inspection was confined
to a review of the holding company's financial data. The
remaining two inspections occurred less than 3 months before
the bank examinations that identified the problems. The
fallowing case illustrates how FRS inspections failed to
disclose problems.
The bank became a subsidiary of a multibank holding
company in the late 1960's. The holding company operated several banks and had other subsidiaries engaged
in real estate, data processing, mortgage banking, life
insurance, factoring, and loan servicing. The principal
nonbank subsidiary was a mortgage corporation.
The bank failed because of numerous deteriorating real
estate loans associated with the mortgage company. The
bank participated heavily in these loans, which were
arranged by officials who controlled both the holding
company and the bank. In fact, some decisions regarding
the bank's operations were made by personnel who worked,
not for the bank, but for the holding company.
FRS inspected the holding company 4 years after it
acquired the bank, but no problems were noted. In
bank examination repcrts issued 1 month before and
7 months after the holding company inspection OCC
examiners criticized loan participaticrs purchased
by the bank from the mortgage subsidiary. However,
on both occasions, the exleminers considered the bank's
financial condition and management good, and the bank
received the highest composite rating possible (a "1"
rating).

4-48

Noting that the condition of the holding company and
its subsidiaries was "generally satisfactory," FRS
issued application approval orders the year following its inspection, authorizing the holding company
to acquire other banks. A later FRS memorandum noted,
"At the time of each of these Orders there was
apparently no evidence available that problems were
developing in [the] mortgage subsidiary."
Thirteen months after the inspection, FRS conducted
a special investigation of the holding uompany and
its mortgage subsidiary. The investigation had been
prompted by a large increase in short term borrowings
by the holding company. The resulting report noted
substantial asset problems in the mortgage subsidiary
which were causing a highly leveraged position foL
the holding company. The report stated,
"of primary concern to the Reserve Bank is
the increasing dependency of [the holding
companyl on [the bank] for financial support
to mset the demand of the mortgage corporation
and the resulting financial strain placed
on [the bank] by such demands."
The report was provided to the OCC regional
administrator.
The OCC examination of the bank 2 months after the
FRS investigation disclosed that mortgage loans had
severely deteriorated. The examiners considered the
condition of the bank and its management poor, and
assigned the lowest composite rating possible, a "4."
The bank never recovered.
Reserve Board oversight of FRBs' holding
company survillanceand Inspection activities

The Division of Bank Supervision and Regulation received data from the FRBs on specific holding companies,
and Division personnel were in frequent contact with FRB
employees. However, Division employees did not completely
monitor FRB supervisory activities. For instance, they had
no system, such as status reports, to keep track of the
number of holding companies inspected and to insure that
all holding companies with closely monitored subsidiary banks
cr leveraging nonbanking subsidiaries had been inspected.
4-49

Interagency coordination
The agencies exchanged information on holding company
matters at both headquarters and regional levels. FDIC
and CCC provided the FRBs with copies of their examination
reports on banks affiliated with holding companies. The FRBs
gave their holding company inspection reports to FDIC and
OCC.
A March 1975 bulletin requires OCC regional offices to
promptly notify, in writing, the appropriate FRB whenever
their examination reveals an unsatisfactory or deteriorating
condition in a bank affiliated with a holding company. FRB
officials said they usually received oral but not written
notices from OCC of significant bank problems.
FDIC examiners can inspect parent holding companies
of State nonmember banks. Such inspections, however, are
not often made.
Holding companies are also inspected by OCC personnel,
who arte authorized to review the operations and condition
of organizations connected with national banks. OCC examiners
can inspect parent holding companies and nonbank affiliates
in conjunction with bank examinations when they need to
consider the interaction which occurs. However, an OCC
official said such inspections are rare.
T.le agencies did not normally conduct simul'aneous holding company inspections and bank examinations, even when the
main subsidiary of the holding company was a national or
State nonmember bank.
Conclusions
For the cases we reviewed, the FRS holding company surveillance by financial analysis and limited onsite inspection did not discover problems in the holding companies or
their nonbanking subsidiaries before those problems affected
the affiliate& banks. FRS should be attempting to identify
and correct holding company problems before the banks are
affected. And we believe that more frequent indepth inspections of holding companies would enable FRS to do so.

4-50

Because it has provided no systematic procedural guidelines or standard inspection report and does not evaluate
holding company inspection units, the Reserve board cannot
be sure that holding companies are effectively and consistently supervised.
We consider the exchange of information among the
agencies especially important to the supervision of bank
holding companies. The problems encountered by holding
companies and their nonbank subsidiaries could threaten
the soundness of affiliated banks and vice versa; thus,
the appropriate supervisory agency should be aware of any
problems. We believe that the channels of communication
shiould be as formal as possible and that information should
be exchanged regularly. Also, we see some merit in the possibilities of simultaneously inspecting holding companies
and examining their subsidiaries--which would require
greater interagency coordination and cooperation than now
exists. (See ch. 11.)
Recommendation
We recommend that the Board of Governors, FRS, implement
a system of supervision which is based on onsite inspections
of holding companies and their major nonbanking subsidiaries.
We also recommend that the Board strengthen its oversight
of Reserve banks' holding company supervision by establishing
-- a systemwide manual of inspectior
--;

procedures,

standard inspection report, and

-- periodic onsite evaluations of Reserve bank supervisory activities.
Agency comments
FRS said:
"The System has for some time condjcted on-site inspections of selected holding companies. Partly as
a result of these inspections and problems which
came to its attention, the Board in late 1974 requested and was granted 'egislative authority to
impose the same supervisory remedies on holding companies that were applicable to banks under the Financial Institutions Supervisory Act of 1966. In
early 1976, the Board directed that this inspection
4-51

program be significantly expanded with initial
efforts directed toward holding companies requiring
special supervisory attention.
"In addition, in 1975 the Board commenced work on
a computer based monitoring system in order to
identify those holding companies which might
require special attention. This program is partially operational at the present time and is expected
to be fully operable within the next few months.
"A manua&. of inspection procedures is currently
under development. However, completion of such
a manual has of necessity awaited experience
gained from the direct on-site inspections whi.h
have been caLried out. We believe that the
recommendations relating to a standardized inspection report as well as periodic on-site evaluations
of Reserve Banks supervisory activities warrant
further consideration. We might note that the
initial steps to set up such periodic evaluations
already have been commenced by the Board.
"While we see no difficulty with the thrust of the
recommendations, the Board is concerned that the
method used in the GAO report may lead to unwarrarted fears as to the general health of bank
holding companies. The sample chosen was one in
which problem banks were at least six time more
likely to occur than in the industry as a whole.
A sample biased toward problem banks is naturally
biased toward problem holding companies."

4-52

CHAPTER 5
BANK PROBLEMS IDENTIFIED BY EXAMINATIONS
Page
Overview

5- 1

What problems did examinations disclose?

5- 3

What types of problems cause the agencies to put
banks on the problem list?

5- 3

Do examiners find the same problems in large and
small banks?

5- 5

Do the agencies generally identify the same types
of problems?

5- 6

Do examiners criticize the causes of problems?

5- 8

Are insider and out-of-territory loans significant problems in banks?

5-10

What violations of laws and regulations are found
by examiners?

5-10

What problems do holding companies cause in banks?

5-12

What problems were found in banks' international
operations?

5-13

CHAPTER 5
BANK PROBLEMS IDENTIFIED BY EXAMINATIONS

OVERVIEW
Examiners found problems in nearly all of the
banks
in our samples including those not on the agencies'
problem
lists. The most frequently found problems were
similar
among the banks in our general and problem samples.
The
degree of severity for problems related to loan
concentrations, liquidity, loan policy, and capital adequacy
differed dramatically between problem banks and
banks
in
general. Also, banks with liquidity, loan collateral,
management or insider loan problems--whether
not--in addition to more common problems were severe or
likely to
be problem banks.
Banks of different sizes had different problems.
Large banks were more often criticiz(
for problems related
to the character of their busiress (classified
sive real estate holdings) whercas smaller banksloans, exceswere most
often criticized for problems related to prccedures
operations (inadequate credit files, poor collection and
procedures).
For banks in general and, to a lesser degree,
for
problem banks, FDIC examiners cited problems
more often
than FRS or OCC examiners.
Surprisingly, far fewer banks were
for ineffective management than were criticized for cited
the related problems of inadequate internal routines and controls
and
violations of laws and regulations:
-- Four percent of the banks in general were cited
for ineffective management; 55 percent, for
lations of lawis and regulations though some vioof
these are of a technical nature and did not
impair the soundness of the banks; and 44 percent,
for inadequate rountines and controls.

5-1

-- Sixteen percent of the problem banks were cited
for ineffective management; 81 percent, for
violations of laws and regulations; and 55
percent, for inadequate routines and controls.
The agencies rarely criticized a bank's loan policies until loan problems developed. For example, if a
bank's managers had not adequately diversified the bank's
risks, examiners did not criticize the inadequate diversilication policy until those lines of credit actually
became classified. Insider ani ^'mt-of-territory lending
for banks in our
were not frequently mentioned proble:;,
samples,

5-2

WHAT PROBLEMS DID EXAMINATIONS DISCLOSE?
Examiners found some type of problem in virtually
all banks in our samples. The types and severity of problems
varied from bank to bank and among various groups of banks.
In the most recent reports of examination for the 600 banks
in our general sample, examiners cited the problems listc-3
below for at least 10 percent of the banks.
Percent of
sample banks
Classified loans
Violations of laws and regulations
Inadequate routines and controls
Overdue loans
Inadequate credit files
Inadequate capital
Concentration of credit
Loan collection procedures
Classified assets
Inadequate loan policy
Excessive real estate holdings

70
55
44
35
32
21
21
15
14
12
12

Over half of the frequently cited problems involved
the banks' loan quality and credit procedures. Examiners
stated that 61 percent of the problems with overdue loans
and 49 percent of the problems with classified loans
were severe. They also stated that no more than 25 percent
of the other problems were severe in the cases in which
they were cited.
WHAT TYPES OF PROBLEMS CAUSE THE
AGENCIES TO PUT BANKS ON THE PROBLEM LIST?
As shown by the following chart, the problems found in
10 percent or more of the problem banks closely resembled
those cited for banks in general.

5-3

Percent of
sample banks
(note a)
Classified loans
Violations of laws and regulations
Overdue loans
Inadequate credit files
Inadequate routines and controls
Inadequate capital
Inadequate loan policy
Loan collection procedures
Liquidity
Concentration of credit
Classified assets
Inadequate collateral documentation
Excessive rezV estate holdings
Management effectiveness
Insider loans

96
81
65
57
55
53
53
40
40
31
28
27
20
16
11

a/Based on information in second earliest reports of examination for those banks selected from lists of problem banks
as of December 31, 1975.
These problems were cited for a larger portion of

the problem banks than the banks in general. Seven problems were cited for over 50 percent of the problem banks;
whereas, two problems were cited for more than lalf the
general sample. Therefore, the number of problc J found
in a bank is related to whether it receives sr cial
supervisory attention.
To a lesser extent, the type of problems found in
problem banks were different than those of banks in general.
In addition to the problems cited above, inadequate liquidity,
inadequate collateral documentation, ineffective management,
and excessive insider loans were criticized in at least
10 percent of the problem banks. No problems were cited
in at least 10 percent of general sample banks which were
not also cited for problem sample banks.
Using the examiners' descriptions of the problems
in the examination reports, we ranked the apparent severity
of the problems. Except for violations of laws and regulations, internal routines and controls, real estate holdings,
and collateral for loans, the examiners clearly cited problem

5-4

banks' problems as being severe more often than those of
banks in general. As shown below, the difference in severity
for certain problems between banks in general and problem
banks is quite dramatic.
Percent of banks with problem
described as severe
Banks
in
Problem
general
banks
(nte
a)
(note b)
(n
Concentration of credit
Loan collection procedures
Classified assets
Inadequate loan policy
Liquidity
Inadequate capital

20
25
25
23
16
22

70
51
58
61
61
57

a/ Based on information in the most recent reports of
examination for banks in our general sample.
b/ Based on information in the second earliest reports
of examination for those banks selected from lists
of problem banks as of December 31, 1975.
Banks with severe problems in these areas were more
likely to be considered problem banks than banks cited
for other problems, such as violations of laws and regulations.
DO EXAMINERS FIND THE SAME
PROBLEMS IN LARGE AND SMALL BANKS?
Problems varied among banks of different sizes. As
shown below, problems related to the nature of the bank's
business, such as classified loans, classified assets,
and inadequate capital were more often cited 'or large banks
than small. The problems most often cited for small banks
were generally related to policies and procedures.

5-5

Deposits (000,000 omitted)
Over
500 to--- $100 to Under

$1000

$500

$100

Percent of general sample-anks
Nature of business:
Classified loans
Inadequate capital
Classified assets
Excessive real estate holdings
Concentration of credit
Overdue loans
Policies and procedures:
Inadequate loan policy
Violations of laws and
regulations
Inadequate routines and
controls
Loan collection procedures
Inadequate credit files

93
31
22
18
17
30

77
19
22
19
23
46

73
21
14
15
17
34

59
18
9
7
23
34

28
7
9

35
14
20

41
14
27

54
1R
47

DO THE AGENCIES GENERALLY
IDENTIFY THE SAME TYPES OF PROBLEM?
As shown below, FDIC examiners reported more problems
to the banks than FRS examiners, who reported rmore than OCC
examiners.
Percent of general
sample banks with problem
FDIC
Classified loans
Violations of laws and
regulations
Inadequate routines and
controls
Overdue loans
Inadequate credit files
Inadequate capital
Concentration of credit
Loan collection procedures
Classified assets
Inadequate loan policy
Excessive real estate
holdings
5-6

FRS

OCC

65
39
47
24
37
20
18
21

47
39
30
25
17
13
13
8

20
27
20
14
8
11
11
8

Some of the disparity between FDIC and the other two
is no doubt due to the fact that the problems most frequently
cited are most often found in small banks, which are mainly
examined by FDIC. But FDIC examiners also cited more often
the problems found usually in larger banks--classified
loans and classified assets. The only exception to this
is inadequate capital--FRS examiners cite this problem
slightly more often.
The agencies often found problems which they disclosed
only in a report "confidential section" not given to the
banks. OCC examiners generally discussed problems more
often in the confidential sections than the examiner's
comments sections. This could explain the disparity between
OCC and the other agencies. However, a bank does not benefit
from a discussion of its problems in a report section it
does not see.
(See ch. 6.)
The agencies identified problems in problem banks with
the same order of frequency, but the differences among agencies were smaller.
OCC cited some problems relatively more frequently,
like liquidity or inadequate credit files.
Percent of problem
sample banks with problem

Classified loans
Violations of laws and
regulations
CTerdue loans
Inadequate credit riles
Inadequate routines and
controls
Inadequate capital
Inadequate loan policy
Loan collection procedures
Liquidity
Concentration of credit
Classified assets
Inadequate collateral
documentation
Excessive real estate
holdings
Management effectiveness
Insider loans

FDIC

FRS

OCC

91
76
54

68
53
63

80
64
56

67
61
80

60
60
48

38
38
28

54
37
46
37

40
30
15
28

24
50
26
18

31
26
22

18
10
5

10
10
4

5-7

DO EXAMINERS CRITICIZE
THE CAUSES OF PROBLEM?
While the examiners frequently cited banks for
problems in two areas of management--internal controls
and compliance with laws and regulations--they did
not often criticize management effectiveness. As
shown below, management was most often criticized
in problem banks with less than $500 million in deposits,
even though 51 percent of larger banks in the general
and problem samples were also criticized for violations
and 32 percent were criticized for inadequate internal
routines and controls.

Bank deposit size

Percent of sampled banks
with management problems
Banks in general
Problem banks
FDIC
FRS
OCC
FDIC FRS OCC

(000,000 omitted)
Over
$500

$1,000
to $1,000

$100 to
Under

$500
$100

9
-

5
6

5
4

2
3

4
5

23
28

11
14

25
11

a/ No bank in our sample of problem banks at FDIC had
deposits of over $1 billion.
As we noted in our study of failed banks (see ch. 9)
poor management policies caused the problems that led to
the failures. These problems included concentration of
credit, inadequate credit information, and poor loan collection procedures. As shown on the previous page, similar
problems were found by examiners in problem banks. But
the examiners often did not criticize a banks' policies
until the problems had already developed. For example,
inadequate loan policies were not cited by examiners
unless the banks had classified loan problems, as shown
by data for banks cited for either problem in our general
and problem samples combined:

5-8

Percent of banks cited for

Agency

Bank deposit
size

Number
of
banks

Only loan
policy
poblem_

Both
policy
and
quality
p-oblem

Only loan
quality
_roblem

(000,000 omitted)
FDIC

Over
$1,000
$500 to $1,000
$100 to
$500
Under
$100

3
18
53
146

FRS

Over
$1,000
$500 to $1,000
$100 to
$500
Under
$100

OCC

Over
$1,000
$500 to $1,000
$100 to
$500
Under
$100

22
40
38

100
78
60
60

28
18
73
57

11
17
16
28

89
83
84
70

63
29
34
44

4
5

16
10
9
25

84
86
91
70

ARE INSIDER AND OUT-OF-TERRITORY
LOANS SIGNIFICANT PROB
LEMS
IN BANKS?
Two kinds of bank problems--insider loans and out-ofterritory loans--are of particular concern because they
are commonly found in banks that failed.
(See ch. 9.)
An
insider loan may be described as direct or indirect credit
to a bank officer, director, major shareholder, or his
interests.
These loans are not necessarily improper or
detrimental to a bank, but they may be if abused. Out-ofterritory loans are those made to borrowers outside a
bank's normal trade area. This is a greater problem for
small banks because they cannot properly service loans to
such borrowers.
The examiners criticized the banks for excessive
"insider lending" in 3 percent of our general sample
and 11 percent of our problem sample.

5-9

Loans were considered to be "out of territory" when
the borrower was located outside of the bank's normal
trading area. Many banks, especially medium-sized or
small ones, were unable to maintain adequate contact
with borrowers outside of their trading areas--which could
make collection difficult. Also, such loans could have
been riskier than most, since borrowers with good credit
could have obtained the loans from banks in their own
localities. When out-of-territory lending was cited
as a problem, it was usually for banks with deposits
under $100 million.
WHAT VIOLATIONS OF LAWS AND
REGULATIONS ARE FOUND BY EXAMINERS?
Banking laws and regulations are an essential element
of the regulatory system. They protect depositors,
customers, investors, creditors, and the public by establishing th Boundaries of banking activities. Violations
gulations reflect management's capability.
of laws anu
Some laws ard regulations are complex, and violating
some technical provisions of them does not affect the
soundness of a bank. Other types of violations, such as
exceeding a bank's legal lending limit could result in
lesses to the bank.
The laws and regulations enforced through examinations
pertained to lending practices; investments in securities
and real estate; dividends; activities of directors,
officers, and employees; deposits and interest rates;
stock registration; affiliations; and bank security.
The examiners cited violations as a problem for
60 percent of the banks in our samples. Reports most
frequently mentioned the violations of the laws and
regulations listed below.

5-10

Percent of banks in which
violations were cited _b
FDIC
FRS
OCC
G
P
G
P
G
P

Area of violation

(General (G) and Problem (P) samples)
Extensions of credit:
Excessive
To insiders
To affiliates
Collateral:
Loans
Securities
Securities acquired
Real estate acquired
other than premises
Amount of borrowings
State laws:
Lending
Others
Interest rate ceiling
Reporting requirements
Bank premises
Interlocking directorate
Dividends
International operations
External crimes
Consumer credit (regulation B)
Truth in lending (regulation Z)
Note:

29
16
8

54
28
22

6
6
7

23
10
10

16
11
10

72
18
28

18
16
7

39
26
7

3
5

10
5
5

4
3
5

10
4
4

3
-

4
2

1
1

13
1

4
2

4
27
3
1
2
25
3
29

6
26
4
2
2
7
4
24

20
9
15
1
8
1
2
2
8
1
17

23
13
23
3
8
3
5
3
23

1
4
1
2
1
1
1
14

2
20
8
16

National banks and State-chartered banks are not
subject to all of the same laws 2nd regulations.

For all three agencies, more problem banks were cited
for violations of laws or noncompliance with regulations
than were general sample banks. However, the more prevalent
violations were nearly the same for general and problem
sample banks in FDIC and OCC. For example, 4 of the 5
laws and regulations cited for 10 percent or more of
the general sample national banks were also cited for
10 percent or more of the problem national banks. Only
3 laws or regulations were violated by 10 percent or
more of the general sample State member banks--8
laws and regulations were cited for 10 percent or more
of the problem sample banks.

5-11

WHAT PROBLEMS DO HOLDING
COMPANIES CAUSE IN BANKS?
Our sample of commercial banks included 344 that were
affiliated with 279 holding companies. Bank examiners noted
that 72 of these banks had problems resulting from their
affiliation. We reviewed the examination reports on these
banks. In 50 cases, holding company management was not the
primary cause of the problems but neither was it a source
of strength. Twenty holding companies had either caused
serious problems or had contributed to existing problems
in the remaining 22 banks. (See ch. 4.)
Bank problems caused by their holding companies are
shown below:
Banks affected
Percent
Number

Type of Problem
Impaired bank liquidity because of excess
management fees or dividends paid to
holding company
High volume of low-quality loans made at
insistence of holding companies
Bank profit decrease
Improper control by holding company over
operations or services of the bank
Overall negative effect on the bank
Violations of laws and regulations
Excessive purchase of assets at insistence
of holding companies

5-12

10
7

45
32

7
7
6

32
32
27

WHAT PROBLEMS WERE FOUND IN
BANKS' INTERNATIONAL OPERATIONS?
We reviewed examination reports for 18 national banks
and 12 State member banks which had substantial international operations. The examiners cited the following problems
related to international operations:
Banks with problem
Number
Percent
Loans:
High percentage of classified
international loans
Poor credit files
Large concentrations
Poor loan analysis
Inadequate information on affiliate
investments
Inadequate information on branch credit

9
3
3
1

30
10
10
3

1
1

3
3

Foreign exchange operations:
Poor internal controls
Lack or violation of net open position
Lack of customer exposure limits
Lack of well-defined policies

5
2
2
1

17
7
7
3

Management:
Poor overall internal controls
Violations of laws and regulations

6
4

20
13

Also, in the latest reports of examination, these
banks were reported as having a total of $80.5 billion
in loans to foreign governments, businesses, and individuals. The examiners had classified 3.7 percent of these
loans as substandard, 0.4 percent as doubtful, and 0.1
percent as loss. Seven percent were "specially mentioned."

5-13

CHAPTER 6
REPORTING PRACTICES: 1971-75
Page
Overview
Discussion of examination results
with bank management
Conclusion
Recommendation
Agency comments

6-1
6-3
6-4
6-5
6-5

Bank ratings

6-8

The report of examination
Conclusion
Recommendation
Agency comments

6-10
6-12
6-13
6-13

Report processing
Regional report review
Headquarters review

6-14
6-14
6-15

Interagency report exchange

6-15

CHAPTER 6
REPORTING PRACTICES:

1971-75

OVERVIEW
The success of the supervisory process depends heavily
on how examination results are disclosed to those responsible for correcting problems--the bank's board of directors.
While the agencies' examiners discussed the results of their
work with bank managers during and after the examination,
the agencies generally did not meet with boards of directors.
Examiners or agency officials met with the boards of directors of less than 10 percent (FDIC 1 percent; FRS 9 percent; OCC 6 percent) of the general sample banks after
examinations conducted in 1974 or 1975.
Even when the banks
had major problems, the examiners met with the boards of
directors in only dbout half of the cases. After the second
most recent examination we reviewed, FDIC representatives
met with the boards of directors of 30 percent of the banks
in our sample of problem banks; FRS representatives with
53 percent; and OCC representatives with 54 percent.
We
believe that the agencies should always discuss the results
of their examinations with the boards of directors or the
directors' audit or examining committees.
The agencies :ated each bank after each examination.
Although the rating systems used were mechanically different, they considered the same basic factors and were
subjective.
Generally, these ratings were not disclosed
to the banks and were important only as internal shorthand
ways of referring to the condition of individual banks.
The agencies prepared reports of examination which were
sent to the examined banks' boards of directors and to
agency headquarters.
The reports were organized differently
but contained the same basic information.
The problems
noted during the examination were presented in a summary
section which was given to the bank.
Detailed schedules,
analyses, and listing contained in the "body" of the report
were also given to the bank.
This section
-- supported
clusions,

the examiner's criticisms and con-

-- documented some of their work,

6-1

and

-- communicated some of the bank's financial data to
agency officials.
The examination reports also had a "confidential"
section which bank personnel did not see. Here, the examiner
expressed his or her opinions on the bank's financial
condition and management quality. This section was a major
medium for communications between the examiner and agency
management about a specific bank.
The agencies' reports of examination were not effectively communicating the examination results to the banks,
because:
-- Many problems and criticisms were stated in the
confidential sections but not disclosed in the
in
sections given to the banks. For example
three consecutive reports of examination for one
bank, the examiner criticized the bank's capital
position in the confidential sections only.
--Much of the information reported originated from
the banks and was included to document the
examiners' work rather than to inform the banks.
The reports provided the banks with their own
balance sheets, income and expense data, deposit
trends, and real estate holdings.
-- The examiners generally did not recommend how the
banks could correct the problems. For 63 percent
of the problems noted in banks in our problem
samples, the examiners did not recommend corrective
actions. In some instances, the required corrective
action would have been obvious to the bank.
The reports of examination should tell the banks, in
a concise and straightforward fashion, the results of the
examination and recommendations for corrective action.

6-2

DISCUSSION OF EXAMINATION RESULTS WITH BANK MANAGEMENT

During and after the examination, the examiners
were expected to discuss their findings with bank managers;
loan classifications, in particular, were to be discussed
in detail.
In a few instances, the banks were given preliminary written report results. The FRB of Philadelphia examiners, for example, gave large banks in their district a
"minireport," containing examiner's comments and 'oan writeups, when the examiner left the bank.
Although specific duties, responsibilities, and liabilities vary from State to State, generally bank directors
are required to be fully aware of the bank's policies,
operations, and condition. They are supposed to apply ordinary care and prudence in administering the bank's affairs,
and they may be liable for any resulting losses if they do
not. Thus, the results of an examination should be important
to the board of directors, and the supervisory agencies
should be doing their utmost to communicate the examination
results to the directors.
Another indication of the board of directors' ultimate
responsibility for the bank is that about half of the States
require some form of directors' audit or examination. While
the actual work might be done by an independent accounting
firm, many boards have established audit or examining
committees to insure that their examining responsibility
is met.
The agencies routinely send copies of examination
reports to the oanks' boards of directors, but they did not
require their examiners or regional officials to meet with
each banks' board of directors after each examination. As
shown by the following chart, the agencies rarely met with
the boards of directors of banks in general and very often
did not meet with those of banks with major problems.
(Cases 1, 2, 3, 4, and 5 in ch. 8 illustrate the agencies'
practices with regard to meeting with directors.)

6-3

Agency
FDIC
FRS
OCC

Percent of banks in which
agencies met with directors
Bagns in general
Problem banks
tnote
.
(note E-1
9
6

30
53
54

a/ Based on actions taken aftt-.
of examination.

the earliest reports

b/ Based on actions taken after the second most recent
examination for sample of problem banks as of December
311 1975.
Both FDIC and FRS have a general policy of meeting
with boards of directors of all problem banks. Officials
of one FRB, however, had a policy of meeting with the board
of directors of each examined bank and believed that this
practice reduced the incidence of serious problems. In
January 1976, OCC instituted a policy of meeting with the
board of directors of every national bank each year.
Conclusion
One factor common to many bank failures was the lack
of oversight exercised by the banks' boards of directors.
(See ch. 9.)
The agencies can at least insure that the
directors have the information needed for exercising the
proper degree of oversight by informing them of the results
of each examination.
We believe that tne report of examination should not be
the only method by which examination results are disclosed
to the bank. The agencies should also meet with the banks'
boards of directors or audit or examining committees after
each examination irrespective of the nature of their findings to
-- emphasize to the bank the importance of the
examination and the agency's concern for its
well-being.
--insure that the boards, which are ultimately
responsible for the bank's operations, are fully
aware of the examination results.

6-4

-- discuss findings,
-- establish closer working relationships with
the boards, and
-- enhance the stature of the examiners.
Perhaps, it wo-ld be appropriate to provide the examiners with some instruction on how to conduct the meetings.
Recommendation
Therefore, we recommend that the Board of Directors,
FDIC, and the Board of Governors, FRS require their
examiners to meet with the bank's board of directors or
audit or examining committee after each examination.
Agencycomments
FDIC said:
"FDIC conducted approximately 7,900 examinations
in 1975.
Senior officials from the various Regional
Offices met with bank management on approximately
1,750 occasions, representing 22% of all examinations.
Throughout 1975, there was an average of 224 banks
under our supervision which were formally designated
as financial problems. FDIC policy is to meet with
bank directors at least where problem situations
exist.
"FDIC staff has in the past year been considering
the question of how often meetings with bank di.rectors should be held.
In consideration of this
subject, the responsibilities of bank directors,
the Corporation's responsibility to bank directors,
and our past and present practices in holding
board meetings were weighed.
"In a broad sense, the board of directors of a
bank is responsible for the formulation of sound
policies and objectives of a bank. the effective
supervision of its affairs, and promotion of its
welfare.
In discharging these responsibilities,
a director's duty is to exercise due care or be

6-5

exposed to a charge of negligent performance of his
duty. To insure that bank directors are aware of the
contents of examination reports the Corporation requires
that a receipt accompanying each report be signed by
the bank's executive officer stating that the report
"...was duly considered by the directors...and a record
of the action taken thereon by the Board has been entered in the minutes." Moreover, at each examination, the
examiner is charged with the responsibility of determining that the bank's board minutes reflect a thorough
consideration of examination reports and correspondence
received from supervisory authorities since the last
examination.
"To enable bank managements to begin work on problem
areas prior to receipt of the completed examination
report, a list of adversely classified assets and
other major criticisms is provided to, the executive
officer at the completion of each examination and most
of the FDIC Regional Offices have implemented deadlines
fox receipt of completed examination reports in the
Regional Office--usually 10 calendar days after the
close of the examination.
"The FDIC Manual of Examination Policies states, with
respect to examiners holding meetings with directors
(Section Q, page 3, paragraph I.E.):
"Except in instances where authority has been
delegated by the Regional Director, the Examiner
should consult with the Regional Office before
calling a board meeting. Ordinarily, meetings
with the board of directors should be held at
the conclusion of all examinations of problem
banks. A meeting of the board may also be required when experience and instinct tells the
Examiner a likelihood exists that the bank will
be added to the problem list or will be earmarked
for other special supervision. Additionally,
where there is a substantial volume of classified
assets, low capit l or other areas of important
criticism, a board meeting may be desirable. This
is particularly true when the trend has been
unfavorable and previous admonitions have
gone unheeded."

6-6

"In keeping with this policy, it is in fact the
practice in most regions for the examiner to
hold a meeting with bank directors if problems
of consequence are found at the examination,
or if significant adverse trends are noted
since the last examination. In virtually all
instances involving problem banks, a representative from the Regional Office will meet
with the directors, and in most cases an invi-

tation is extended to the state aut'ority to
participate in the meeting.
"The FDIC is cognizant of the benefits flowing
from more frequent meetings with the boards
of directors of banks under our direct supervision and anticipates holding such meetings
with increased frequency in the future. We
are also actively reviewing the posture of the
FDIC in this regard with a view of improving
upon the Limeliness and conduct of such meetings."
FRI; stated:

"The System has for many years been concerned
that the board of directors be particularly
aware of the results of an examination. Thus,
the System has historizcilly required that the
examination report be considered and discussed
at a meetin- of the board of directors. To
insure that this is done, directors are required
to sign a statement attached to the report that
it has been so read and considered. Further,
examiners are instructed to review the minutes
of board of director meetings to insure that
the spirit of these requirements has been
fully carried out.
"With respect to meetings, the Board in 1975
directed that an earlier existing policy for
most of the System be expanded to all Reserve
Banks. This policy requires that Reserve Bank
staff meet with the board of directors
of all so-called problem banks. The Board
believes that such meetings are important
where significant problems are revealed."

6-7

BANK RATINGS
The supervisory agencies developed systems to rate
banks on financial condition and management quality. The
ratings were used only by the agencies as a shorthand for
describing a bank's condition and were generally not disclosed to the banks. A rating was an indicator of the need
for supervisory attention, but not the sole determinant
of whether or not a bank was designated to receive special
supervision. (See ch. 8.)
At FDIC the examiners-in-charge rated banks. At FRBs,
ratings were assigned by the examiners-in-charge or the
review examiners, the chief examiners or the vice presidents, depending on the FRB. At OCC, the regional administrators assigned the ratings.
The ratings were based upon information developed during the examinations and were combinations of specific
ratios and judgment.
The agencies used different systems to rate banks, but
they considered the same basic factors:
asset quality,
capital adequacy, and management quality. FDIC also considered the adequacy of the bank's earnings.
The FDIC rating

included the rdtios of

-- adjusted capital and reserves to adjusted gross
assets,
-- net capital and reserves to adjusted gross assets,
and
-- net earnings to average gross assets.
The FDIC rating also included the examiner's judgment of the
bank's management as good, satisfactory, fair, unsatisfactory, or poor.
The rating system used by all FRBs had four elements:
--a rating of capital position (1, I, 2, 3 or 4),
--a rating of asset quality (A, B, C or D),
-- a rating for management (S, F, or P), and

6-8

-- a composite rating (1, 2, 3 or 4) of those three
factors.
Although the rating system employed several ratios and
some thresholds, judgment was again e major component.
OCC's rating system included an overall rating of the
bank, ranging from "1" to "4"--"1" being the best.
In addition, the bank was rated for capital position, quality of
assets, and management. The best rating indicated that the
bank was sound in every respect. A "2" rating was given to
banks with "relatively moderate to moderately severe" asset
weaknesses, which had insufficient capital, unsatisfactory
management, or a combination of problems and weaknesses.
A "3" rating was given to banks with "an immoderate volume
of asset weaknesses" which, when combined with other factors, could have developed into "a situation urgently
reguiring aid either from the shareholders or otherwise."
A 4" rating was given to banks whose failure, if aid was
not provided, appeared "probable." The ratings for capital
position and asset quality were based on specific ratios
coupled with the regional administrator's judgment. Management ratings were based on the judgment of the regional
administrator rather than on established criteria.
The following chart summarizes the composite ratings
received by the banks in our general sample as a result of
their most recent examinations.

6-9

Percent of banks

recelv-----in
Agency
(note a)
FRS
OCC

1
52
46

rang- f

37
34

10
19

1
1

a/ As explained on page 6-8, FDIC does not develop an overall rating for a bank. However, FDIC uses a problem designation system which designates banks as "other problem,"
"serious problem," and "serious problem potential payoff."
(See ch. 8.) Five percent of the FDIC banks in our general
sample were designated as one of these.
While about half of the banks received a rating of "1", our
analysis of ratings for these banks after previous examinations shows a decrease in "1" rated banks and increases in
"2", "3", and "4" rated banks.
THE REPORT OF EXAMINATION
The report of examination had three distinct parts:
1.

The "examiner's comments" or "summary."

The "body."

The "confidential" section.

The examiner's comments section presented the examination's results and was the primary written communication
from the examiner to the bank. The examiner cited problems
and sometimes suggested actions to resolve them.
However, in the second earliest reports on our sample
of December 31, 1975, problem banks, the agencies' examiners
recommended corrective steps for an average of only 34 percent of the problems they found. FDIC recommended actions
for 37 percent; FRS for 23 percent; and OCC for 39 percent.
In some instances, the required corrective action would have
been obvious to the bank.

6-10

The body, which was the bulk of the examination report,
presented the facts and analyses on which the examiner's
comments were based. Tables, questionnaires, lists, and
some narrative comments were included. This section served
a number of functions:
-- It detailed the results of some examiner analyses.
-- It documented some of the steps followed by the
examiner.
-- It supplied some financial information to the supervising agency.
Although the body section was given to the bank, it
contained information such as the balance sheet and income
and expense data which the bank had furnished to the
examiners.
The confidential section was not provided to the
examined bank.
In addition to some factual material, this
section contained the examiner's more explicit comments
and opinions on the bank's condition, management, ownership,
earnings, growth potential, and progress toward resolving
problems. It was intended as an internal communication from
the examiner to agency management.
The confidential sections of reports we reviewed
contained criticisms which were not noted elsewhere in the
reports. The examiners were more critical of bank management here than they were in the comments section as shown
by the following table, based upon information in the second
earliest reports of examination foL our sample of problem
banks as of December 31, 1975.

Problem or criticism
Inadequate or incompetent management
Inadequate capital
Insufficient liquidity
Earnings

Percent of reports
in which problems were noted in
Confidential
Examiner's comsection
ments section
FDIC FRS -OCC
-FDIC
FR-S -CC
63
43
19
11

6-11

45
63
35
25

60
68
54
26

26
61
37
17

10
60
30
18

10
38
50
8

The following cases illustrate the types of problems
discussed in the confidential section which were not disclosed to the banks. (See also cases 2 and 4 in ch. 8.)
Case 1
For three consecutive examinations, the FDIC examinerin-charge criticized the effectiveness of the bank's management and indicated a severe problem with management dominia-!
tion in the confidential section but not in the examiner's
comments section. The examiner-in-charge criticized the
management's responsiveness to problems in only the confidential section in the most recent report of examination.
Case 2
The FRB examiner-in-charge criticized the bank's
unsatisfactory capital ratios in the confidential sections
of two consecutive reports and indicated that the bank's
capital was inadeguate in the confidential section of the
following report.
Also, in one year the examinerin-charge criticized excessive amounts of real-estate
holdings and a lack or top management in the conriaential
section. None of these criticisms were pointed out in the
examiners comments sections of the reports given to the
bank.
Case 3
The OCC examiner-in-charge criticized the bank's loan
policies in the confidential sections of three consecutive
reports of examination but not in the examiner's comments
section. Also in the second and third reports, the confidential sections contained criticism of costs and expenses,
internal routines and controls, and borrowing frequency
which were not disclosed in the examlner's comments section
of the report given to the bank.
Conclusion
The report of examination was not serving its primary
function as effectively as possible.
We believe that the
report of examination should present clearly and concisely
the results of the examination, the agency's recommendations
for corrective action, and any information necessary to support the examiner's conclusions.
It need not go to great
length to provide information which the bank already h'as.

6-12

If the agency needs additional information for review or
statistical purposes, the report sent to headquarters should
be accompanied by a detailed, structured set of workpapers
and standard data collection forms. (See ch. 4.) Thus, the
bank would not be burdened by a report containing superfluous information, and the agencies would be better able
to review the examiners' work.
OCC is implementing new examination procedures which
will result in a revised report of examination and standard
workpapers.
(See ch. 7.)
Recommendation
We recommend that the Board of Directors, FDIC, and
the Board of Governors, FRS, develop and use reports of
examination which provide the banks with the results of the
examination and any necessary supporting information.
Agency comments
FDIC said:
"FDIC conducted an intensive study in 1965 to assess
the impact of its examination report on banks. As a
result in 1969, a new examination report format was
put into use. We believe this report format, and the
guidelines under which it is used, provides a clear,
concise picture of problem areas to bank managements.
Various FDIC staff members have attended familiarization sessions on the OCC's new examination report
format.
The OCC has tested this new format in only
ten banks and the impression of the FDIC staff members
is that the report format is somewhat cumbersome,
especially in problem situations.
"There appears to be some misunderstanding with respect
to the purpose and thrust of the confidential (supervisory) section of the report of examination.
The
purpose and thrust of the confidential section are to
allow the examiner to comment on matters uncovered during the course of the examination which may not lend
the:nselves to complete substantiation, but which may
serve to alert his superiors that further investigatory
cr supervisory efforts may be necessary.
For obvious
reasons, such material is not, and should not, be provided to the management of the bank. However, a
thorough study of the role and use of the confidential
6-13

section was started some months ago and, when completed,
will probably result in significant changes in its
thrust, format and content, or in its elimination."
FRS said:
"We believe the bank examination report presently provides the banks with the results of an examination and
necef ary supporting information. We also believe it

should provide the System with the information it needs
to carry out its supervisory functions. The present
examination report adequately carries out these needs.
It should not be forgotten that the System also uses
other methods of communicating its views to its member
banks, such as correspondence, informal meetings, and
consultations on applications. Of course, the System
is continually exploring methods of improving
communications."
REPORT PROCESSING
The examiners-in-charge were responsible for drafting
Where and when
and signing the reports of examination.
they drafted the report varied among and within the agencies.
Regional report review
In all three agencies the reports of examination were
reviewed in the regional offices before they were finalized
In
and sent to the banks and the agencies' headquarters.
were
examiners-in-charge
general, the reports drafted by the
support
reviewed for arithmetic accuracy, grammar, logic,
for statements, and internal consistency. Reviewer positions
were filled by senior field examiners either permanently
or on a rotating basis.

6-14

FDIC stated that about 30 days elapsed from the
drafting of an examination report to its transmittal to
the bank and receipt by Corporation headquarters. The
FRBs attempted to send the reports to the banks within
30 days of completing the examination. OCC attempted to
send reports to the banks within 20 days of completing the
examination.
Headquarters review
Each agency headquarters received a copy of each report
of examination. FDIC headquarters staff reviewed the reports, designated certain banks for special attention, and
monitored the supervisory actions taken by the field offices.
At FRS, the headquarters staff reviewed each report but paid
special attention to those banks with composite ratings of 3
or 4 or those rated 2 which, in the reviewer's judgment,
required intensive monitoring. The FRS reviewers would
suggest supervisory action only in those cases where they
believed the FRB's action was inappropriate. OCC headquarters staff primarily reviewed the reports to insure that
banks requiring increased supervision were identified, and
to validate the follow-up activity of the regional offices.
INTERAGENCY REPORT EXCHANGE
Each agency could request any report of another agency.
In addition, FRS provided FDIC with all reports on banks
composite-rated 3 or 4, and OCC provided FRS with all reports and FDIC with all reports on problem banks.
State exchange arrangements varied from region to
region but FDIC and FRS generally provided their reports of
examination to the State banking agencies.

6-15

CHAPTER 7
EFFORTS TO IMPROVE BANK EXAMINATION
Page
Overview

7-1

OCC's new examination approach
Monitoring systems
Commercial examination procedures
Preexamination analysis and review
Detailed examination
Revised examination report
Specialized and special supervisory examinations
Evaluation of large shared loans
Revised trust examination procedures
Revised EDP examination procedures

7-1
7-2
7-4
7-5
7-6
7-10
7-11
7-13
7-14
7-14

Changes in FRS's examination approach
Revised examination procedures
Monitoring systems

7-15
7-15
7-16

Changes in FDIC's examination approach
Frequency of examination
Scope of examination
Monitoring systems
Revised trust examination procedures

7-19
7-19
7-20
7-20
7-22

New approaches to consumer credit compliance
examinations

7-22

Conclusions

7-23

Recommendations

7-25

Agency comments

7-26

CHAPTER 7
EFFORTS TO IMPROVE BANK EXAMINATION
OVERVIEW
The Federal Deposit Insurance Corporation and the
Federal Reserve System recently revised their examination
approaches to give greater priority to examining the weakest
banks and less emphasis to examining relatively trouble-free
banks.
To assist in identifying banks that may have problems, the agencies are expanding their systems to analyze
banks' performance by using financial data that agencies
periodically obtain from the banks.
The Office of the Comptroller of the Currency initiated
development of a new examination approach in the fall of
1975 which also focuses more on banks with problems and less
on trouble-free banks; however, its changes are much more
extensive than those being made by FDIC and FRS. OCC has
developed examination procedures emphasizing early identification of weaknesses in management policies and procedures.
If OCC can influence the banks to rectify these weaknesses
promptly, many of the problems now occurring can be corrected before they seriously threaten the soundness of the
banks. This concept, in our opinion, offers significant benefits over the traditional examination approach which has
been used by the three regulatory agencies.
At the time of our study, the process had only recently
been developed and field tested at 10 banks. Neither we nor
the agency could fully evaluate the practical problems that
may be encountered in implementing the new procedures, such
as the resources needed and the applicability of the process
to all types of banks. Undoubtedly, many practical problems
will be encountered and futher refinement of the process
will be necessary. We believe, however, that these problems
can be worked out as OCC gains additional experience. The
basic concept of the process seems logical and, we believe,
should be pursued jointly by the three supervisory agencies.
OCC'S NEW EXAMINATION APPROACH
In May 1974, Comptroller of the Currency, James E. Smith,
commissioned the public accounting firm of Haskins & Sells
to comprehensively review and evaluate OCC operations--the
first major outside study of the Office since its establishment in 1863. On May 30, 1975, the firm reported to the
7-1

Comptroller numerous recommendations for modifying or
Regarding bank examinations,
extending existing activities.
Haskins & Sells recommended that OCC
-- monitor the financial reports of national banks,
-- require national banks to report financial data more
promptly and in accordance with uniform principles
of accounting and reporting, and
-- modify the examination procedures.
Monitoring systems
To monitor national banks, Haskins & Sells recommended
a system which they called the National Bank Surveillance
The system consists of four basic elements:
System (NBSS).
-- A data-collection system.
--A computer-based monitoring system to detect unusual
or significantly changed circumstances within a bank
and within the national banking system.
-- An evaluation by experienced personnel of the impact
of such changes on bank soundness.
--A review procedure that would provide administrative
controls over all proposed OCC remedial actions.
To implement the recommendation, in September 1975 OCC
established a small staff of experienced OCC examiners and
Information for the NBSS data
Haskins & Sells employees.
of condition (balance sheet
reports
from
was
derived
base
national banks are
which
of
income
data) and reports
FDIC also processes
required to periodically submit to OCC.
(See ch. 11.)
the same data from all banks.
The staff, in implementing the system, generally
followed the concepts set out in Haskins & Sells' report,
and by mid-1976, a limited system, with a 5-year data base,
By
began operation with data reported for March 31, 1976.
although
operational,
fully
was
the
system
1976,
October
OCC plans to add additional data to the system, including
data from its examination reports.
NBSS supplements the new examination procedures by
detecting, each quarter, financial changes in national banks.
7-2

Data produced from the system is to be used to identify
those banks which need priority examination and to provide
statistical data in a usable form to assist the examiners in
evaluating the bank's financial condition.
One computer program provides a statistical profile, or
performance report, of each national bank in comparison with
a profile of its peers.
Another computer program quarterly
summarizes key performance data, and ranks those banks which
are to receive priority review.
For those banks ranked by
the computer as being in greatest need of review, trained
specialists analyze the bank performance reports, looking
for high or low percentile rankings and for short term and
long term trends.
The performance reports contain ratios of
financial data for current and past periods for each bank,
as well as for its peers.
Certain key ratios provide, in
OCC's opinion, the best general measures of unusual or
changed circumstances in a bank that require further investigation.
For example, one ratio monitors changes in the
composition of the loan portfolio.
This ratio is used as an
indicator of changed management emphasis on types of loans
made.
An NBSS specialist who detects unusual or significantly
changed circumstances within a bank, is to report them to
the regional administrator, who may direct any investigations considered necessary--ranging from a telephone call to
the bank to a full, priority examination--to analyze the
impact of the change on the bank's soundness.
In planning bank examirntions, the examiner also uses
the bank performance report to develop an overview of
financial conditions and reslts of bank operations and to
to identify potential problem areas so staff and procedures
can be selected.
NBSS also includes an action control system to monitor
the problems identified to see that they are resolved.
Banks designated for priority review are placed quarterly in
the action control system. Banks cannot be removed from the
system until all problems arc resolved.
For those banks
that remain in the system, reports will be made every
2 weeks showing the progress o- the lack of progress in
resolving their problems.
According to OCC officials, the system will be expanded
to also monitor the actions taken by banks in response to
deficiencies disclosed in examination reports.
During the
7-3

period of our review, OCC should have been more aggressive
in requiring banks to correct problems noted during examinaIn this regard. the use of the action
(See ch. 8.)
tions.
the progress that banks make in
monitor
to
system
control
be a useful tool to the
would
problems
correcting their
agency.
Commercial examination procedures
During the fall of 1975, OCC formed a task force to
revise its commercial examination procedures. The task
force developed more sophisticated, formal, and uniform
procedures for examining banks, incorporating (1) the recommendations of Haskins & Sells, (2) the informal practices of
many examiners ,n the past, and (3) other changes considered
necessary. In the spring of 1976 these procedures were
field-tested in two banks. The'procedures were revised as a
result of the field test, and during July 1976, 4 examiners
from each of the 14 OCC regional offices were instructed on
the revised procedures. These examiners then conducted
pilot examinations of eight banks. Beginning in September
1976, additional bank examinations commenced under the new
approach. The four trained examiners from each region began
in mid-1976 to gradually train other examiners. OCC expects
all its examiners to be using the new procedures by mid-1977.
The new procedures provide for three types of examinations:
General examinations which are broad in scope and
are to be performed once every 2 years at all banks.
S2ecialized examinations which are limited in scope
and are to be performed at all banks twice in each
2-year period.
Special supervisory examinations which are made only
at those- ban- with severe problems necessitating
close supervision.
The limited testing of the new procedures indicates
that the general examinations, at least the initial examination at each bank, will be very time consuming in relation
to the traditional examination. During the 1976-77 cycle,
OCC may not have sufficient staff to make a general examination plus two specialized examinations of all national banks,
in addiuion to the special supervisory examinations of banks
requiring close supervision.
7-4

During 1975, OCC made 6,000 regular commercial examinations and 860 special examinations. The average time required to complete the examination of the test banks was
about three times the amount required to examine the banks
under the traditional method. OCC has not estimated the
resources required by the new procedures. Officials said
that, while some problems will be encountered in meeting
their 1976-77 examination goals, the required examinations
for the 1978-79 cycle can be mat with their existing statf.
They also said that the time required to make the
general examination under the new procedures will decrease
as the examiners become more familiar with the procedures.
Officials pointed out that the second general examination of
a bank will consist largely of updating the workpapers of
the initial examination and will not require as much staff
time. They also stated that the two specialized examinations to be made in each 2--year cycle will not require as
much staff time as the current traditional examination.
The new general examination consists of two separate
phases--the preexamination analysis and review, and the
detailed examination.
Preexamination analysis and review
The preexamination analysis and review ordinarily is to
be performed by the examiner-in-charge and one or two assistants, depending on the size and complexity of the bank, and
is expected to take from 1/2 day to 2 weeks to complete.
Where possible, the review is to be performed at the bank
several weeks in advance of the examination date.
The principal purpose of the preexamination analysis
and review is to determine the scope and objectives of the
general examination. In other words, OCC expects to identify
areas where deficiencies exist and where it should put the
most emphasis. This analysis and review is also intended to
-- familiarize the examiner with the bank's operations,
-- determine staff requirements for the detailed
examination,
-- identify potential problems in applying the
examination procedures,
-- coordinate work schedules with bank management, and
7-5

-- decide which affiliated companies to examine and
how broadly to cover them.
This phase of the e: mination process consists of
obtaining basic data about the bank's policies, procedures,
controls, and internal and external audit activities. The
data is evaluated and the scope of the general examination
is defined, including the extent of examination and verification procedures to be performed during the detailed examination.
If the examiners find that the conclusions reached
during the preexamination analysis and review phases were
incorrect they may revise the scope during the general
examination.
The work performed during the preexamination analysis
and review includes
-- reviewing prior examination reports and applicable
working papers,
-- analyzing bank financial data as shown on the NBSS
report, including any comments or analysis by NBSS
specialists,
-- completing an internal control questionnaire,
-- reviewing the bank's audit functions,
-- completing an examination planning and control
questionnaire, and
-- reviewing minutes of board of directors and
committee meetings.
This phase of the work is intended to tailor the work
programs for the general examination to the bank being
examined and at the same time to provide for consistent examinations whose scope is dictated by the bank's condition and
not by the examiner's judgment alone.
Detailed examination
The basic task of the detailed examination is to complete the work programs, with any adjustments that become
necessary during the course of the examilnation; to reach a
conclusion on the overall condition of the bank, present and
prospective; and to develop recommendations for correcting
deficiencies.
7-6

In our view, the most important facet of the new examination procedures is that they will center more on the
underlying causes of problems rather than on the results of
operations. Poor results are visible in bad loans, concentrations of credits, excessive insider loans, risky in-estments, inadequate capital, inadequate liquidity, violations
of laws, etc. The traditional examination has focused on
identifying these types of problems.
(See ch. 4.)
The agencies have previously made little use of a
formal or structured approach to examining those elements of
bank activities that cause problems. The extent of examination ci bank policies, practices; procedures and controls

was largevly left to the discretion of the examiner, and
according to agency officials, time restrictions often
caused examination efforts in these areas to be minimal or
superficial. While the new procedures still provide for
examining the end results of operations, they place much
more emphasis on identifying conditions which, if not corrected, could lead to poor results.
OCC has developed a comprehensive handbook, a standard
internal control questionnaire, and sets of examination and
verification procedures for specific asset and liability accounts and for particular banking and examining activities.
According to OCC officials, many examiners had developed
their own informal examination procedures, which differed
from examiner to examiner and from bank to bank. To a large
extent, the new examination procedures represent a composite
of these informal procedures.
The new approach provides greater assurance that indepth
analysis of policies, practices, procedures, and controls is
made during each examination. Additionally, it provides
documentation of examinatior pro cedures followed, tests performed, information obtained, and conclusions reached. This
documentation can assist the examiner-in-charge in judging
the overall condition of the bank and in planning subsequent
examinations.
In essence, OCC will be looking at how well banks are
managing themselves from day to day. Where weaknesses are
found in bank management, OCC will be recommending changes
in bank policies, practices, controls, and audit to a much
greater extent than previously. While the objective of the
new procedures is to identify weaknesses in bank management
which could lead to such problems as bad or risky loans and
investments, and liquidity and capital deficiencies, it can
7-.7

also help to reduce fraud--sometimes a cause of bank failure.
(See ch. 9.) Although fraud detection is not one of the
primary objectives of the new procedures, early correction
of weaknesses in policies, procedures, controls, and audit
activities may reduce the opportunity for fraud or allow it
to be discovered before the bank's condition is seriously
impaired.
The contrast between the old and new approaches can be
seen by comparing the examination reports of the 10 banks
that were examined using the new procedures with prior
reports for the same banks that were prepared under the old
approach. Numerous weaknesses in managerial practices and
controls were discussed in the new reports which apparently
had existed for a long time but had not been identified in
the prior reports. The following examples, in our opinion,
illustrate the contrast in the examination approaches.
Case 1
The new report on one of the test banks depicted the
condition of the bank as unsatisfactory because of the
amount of classified assets.
The report attributed this condition to poor, unwritten, or nonexistent lending policies.
The report stated that
"* * * the bulk of criticized items have orgina-

tion [sic] dates in the 1972 to 1974 period and
many reflected weaknesses at inception, particularly with respect to financial support, establishment of valid repayment sources, documentation
and collateral, and these deficiencies have become
especially pronounced during this period of economic strain. Those granted in the 1975-forward
period which are listed in this report often
exhibit the same deficiencies which can be traced
primarily to the absence of a sound lending policy,
thus allowing for the continuing extension of
credit without defined and approved guidelines."
The report pointed out that a lending policy was being
drafted by the bank and suggested that the bank establish an
internal loan review department.
The three prior examination reports on this bank, prepared under the traditional approach, criticized the volume
of classified assets but did not criticize the bank's lending policies or controls. In the confidential section of
7-8

two prior reports the examiner concluded that the lending
policies were reasonably sound and conservative. The confidential section of the other report did not express any
opinion on the bank's loan policy.
Since the report is the product of the examination procedures used, one can understand why the traditional reports
were not critical of the bank's lending policies and controls. The traditional approach is to examine a large portion of the loans as of a certain date and to appraise and
classify them according to the degree of risk involved.
(See ch. 4.)
In addition, the Comptroller's old handbook of examination procedures required the examiner to analyze the bank's
lending and collection policies and Practices; however, the
examiner had almost complete discretion in deciding the
specific procedures to be used and the workpapers to be
prepared.
Under the new approach, l1ans are still examined in
detail, appraised, and classified. Increased emphasis, however, is placed on evaluating whether the bank's policies,
procedures, practices, internal controls, and internal and
external audit are adequate to assure compliance ,with laws,
regulations, and sound banking principles.
To provide a basis for these evaluations, the examiner
completes an internal control questionnaire and a prescribed
schedule of detailed examination and verification procedures.

Case 2
One of the test banks had no problems requiring attention, according to a January 26, 1976, report conducted under
the traditional approach. In a report prepared June 30,
1976, using the new approach, the examiner concluded that
the bank's overall condition was good, but he pointed out
numerous deficiencies in internal audit and controls and a
lack of written policies on accounting procedures and concentration of credit.

7-9

The January report analyzed the bank's audit department
anJ the scope of its audits and found them adequate. The
analysis of the audit department and internal audit scope
was limited to a one-page, question and answer worksheet.
The new procedures provide for a more indepth review and
evaluation. In addition to a nine-page questionnaire, it
includes numerous examination procedures, such as reviewing
the internal audit reports and related workpapers.
The same auditor was still employed by the bank in June
but OCC was very critical of the audit department. The June
report concluded:
"The internal audit function is considered ineffective. The audit program, scope of audits and
documentation thereof are generally considered to
be unacceptable.

* * *

"The internal audit staff lacks * * * experience and

professional

ckground to audit a bank the size and

complexity of your bank.

* * *"

The January report did not criticize any bank activity
or recommend improvements.
The confidential section of the
report, which did not go to the bank, considered internal
controls and audit procedures adequate.
Since the bank had
no changes in management or substantial growth in resources,
the numerous recommendations in the June report appear attributable to the broadened scope of the new examination
procedures, rather than to a deterioration in bank operations.
Revised examination report
The examination report itself has been revised to communicate information more effectively both to OCC management
and to the banks.
The traditional examination report contains numerous
pages of data, taken from the bank's records, that is
readily available to bank management. Many of the critical
comments are contained in the confidential section, which
the bank does not receive.
(See ch. 6.)
The new report contains four major sections:
-- Letter to the board of directors.
-- Comment section.
7-10

-- Appendix.
-- Confidential section.
The letter to the board is to set forth the scope of
the examination and the examiners' evaluation of the condition of the bank--either positive or negative. Where problems exist, the letter is to describe the probable causes of
the problems and recommend corrective actions.
The comment section is several pages of narrative in
which the examiner discusses the problems found and evaluates such areas of bank activity as loan portfolio management, investments and broker-dealer activities, earnings,
capital adequacy, and asset-liability management.
Much of the appendix contains schedules supporting the
narrative in the comment section, such as a writeup of classified loans and a list of credit data and collateral exceptions.
The confidential section of the report, which is not
furnished to the bank, is to relate matters requiring the
prompt attention of OCC senior staff, s, :h as
-- suspected violations of law uncovered during the
course of the examination,
-- actions of senior bank officers which may require
such official sanctions by OrC, as the threat of
cease-and-desist orders or officers' removal, and
-- subjective comments which have not been proven by
the examiner but which nevertheless constitute
areas of concern.
The examination report also contains a form requiring
the signature of each board member attesting that he or she
has personally reviewed the content of the report.
Specialized and seecial supervisory examinations
OCC decided that, with its new more extensive examinations and with NBSS to identify changing situations in banks,
completely examining a bank three times every 2 years is
unnecessary. Therefore, during each 2-year cycle it will
normally examine each national bank completely once and perform two specialized examinations. For those banks which
7-11

are well managed, the specialized examinations will be
directed primarily at following up on changes that are disclosed by OCC's surveillance system. Fcr those banks which
show substantial weaknesses during the general examinations,
the specialized examinations will be directed largely at
following up on the actions taken to correct these weaknesses
as well as any changes detected by NBSS. In determining the
scope of specialized examinations, the examiners are to consider the bank's changes in policy, procedures, or management and any plans that could significantly affect future
operations.
OCC has established minimum procedures to be used
during specialized examinations. The examiners may add procedures after considering such matters as
-- the results of the most recent general examination,
--the risk ascribable to the policies and practices
employed by the bank,
-- internal controls,
-- the capability of managers and directors,
-- the nature of and risk ascribed to transactions with
and investments in related organizations,
-- the internal audit function,
-- the scope and results of the most recent examination
by external auditors,
-- the anticipated impact of local and national economic
factors, and
-- adverse changes in risk assets, earnings, or liquidity, or other matters coming to the examiners' attention as a result of performing the minimium procedures.
Other special supervisory examinations are to be performed when a bank's condition necessitates an examination
or supervisory visit more than twice in one calendar year.
These examinations have no minimum scope requirements.
Rather, they are to consist of procedures selected to fit
the circumstances in each case.

7-12

These specialized examinations will be scheduled primarily in response to NBSS identification of a bank with severe
changes in its quarterly financial reports.
Evaluation of larde shared loans
In 1975, OCC began a program of conducting special
examinations at certain banks which participate with other
banks in loans to large corporations. The purpose of the
program is to provide uniform treatment of the same loan
among participating banks. A loan qualifies for the program
(and is termed a shared national credit) if it totals
$20 million or more and two or more banks participate.
A team of OCC bank examiners reviews a shared national
credit at the lead bank (or the national bank with the largest dollar share when the lead bank is State-chartered) and
votes whether or not the loan will be classified (i.e.,
criticized). The shared national credit evaluation is then
incorporated into regular examination reports of all national banks which participate in the loan.
In 1975, OCC reviewed 521 shared national credits at
14 lead national banks. The loans totaled $48 billion-9 percent of the dollar value of all outstanding loans in
the commercial banking system.
In 1976, under
shared
national credit program, OCC reviewed 704 loans the
at 16 lead
banks. These loans amounted to $63 billion, or 13 percent
of the value of all commercial bank loans.
Many of the participating banks are State-chartered.
FDIC and FRS received limited data on OCC's 1975 shared
national credit evaluations and its 1976 consolidated report.
FDIC and FRS, however, did not use the OCC's evaluations
when their examiners reviewed the loans at the Statechartered participating banks. On December 21, 1976, FDIC
headquarters advised its regional directors that their examiners should begin utilizing the OCC's shared national
credit classifications when they examine a participating
State nonmember bank unless some change has occurred since
OCC's classification which would warrant a different classification.
We traced 183 State bank participations in 53 loans
evaluated by OCC's shared national credit program, to compare the evaluations of FRS and FDIC examiners to those of
OCC's team. In over half the cases for which the examination dates were comparable, the FRS or FDIC evaluation of
the loan differed from the OCC uniform rating.
7-13

Loan eva'uations were inconsistent at both FDIC- and
At each of the 12 State member banks
FRS-superviseo banks.
we reviewed and at both of the State nonmember insured banks
which had participated in more than one shared national
In general,
credit, at least one loan evaluation differed.
many more State members than nonmembers participate in
Of the 183 participations we
shared national credits.
traced, only 19 were to State nonmember insured banks.
Revised trust examination erocedures
OCC has also made extensive changes to its trust examination rrocess, as the Haskins & Sells study recommended.
The new approach includes preprinted forms which are to
These
be completed for each trust departnme:t examined.
forms provide for more uniform examinations but still permit
the examiner-in-charge some leeway for dealing ;yith a particule- bank's situation.
The examiners may reduce their verification work if they find they can rely on the work done by
the bank's internal and external auditors.
In March, April, and May 1976, the new procedures were
field tested in six banks: two in California, one in Iowa,
Full implementation
one in Kansas, and two in Pennsylvania.
began October 1, 1976.
Revised EDP examination
_rocedures
Traditionally, examinations of electronic data processing operations have been regionally administered with little
or no national coordination. They consisted of interviews
with bank personnel supplemented by limited reviews of
The EDP reports contained questioncorroborating documents.
naires requiring in some cases the examiners' overall assessThere were no agencywide
ment of some EDP-related activity.
work plans or guidance to assist the examiners in these
A headquarters official concluded that examiassessments.
nations were not being conducted uniformly and in many
The Haskins & Sells report
instances were of poor quality.
made several recommendations for improving OCC's EDP examinations.
By November 1976, OCC was completing
numerous EDP related areas such as:
-- Upgrading EDP examiners'

improvements

expertise.

-- Developing a detailed examination handbook.
7-14

-- Developing a comprehensive work program.
-- Expanding the EDP field staff.
-- Revising the EDP examination report.
-- Increasing headquarters direction of EDP examinations.
The new OCC handbook and work program should improve
and standardize examinations.
In the traditional EDP examination report, questionnaires were filled out on various EDP activities whether or
not a deficiency was disclosed. (See ch. 4.) The revised
report eliminates the questionnaires and consists of narrative comments on
--the scope of the examination,
-- any exceptions and deficiencies noted, and
-- specific recommendations for improvement.
CHANGES IN FRS'S EXAMINATION APPROACH
During 1975 the Federal Reserve Board's Committee on
Bank Regulation and Supervision undertook a number of studies
and projects to update and improve examination policies and
procedures.
Revised examination 2rocedures
In Marcn 1976, the Board adopted a limited-scope
examination of historically sound banks, referred to as an
asset-management examination. These examinations are to be
alternated with regular examinations. Use of the new procedure, however, is left to the discretion of the Reserve
banks.
This examination is designed to increase efficiency by
shifting some examination resources from banks that are
prudently operated and relatively trouble-free to those
banks that are in more critical need of attention.
The asset-management examination ±.- 4nt-,3ed to be
integrated with a surveillance program whicn, according to
FRB, need not be formal, but which should be sufficient to
highlight unusual shifts in a bank's position. The
7-15

surveillance results may influence whether an assetmanagement examination or a regular examination will be made.
If substantial changes in senior management, ownership, or
local or general economic conditions have occurred or harmful
trends are developing, a regular examination may be warThis is, however, a subjective decision left to the
ranted.
discretion of the Reserve bank.
Techniques employed in this type of an examination may
The
differ from those employed in regular examinations.
principle thrust of the examination is to
-- analyze assets (The examiner uses discretion in
deciding how many to examine.),
-- identify and analyze changes in overall financial
condition and the caliber of management since the
previous examination, and
-- ascertain that policies and procedures are being
followed that will insure compliance with relevant
laws and regulations.
Monitor in_ system

The Board has developed three major computer programs
that perform screening and monitoring functions on a variety
The
of data files for banks and bank holding companies.
main computer program generates a list of banks or bank
holding companies by specifying any set of financial ratios
for a peer group, which have actual or potential financial
problems, and monitors the progress of such companies over
time. The data sources for the main computer program are
the periodic reports of condition and income foc banks and
the bank holding company annual report and quartetly financial report (now under development).
The consolidated bank holding companies shareholders'
report program uses published financial data to produce a
comparative ratio analysis of the 300 largest bank holding
The program produces six reports including
companies.
comparative percentage breakdowns of each holding company's
financial statements, year-to-year percentage changes in
various financial items and ratios, and rankings of bank
holding companies within peer groups by 24 financial ratios.
The data sources for this program are the annual and quarterly reports to shareholders published by large bank holding companies.
7-16

The weekly bank monitoring program screens four weekly
repcrting series which allow analysts and examiners to
follow weekly and monthly changes of key balance sheet items
of large banks and to derive monthly net income of reporting
banks.
The main computer program and the shareholders'
program became operational during September 1976, and the
weekly monitoring program will be operational during
January 1977.
Additionally, FRS deve'oFwd in 1975 a report that
identifies transactions tha' cake place between the nonbank
portion of the holding company and the bank portion. Major
transactions are to be reported 10 days after they occur;
other transactions are to be reported quarterly. Information from the report is computer processed at the Reserve
bank and sent to the Board. The report is reviewed at the
Reserve bank and the computer printout summary of the
report is reviewed at the Board to identify any large,
unusual, or improper transactions. A memorandum is prepared
quarterly for the Board that summarizes major transactions
and balances.
In order to set up the surveillance system for bank
holding companies, the Board began developing in 1974 a
computer supplement to the bank holding company annual report.
In 1975 the Board developed the intercompany transactions
and balances report that identifies major transactions between the bank and nonbank portion of the holding company
During 1976 the Board revised the bank holding company
annual report to add new information to aid monitoring, and
reformat the report to aid computer processing of the information. The Board is now in the process of developing a
quarterly financial report for bank holding companies wnich
is intended to enhance the monitoring of the financial condition of these companies.
In addition to its computer programs, the Board monitors banks and bank holding companies through manual systems. For example, the Board monitors on a daily basis
stock market prices and earnings reports that appear in
the
financial press. Formalized relationships have been set
up
with stock surveillance groups of the major stock e::changes
which alert the Board when a stock price breaks a price
or
volume parameter. Monitoring of earnings releases enables
the Board to obtain information before it would otherwise
be
available to the Board.
7-17

In September 1976 the conference of presidents of the
Federal Reserve Banks completed plans for a minimum monitoring system to be developed by each Reserve bank in addition
to any ot.er monitoring the bank considers necessary. Meanwhile, several Reserve banks have developed their own monitoring systems. The Board's surveillance group is to work
closely with the Reserve banks in developing a minimum
surveillance system so that the systems are compatible.
According to FRS the Reserve Banks' systems are directed
more to the district level and the Board's system is
directed towards monitoring large peer groups of banks and
bank holding companies that cross district boundaries.
The Boston Federal Reserve bank began developing a
monitoring system about 4 years ago. The system started to
monitor banks about 2 years ago; the portion dealing with
bank holding companies is still under developme.t. The
system's purposes include monitoring individual banks as
well as the banking industry, providing a basis for scheduling examinations, and preparing an examiner for an examination.
Data for the system comes from reports of condition
and income, weekly reports from certain banks, holding compan', reports, and internally generated information. Banks
and holding companies are ranked in relation to each other,
..- the most extreme cases can be designated for additional
review.
The Kansas City Federal Reserve bank monitors the
liquidity position of 36 large banks in its district to
identify banks whose liability management activities may
pose a threat to their financial stability. The Reserve
bank's staff developed several ratios which relate a bank's
confidence-sensitive si.ney (such as Federal funds and
$100,000-or-larger certificates of deposit) to that bank's
ability to refund this money to lenders on snort notice.
Such funds are not backed by Federal deposit insurance and
can be highly volatile. The Reserve bank uses rankings
rather than absolute criteria, and examines trends over time.
Data for this system comes from weekly reports filed by
certain large banks and from internally generated data on
borrowing from the Reserve bank. The Reserve bank began
developing the system in late 1974 and put it into operation
in early 1975.
Of the 36 banks tracked, 33 are national banks monitored largely for comparative purposes (although adverse
7-18

trends are brought to the attention of the OCC regional
administrator), and 3 are State member banks, over which
the Reserve bank has supervisory authority.
The Kansas City Federal Reserve bank is also developing a comprehensive bank monitoring system, which it expects
to begin operating in early 1977.
The San Francisco Federal Reserve bank is developing a
financial monitoring system to track the condition of banks
and bank holling companies in that district.
In addition to
monitoring, the system is expected to be useful in scheduling
examinations, preparing examiners to begin an examination,
and providing data for research, as well as in other areas.
The system will use data from call and income reports,
weekly data on certain large banks, quarterly dat, 'n bank
holding companies, and examination data. The insc ation
will be analyzed on two levels: (1) all institutions will be
compared quarterly with approximately 18 relative or absolute ratios relating to liquidity, leverage, capital adequacy, profitability, and operating efficiency, and those
comparing unfavorably will be noted and (2) institutions so
noted will be subjected to detailed individual analysis.
The system is designed to give users flexibility in changing
the ratios used without reprogramming.
The Reserve bank decided in mid-1975 to begin developing such a system and entered into a $76,000 contract for
its design. The system is expected to be operational in
early 1977 and is expected to have yearly operating costs of
about $23,000.
CHANGES IN FDIC'S EXAMINATION APPROACH
On November 2, 1976, the Director, Division of Bank
Supervision, announced a new examination policy to become
effective January 1, 1977. The principal policy changes
relate to examination frequency and scope. FDIC is also
planning to make greater use ,f financial data that banks
prepare for it each quarter.
FrequencY

o f examination

The new policy is to conduct, at least once every
12 months, a full-scope examination of each State nonmember
insured bank having supervisory or financial problems.
Additional examinations or visitations of such banks will be
7-19

made as considered necessary by the regional directors.
Banks not having supervisory or financial problems are to be
examined at least once every 18-month period, with no more
than 24 months between examinations.
As stated in chapter 4, during the period of our review
FDIC did not have a policy on examination frequency.
In
practice, however, it examined most of its banks once each
year.
Sco2e of examination
The scope of examination, as well as the report, may be
modified for banks with assets of less than $100 million
that have been operating for 3 full years and meet certain
prescribed standards with respect to management, capital,
earnings, fidelity coverage, controls, and audit.
FDIC's new policy statement provides:
"* * * Full use should be made of the bank's EDP

and management reports, and sampling should be
utilized wherever possible, and proof and verification procedures may be eliminated or substantially limited unless circumstances indicate
additioaal effort is needed in these areas.
Additionally, the volume of loans subjected to
analysis may be reduced, and less important
branches need not be examined. Emphasis at these
modified examinations should be placed on management policies and performance; the evaluation of
asset quality, alignment and liquidity; capital
adequacy; and, compliance with applicable laws
and regulations.
Where adverse trends or other justifications appear,
appropriate revisions in the conduct of the examination should be made and report schedules added."
For banks with assets over $100 million which do not
have supervisory or financial problems, some curtailment is
permitted in the scope and reports of examination under certain conditions.
Monito ring systems
FDIC has in operation and under development several
systems to moniitor bank performance for adverse trends and
7-20

identify banks which may have potential problems. Banks so
identified may be scheduled for priority examination or
other followup. These systems are based on data reported
periodically by banks on reports of condition and income.
These systems were designed to utilize different methodologies and are, to some extent, competing. FDIC plans to
evaluate all of these systems over the next year or two to
determine which provide the most useful results. Thereafter,
FDIC plans to integrate the most effective systems into a
coordinated bank monitoring system.
Three systems are currently in operation.
-- Financial Trend Analysis. From this system a user
can obtain a printout showing which banks in certain
geographical areas meet certain levels for all or
some of 83 variables.
-- JAWS
banks
mined
staff
these

(Just A Warning System).
This system identifies
whose financial ratios do not meet predeterlevels in 13 critical areas. Headquarters
set a critical threshold for each ratio, but
can be changed for individual regional offices.

-- Early Warning System. Based on statistical analyses
to identify the most critical differences between
problem and non-problem banks, seven variables were
selected and various weights, or importance, were
assigned to each. This sytem produces a score for
each bank which is designed to indicate the severity
of its potential problems.
Two other systems are under development:
-- Monitoring System. On the basis of 11 variables,
this sytem compares one bank against other banks of
comparable size, and identifies those banks which are
furthest above or below the group average.
-- Regression Model. Based on balance sheet data, this
system generates a model bank with an asset structure
similar to the bank under study, and compares income
and expense data of the bank under study with projected data for the model to evaluate operating
efficiency.

7-21

Revised trust examination Erocedures
Changes in FDIC's trust examination process include
(1) a revised report format, more extensively covering
corporate activities and collective investment funds, and
(2) preprinted checklists, similar to the questionnaire and
checklists established by OCC but not as extensive.
Of the three agencies, FDIC was the only one that did
not have specialized positions for trust examiners. FDIC
has now established 14 trust specialist positions which are
being filled.
NEW APPROACHES TO CONSUMER CREDIT
COMPLIANCE EXAMINATIONS
The agencies have planned expanded efforts in consumer
credit regulation, following the enactment in 1975 of increased legislative requirements.
In testimony before the U.S. Senate Committee on Bankand Urban Affairs, the State Bank Commissioner
Housing
ing,
of Connecticut described a test based on a sample of 15 FDIC
examination reports. With only 2 exceptions, all 15
reported compliance. In contrast, 15 State reports revealed
961 offenses, including $35,180 in overcharges.
FDIC, which has been using separate consumer credit
compliance reports nationally since September 1974, plaois to
adopt standard statistical sampling techniques and to install a specialist within each region, but not to change its
examination or reporting procedures.
FRS, which plane to perform separate consumer credit
compliance examinations, found that the techniques needed to
examine bank policies and practices in the consumer credit
area are quite different from those used for determining the
safety and soundness of banks. The Federal Reserve Board
has developed new supplemental manuals for consumer credit
examinations. Additionally, several Federal Reserve banks
are developing their own procedural checklists foL the other
consumer credit regulations. FRS is also developing a
separate report of examination and procedures for consumer
credit compliance examinations. A committee of the Board of
Governors has been formed to study various approaches to
uniform enforcement of consumer credit laws.

7-22

OCC conducted a test project during 1975 and 1976 in
one regional office.
It found that consumer credit protection laws were violated more frequently than was previously
thought. OCC officials, acknowledging that the national
banks have received only cursory reviews for compliance with
consumer credit laws, have begun a special crash program in
September 1976, with the target of examining all national
banks within 12 months. Key elements of the new examination
effort include
--a revamped and greatly expanded examination questionnaire which will enable the examiner to probe the
policies, procedures, and practices of national banks,
-- expanded programc to train assistant examiners in the
new consumer-oriented examination procedures,
-- coordinated followup procedures which will require
the regional officer to secure early correction of
banks' deficient practices,
-- the help of the Comptroller's Enforcement and Compliance Division in getting banks to correct deficiencies, and
-- the use of standard statistical sampling techniques
to provide examiners with a simplified yet accurate
testing approach.
All three agencies, as part of their increased efforts
in consumer credit regulation, have begun intensive examiner
training schools. Beginning in September 1976, the three
agencies started training experienced bank examiners to look
for consumer credit and fair housing violations. They expect
to eventually train all bank examiners in procedures for
consumer credit compliance examination. A separate staff of
compliance examiners will be developed to work independently
of other examiners or, in the case of FRS, to work concurrently with the commercial examiners.
CONCLUSIONS
We support FDIC's and FRS's objective of giving greater
emphasis in the examination process tc the weaker banks and
less emphasis to the relatively trouble-free banks.
In our
view, however, the new approaches adopted by FDIC and FRS
will not provide the degree of assurance that OCC's new
approach will provide that examiners will systematically and
7-23

indepth examine banks' policies, practices, procedures, controls, and audit to identify weaknesses in bank management
which could lead to serious problems.
OCC's revised commercial examination procedures should
provide the agency with more meaningful information regarding the banks it supervises and result in more complete and
More importantly, the new approach
consistent examinations.
should result in early detection of situations which could
cause banks difficulty. Examiners could thus help banks
avoid problems rather than point out problems after they
have occurred.
To derive the full benefit of this approach OCC must
act more aggressively than in the past to influence banks to
remedy defects in operations disclosed by its new examina(See ch. 8.) While the new procedures do provide
tions.
better documentation for deficiencies noted and more effective communication between OCC and bank directors and senior
management, the new procedures will not guarantee that weaknesses noted will be corrected. We believe that a computerized system for monitoring the actions taken to correct
a NBSS action control system, is a
deficiencies, such as
step in this direction.
The new OCC procedures for examining trust departments
and EDP operations, in our view, would assure more uniform
and indepth examinations than do the traditional approaches
and could be used by all three agencies.
More experience is needed with the new examination processes before many practical aspects of the processes can be
fully assessed. However, we believe that the concepts are
logical and offer benefits which could also apply to FDIC
Because of the importance of the changes, we beand FRS.
lieve that OCC should invite FDIC and FRS to jointly compare
its new processes with the traditional processes, as well as
the modifications being made by the other two agencies, both
Such
in terms of benefits derived and resources consumed.
fully
for
foundation
sounder
a
provide
an assessment would
implementing the new processes at. OCC, as well as at FDIC
and FRS. It could help resolve such issues as:
-- Costs and staffing implications of new processes.
-- Applicability of new processes to banks of all
sizes.

7-24

-- Whether the agency already has sufficient data about
ceit-.n well-managed banks to waive some of the
detaied review of policies, procedures, etc. at
these banks.
In our view, the responsibility to analyze all large
shared national credits should be centralized in one group
composed of examiners from all three agencies. This group
could produce classifications of these loans at the lead
banks which would be accepted by all three agencies when
they examine the participating banks--both national and
State banks. The three agencies operate under a uniform
agreement for classifying loans; thus examiners from the
three agencies should not encounter insurmountable difficulties in arriving at uniform classifications.
By different routes, the agencies are striving to find
the most meaningful system for monitoring banks and the most
effective approach to examine banks for compliance with consumer protection laws. We believe they would benefit from
jointly evaluating the various systems and approaches being
developed. Each agency could modify its approach to incorporate strengths that other approaches may offer.
RECOMMENDATIONS
We recommend that the Comptroller of the Currency
invite FDIC and FRS to jointly evaluate its new examination
approach. We further recommend that, in the event of a
favorable assessment of the new process, the Board of Directors, FDIC, and the Board of Governors, FRS, revise their
examination processes to incorporate the concepts of OCC's
approach.
We recommend that the Board of Directors, FDIC, the
Board of Governors, FRS, and the Comptroller of the Currency
jointly staff a group to analyze shared national credits at
State and national lead banks under Federal supervision and
that the three agencies use the uniform classification of
these loans when they examine the participating banks.
We recommend that the Board of Directors, FDIC, the
Board of Governors, FRS, and the Comptroller of the Currency
work together to refine their monitoring systems and their
approaches to examining for compliance with consumer credit
laws.

7-25

AGENCY COMMENTS
With respect to our recommendation relating to OCC's
new examination approach,
FDIC stated:
"In light of the limited testing that has been
conducted (10 banks) of the OCC's new process, we
believe it is premature to consider that process
a success either for large or small banks. Representatives of the OCC admitted that, while the new
procedures are workable in banks with assets between $50 million and $1 billion, they do not
appear feasible for banks with assets of less than
$25 million. We therefore question the logic and
wisdom of GAO's recommendation that FDIC adopt
such process, either for the large or small banks
under our direct supervision, especially when it
is recalled that 91% of the banks we directly
supervise have assets of less than $50 million
and 77% less than $25 million. Since the number
of large banks directly supervised by the FDIC
has and continues to increase, our examination
process is necessarily designed to handle small,
medium and large-sized banks. However, we shall
follow closely OCC's experience with the new
examination process as it undergoes further testing, and we remain receptive to further revision
in our own examination approach which will be
beneficial to and improve our supervisory capabilities.
"In our judgment, the discussion of changes in
FDIC's examination approach does not reflect
sufficiently the impact and significance of those
changes, especially with respect to our review of
the management policies and internal controls of
a bank under examination. We believe that the
changes made by the FDIC represent, at the present
time, the most logical, beneficial, and prudent
improvements in the examination orocess. We have
blended the proven techniques and practices with
a new approach which we feel should enable FDIC
to focus more directly on, and devote more time
and effort to, problem and near-problem situations, and concomitantly less on healthy banks.
We refer to excerpts from our General Memorandum #1, included with our general comments."
7-26

FRS stated:
"The Comptroller's new procedures are based
in large part on the Haskins & Sells report.
At the time that report was prepared, the
Comptroller furnished it to the other banking
institutions in the belief that some of the
recommendations might be jointly applicable.
A task force at the Federal Reserve reviewed
the report shortly after its issuance and
concluded that, in most instances, the System
had already implemented those recommendations
involved which would have been applicable to
the System. Subsequent to that time, the
development of new examination procedures
at the Comptroller's office has been substantially completed.
Recently, senior members
of the Board's staff attended a briefing by
the Comptroller's office on these new examination procedures and the report form to be used
by that agency. The Board believes that the
Comptroller has been most cooperative in sharing his new systems with us and fully intends
to use whatever benefits may be derived from
the Comptroller's efforts in this area in our
on-going review of our examination procedures."
OCC stated:
"On November 23, 1976, OCC staff members made
a presentation to approximately 20 FRS and FDIC
staff members on the revised examination procedures. Copies of our draft Handbook of Examination Procedures were furnished. Their review
and evaluation on an ongoing basis is welcomed.
The Acting Comptroller has proposed to the
Interagency Coordinating Committee that a permanent staff group be set up for this purpose."
With respect to our recommendation relating to joint
evaluation of shared national credits,
FDIC stated:
"Although--as the GAO report points out--of the
183 participations in shared national credits
traced by GAO only 19 were to state nonmember
insured banks, the FDIC is now a participant
in the Shared National Credits Program."
7-27

FRS stated:
"A joint approach to shared national credits is
clearly desirable. In fact, in June 1976 the
Board and the Office of the Comptroller of the
Currency entered into a preliminary agreement
which provides for a sharing by each agency of
examiners' classifications of a national credit."
OCC stated:
"In 1974, meetings were held with representatives
of the OCC, FRS and FDIC present to discuss the possibilities of using a uniform program for the
review of selected large shared loans. Both the
FRS and the FDIC found merit in the program but
they believed sufficient pitfalls existed to delay
their participation in the program. Also, in
March of 1974 this Office met with representatives
of the Conference of State Bank Supervisors to
discuss the proposed program. They indicated
interest and agreed to work out arrangements with
various bank supervisors.
"In 1975, the Office of the Comptroller of the
Currency conducted uniform reviews of shared
national credits in applicable Naticnal Banks.
The loan write-ups generated by these reviews
were made available to both the FRS and the
FDIC. In March, 1975 FRS expressed their continued interest in the program and hoped they
could participate if the "pitfalls" could be
overcome. In November, 1975 'RS revealed they
were instituting a test review program involving state member banks paralleling our methods
and procedures. In July, 1975 FDIC again expressed interest and a meeting was held in
September, 1975 with representatives Jf the
FDIC. This Office indicated FDIC involvement
would be welcomed in whatever way they deemed
appropriate.
"During May, 1976 the second uniform review was
conducted and again the data generated was made
available to the FRS and FDIC.
"In July, 1976 the Comptroller of the Currency
and the Vice Chairman of the Federal Reserve
7-28

Board met to discuss the approaches of the two
agencies to shared national credits. It was
agreed that the 0; should continue to provide
FRS with the information developed under its
program and to explore at a staff level whether
uniform procedures could be developed between
the two agencies waich would be acceptable to
all of the Federal Reserve Banks. It is our
understanding that the New York Federal Reserve
Bank is conducting a pilot project involving
shared credits which may assist in resolving
some of the anticipated problems associated
with a combining of the approaches of the two
agencies."
With respect to our recommendation relating to monitoring systems,
OCC stated:
"The OCC has met on several occasions with
officials of the other two Federal supervisory
agencies to present its NBSS system. Those
orientations were given both orally and with
complete submission of all relevant documents.
Further, we have offered the other supervisory
agencies computer programs and technical knowledge to implement the programs."
FDIC and FRS did not respond to this recommendation.
With respect to our recommendation relating to consumer
credit compliance examinations,
FDIC stated:
"We are, of course, in favor of the three
federal bank regulatory agencies sharing
and working together in the important area
of consumer credit compliance. However, in
many instances healthy competition in the
area of consumer credit compliance as well
as in other areas of banking supervision
between the three federal bank regulatory
agencies can lead to a better system of
supervision then complete uniformity. Thus,
the development of an independent approach
by one or more of the agencies may lead to a
better end result."

7-29

FRS stated:
"The second portion of this recommendation
deals with the desirability of uniform refinement of consumer credit enforcement and
In the report, the GAO
compliance policies.
states that some agencies believe there is
a possible "conflict between a bank's objective of financial soundness and strict comThe
pliance with consumer credit laws."
Board does not agree with this statement.
On the contrary, we believe that stringent
enforcement of consumer laws and regulations
will achieve compliance and thereby reduce
the likelihood that banks will incur substantial liability as a result of consumer
suits.
"The Federal Reserve has had the major
responsibility for drafting regulations to
implement the explosion of legislation that
has taken place in this area over the past
Ini this connection, the Board's
two years.
Division of Consumer Affairs has worked very
It has
closely with the other agencies.
formed a lederal Reserve task force to develop approaches to the enforcement of newly
A cadre of
enacted consumer credit laws.
examination specialists who will concentrate
on inspection and compliance is being trained.
Two schools on consumer regulations were
conducted in 1976 and four have been planned
for 1977.
"Additionally, examination manuals that deal
with the full array of consumer regulations
A new examinahave recently been prepared.
tion report form dealing exclusively with this
area has been prepared and is expected to be
in use in the near future."
OCC stated:
"With reference to consumer credit compliance
examinations the draft report does not fully
recognize that our new program is already
Over 6% of our field staff is
operational.
We
currently allocated to the consumer area.

7-30

have conducted three two week schools which
trained over 140 examiners in the new procedures; a second series of three schools is
scheduled for March and April, and a third
series will take place in the Fall.
The
schools stress examination techniques and
feature heavy reliance on case studies to give
experience in examining for compliance.
The
procedures are tailored to spot problems most
likely to result in harm to consumers.
We
make use of sophisticated advanced financial
calculators, specially programmed for banking
applicatio.is, and sampling techniques designed
to increase our effectiveness.
Eleven percent of the country's 4,700 national
banks have been examined under the new procedures.
Prelim'nary analysis of these reports
indicates that our expanded efforts in this
area are both justified and effective.
"The draft report also does not reflect the
extent to which other agencies have cooperated
in developing our new program.
The Federal
Reserve Board and H.U.D. aided in reviewing
our procedures.
Speakers from the Federal
Reserve Board, H.U.D. and the Justice Department participated in our schools.
Observers
from the Federal Reserve Board, FDIC, N.C.U.A.
ani H.U.D. attended the schoo.s to assess the
new procedures.
As a result many of our examination procedures and teaching materials
have been adopted by these .our agencies.
This experience has reinforced our awareness
of the benefits of such cooperative efforts."

7-31

CHAPTER 8
EFFECTIVENESS OF AGENCIES IN RESOLVING PROBLEMS

Page
Overview

8-1

How the agencies deal with problems
Informal enforcement actions
Formal enforcement actions

8-4
8-4
8-7

Frequency of enforcement actions taken by agencies
Results of enforcement actions
What types of problems can formal actions be
used to correct?
What happened when formal actions were used?
Conclusions
Recommendation
Agency comments

8-12
8-13
8-].4
8-15
8-18
8-18
8-19

Case studies--How agencies dealt with banks
to resolve problems
Conclusions

8-23
8-44

How the agencies decide which banks
require special supervisory attention
FDIC problem classifications
FRS problem classifications
OCC problem classifications
Different criteria--different problem banks
Conclusions
Recommendation
Agency comments

8-44
8-45
8-46
8-46
8-47
8-49
8-49
8-49

Dynamics of the prob'
Conclusions

3-51
8-53

n bank list: 1971-75

Enforcement actions against bank holding companies

8-54

Do the supervisory agencies have appropriate powers?
Conclusions

8-55
8-57

CHAPTER 8
EFFECTIVENESS OF AGENCIES IN RESOLVING PROBLEMS
OVERVIEW
Our analysis of enforcement actions taken by the
supervisory agencies for almost 900 banks included in
our samples showed that informal actions were used most
of the time and that formal actions were seldom used.
The agencies dealt with problem and nonproblem banks
in basically the same way. Even though the same types of
problems existed from one examination to another, the agencies did not always change or intensify the type of enforcement actions used to get the problems corrected. The
supervisory agencies should have used their formal enforcement powers more often.
Examiners find some type of problem in virtually all
banks; however, some banks have more serious problems and
require more supervisory attention than others. The agencies
cannot correct the banks' problems themselves but they
can use many enforcement tools to get banks to correct
their problt,.s. These tools include both informal and formal
enforcement actions.
Informal enforcement actions are nothing more than an
agency's attempts to persuade bank management to take
corrective action. Formal enforcement actions are used as
a last resort for getting problems corrected. Some of the
formal enforcement actions do not help correct problems
or save banks, but result in closirg the bank to protect
depositors.
After an examination, the agencies evaluate the effect
that the problems identified during the examination can
have on the bank's soundness. If the problems are serioL
tne bank is designated for special supervisory attent:on.
Such banks are sometimes referred to as "problem banks."
'cause the agencies use different criteria to identify
problem Danks, they often do tlot agree on which banks
require special supervision. Of the 4,744 national banks
operating cn December 31, 1975, OCC considered 85 as requirialg special supervision; FRS 267; and FDIC 52.

8-1

Among the 1,046 State member banks, FRS identified 65
problem banks and FDIC identified 17. Because the agencies' interest in and responsibility for dealing with
the banks overlap, and because their interest should
intensify as serious problems arc identified, we
believe they should work towards a common definition of
banks requiring close supervisory attention.
To assess the supervisory agencies' effectiveness in
getting banks to resolve their problems once they have been
designated for special supervisory attention, w -nialyzed
the agencies' "problem list" for the 5-year period ending
December 31, 1975. During that period 718 State nonmember
banks, 128 State member banks, and 686 national banks had
at some time been in the agencies' problem bank category.
Of those banks, 414 (58 percent) of the State nonmember
banks, 38 (30 percent) of the State member banks, and 392
(57 percent) of the national banks were returned to nonproblem status by December 31, 1975. Although most returned to nonproblem status within 2 years, 19 percent
were problem banks from 2 to 5 years, and 5 percent were
problem banks for over 5 years.
The supervisory agencies' success in getting bank
problems corrected depends heavily on cooperation from bank
management in changing the practices and policies which
caused the problems. Those banks which are receptive to
the agencies' identification of problems and suggestions
for solutions stand a better chance of correcting their
Informal enforcement action works for
problems sooner.
these banks.
us are those banks which are problem banks
What conce
time, for example the 201 banks that were
of
for long periods
2 years during 1971-75. We believe
over
fur
problem banks
that the supervisory agencies should have used formal enforcement actions more frequently when dealing with these
banks. During the entire 5-year period, the agencies made
limited use of written agreements and cease and desist orders, probably their most effective tools. The use of
written agreements was FDIC 3, FRS 8, and OCC 48, and the use
of cease and desist orders was FDIC 38, FRS 5, and OCC 13.
During 1976, each agency increased its use of cease and
desist orders. FDIC used 29, FRS used 4, and OCC used 7.
Also, OCC increased its use of wsitten agreements in 1976,
when it used such acti 'n 23 times.
The supervisory agencies have requested additional
statutory authority to remove a bank official whose acts
8-2

stem from either personal dishonesty or gross negligence
and to assess civil penalties against banks and individual
officials for specific violations. Our study of failed
and problem banks showed that the authority to remove individuals or to apply penalties could have been helpful in
dealing with the officials of these banks. We believe that
the authority to remove individuals or to apply civil
penalties could be useful to the agencies and we would
support such legislation.

HOW THE AGENCIES DEAL WITH PROBLEMS
Once the supervisory agencies have identified problems
and communicated them to the bank, they have at their
disposal a number of enforcement tools which they can use to
get bank management to correct its problems. These tools
include both informal and formal actions.
For purposes of analyzing agency files, we identified
10 kinds of informal enforcement actions and 7 kinds of formal actions.
Informal enforcement actions
Infor;nal enforcement actions, sometimes referred to as
mora. suasion, are simply the supervisory agencies' efforts
tc persuade bank managers to correct a problem.
Discussion at time of examination
The examiner-in-charge discusses problem situations
with the bank's executive officers as problems are discovered
or at the close of the examination. The purpose of such
meetings is to direct managers' attention Lo the problems
found and to possible resolutions. It the problems are
serious, regional or district officials may attend the
discussions. If the bank is State chartered, State officials
may also attend. The supervisory agencies may also discuss
the deficiencies with the bank's board of directors.
(See below.)
Request for formal response
to reported deficiencies
The supervisory agencies frequently request that banks
respond formally to criticisms in examination reports. Such
a request is made in the transmittal letter to the bank.
reviewing the bank's response, may conThe agency, aftt
clude that the bank is correcting or has corrected its problems. The agency would then followup no further until the
next scheduled examination. On the other hand, if the agency
is not satisfied that the problem is being dealt with, it
can take other followup actions.

8-4

Request for 2eriodic _rogress reports
The supervisory agencies often ask banks to report
periodically on progress in correcting deficiencies (e.g.,
the status of classified assets).
Such a request also is
made in the transmittal letter accompanying the bank
examination report. After reviewing progress reports, the
agency may decide the bank is correcting its problems and
may request no further progress reports. On the other hand,
the agency may decide that more frequent progress reports
are required or that some other type of enforcement action
is needed.
Request for meeting with
bank's board of directors
The supervisory agencies can request a meeting with the
bank's board of directors to discuss examination results
and the bank's condition.
Since January 1976, OCC's policy is to meet with each
board of directors annually, usually at the time of the
examination. FDIC and FRS do not routinely meet with the
bank's boards of directors.
(See ch. 6.)
Written communications
One method of informal followup, other than the
transmittal letter, is a letter from the supervisory agency
to the bank. Depending on the seriousness of the problems,
the letter may be signed by the examiiier-in-charge, a regional or district official, or a headquarters official. If
a State agency is involved, a State official may sign the
letter.
The agencies can use written communications to make
followup requests for for mal responses to examination report
deficiencies and progress reports.
Bank visits
The supervisory agencies can visit banks to followup on
problems. Such a visit may be to meet with directors, executive officers, or other individuals in the bank.
Special

examinations

OCC and FRS use special examinations to monitor certain
bank problems. Such exi 'inations are limited in scope. For
example, the agency might visit the bank and review its
8-5

classified loans if the examiner cited them as a serious
problem during the last examination or if the agency notes
from the bank's progress reports that classified loans are
not improving.
FDIC does not generally conduct special examinations
but prefers to increase examination frequency o0 problem
The frequencies of examinations for the 1970 and
banks.
1975 problem bank samples were as follows:
Months between examinations
OCC
FRS
FDIC
12/31/70 sample

6.5

8.0

5.3

12/31/75 sample

6.7

8.1

5.8

The three agencies may also place examiners in banks
for long periods to monitor certain problem situations.
Branch application rrejections
The supervisory agencies may reject a bank's application
for a new branch as a way of inducing management to correct
These actions can be effective in improving
its problems.
the condition of banks suffering from managerial neglect.
FRS also may reject a bank holding company's application for
banking and nonbanking subsidiaries t) influence management
to correct problems.
Public disclosure
The supervisory agencies can disclose or threaten to
disclose a bank's problems publicly to force bank management
However, public disclosure of
to correct its problems.
problems requires advance notice to the bank and could
have undesirable effects, such as causing depositors to
withdraw their funds from the bank.
Threat of le2al action
One of the more effective informal actions that tiic
supervisory agencies can use is the threat of taking legal
or formal action if the bank does not correct itb problems
within a given period of time.

3-6

Formal enforcement actions
Formal enforcement actions are used by the supervisory
agencies as a last resort to get bank managers to correct
their problems. Some formral actions do not help correct
problems, but result in closing the bank to protect
depositors.
Written agreements
The supervisory agencies use formal written agreements,
sometimes referred to as voluntary agreements or letter agree·ments, to confirm a bank's plans to correct problems. The
agency and the bank both sign the agreement. A violated
agreement can be the basis for issuing a cease and desist
order against the bank.
The agencies'use of written agreements for the period
1971 through 1976 was as follows:
Year
1971
1972
1973
1974
1975
1976

FDIC

FRS
(note a)

OCC

Total

1
1
1
-

1
3
2
2
1

3
4
6
17
18
23

5
5
10
19
20
24

a/Does not include 12 agreements against bank holding
companies.
Cease and desist orders
The supervisory agencies, under authority of the
Financial Institutions Supervisory Act of 1966 (12 U.S.C.
1818(b)), can issue cease and desist orders against banks to
get problems corrected. First, a notice of charges is
served upon a bank
-- which has engaged or is engaging in unsafe or unsound
practices,
-- which has violated or is violating a law, a rule, a
regulation, or a written agreement with the agencies,
or any condition imposed in writing by the agencies
in connection with the granting of any application or
other request, or
8-7

-- which is about to do either.
The notice of charges presents a
stituting the alleged violations
establishes a time and place for
whether a cease and desist order

statement of facts conor unsound practices and
a hearing to determine
should be issued.

If bank representatives do not appear at the hearing or
if the hearing confirms the violation or the unsafe or unsound practices, the agencies may issue the cease and desist
order. A bank can consent to the cease and desist order,
thereby obviating a hearing. Once the order becomes effective, it remains in effect until it is stayed, modified,
terminated, or set aside by the agency or a reviewing court.
The agencies'use of cease and desist orders for the
period 1971 through 1976 was as follows:
FRS
(note a)

OCC

Total

7
10
9
4
8
29

1
3
1
4

2
4
2
5
7

8
15
13
6
14
40

Year

FDiC

1971
1972
1973
1974
1975
1976

a/Does not include 12 orders against bank holding
companies.
Removal of management
Also under the Financial Institutions Supervisory Act
of 1966 (12 U.S.C. 1818(e)), FDIC and FRS may order the
removal of a director or off cer of a State bank which
they supervise and OCC may recommend that FRS remove
one from a national bank when
-- the director or officer has violated a law,

a rule, a regulation, or a final cease and
desist order; has participated in any unsafe
or unsound banking practice, or has committed
or engaged in any act, omission, or practice
which constitutes a breach of his fiduciary
duty; and
8-8

-- as a result, the bank has suffered or will
probably suffer substantial financial loss or
other damage, or the interests of its depositors
could be seriously prejudiced; and
-- the violation, practice, or breach involved personal
dishonesty on the part of the director or officer.
The agency must first serve the director or officer
with a written notice of its intention to remove him/her
from cffice. The notice of intention states the grounds
for removal and establishes a time and a place for a hearing. As with a cease and desist order, the agency can remove the director or officer if he fails to appear at the
hearing or if the charges specified in the notice of intention are substantiated. The removal order, too, remains
in effect until stayed, modified, terminated, or set aside
by the agency or a reviewing court.
In addition, the agencies have the authority (12 U.S.C.
1818(g)(1)) to suspend any bank director or officer indicted
for a felony involving dishonesty or breach of trust. The
statute provides that such a suspension can be enforced
by written notice and remains in effect until the charges
are disposed of or the suspension is terminated by the
agency. In Feinberg v. Federal Deposit Insurance Company,
420 F. Supp. 109 (D.D.C.- 1976), a three-judge distrct court
declared the statute to bL "constitutionally infirm" insofar as it permits the issuance of a notice and order of
suspension without affording the individual an immediate
post-suspension hearing, preceded by notice of such a
right, and an opportunity to be represented by counsel, to
make written submissions, and to make oral argument. FDIC
officials said they are working with the other agencies to
prepare and issue regulations in an effort to comply with
the due process requirements.

8-9

During the period 1971 through 1976, the agencies took
action to remove or suspend management as follows:
Year

FDIC
(note a)

1971
1572
1973
1974
1975
1976

3
3
4
6
3

1
2
1

3
8
3
9
3

7
11
7
17
7

FRS
(note a)

OCC
(note a)

Total

a/Includes 15 FDIC, 2 FRS, and 25 OCC suspensions.
Financial assistance
FDIC has the authority (12 U.S.C. 1823(c)(e)) to provide
funds to insured banks in danger of closing which are essential for providing banting services to the community or to
assist a merger, or sa.e of assets and assumption of liabilities of A,failing or failed bank into or by another insured
bank. In providing financial assistance, FDIC can require
that bank managers correct theirc problems.
Such assistance may include
-- making deposits in the troubled bank,
-- purchasing assets of the failing or failed bank,
-- granting a loan secured by the assets of the failing
or failed bank, or
-- guaranteeing another insured banK against loss
in assuming the assets and liabilities of the
troubled bank.
FRS has the authority (12 U.S.C. 347(a)) to extend credit
to member banks
-- to increase their available funds because of
developments such as a sudden withdrawal of
deposits or seasonal requirements for credit
which cannot reasonably be supplied from the
banks' own resources or
8-10

--to assist them in meeting unusual situations
which may result from national, regional, or
local difficulties.
Cancellation of deposit insurance
FDIC has the authority (12 U.S.C. 1818(a)) to
terminate a bank's deposit insurance if
-- its officers or directors are engaging in
unsafe or unsound banking practices,
-- it is in an unsafe or unsound condition, or
-- it has violated an applicable law, rule,
or regulation, or order; a condition imposed
in writing; or a written agreement with FDIC.
When FDIC initiates proceedings to terminate insurance,
it may give that bank a maximum of 120 days to correct its
problems. If the bank corrects all or some of its problems
within the t.me period allowed, FDIC may drop the termination proceedings altogether or take other action, for example a cease and desist order. If the bank does not correct
its problems, FDIC's Board of Directors can terminate its
insurance.
During the period 1971 through 1976, FDIC initiated
termination proceedings as follows:
Year

Number of
proceedings

1971
1972
1973
1974
1975
1976

5
5
1
3
5
8
27

Only 1 of the 27 proceedings, in 1976, resulted in termination of deposit insurance. Before 1371, FDIC terminated
the insurance of 13 banks. Canceling a bank's deposit insurance does not solve its problems.

8-11

Cancellat rl of FRS memberh
FRS has the authority (12 U.S.C. 327) to cancel a
bank's membership in the Federal Reserve. As far as we
could determine, FRS has used this authority only once as
a corrective tool. As with terminating deposit insurance,
this action does not solve a bank's problems.
Revocation of charter
OCC has the authority (12 U.S.C. 93,481) to revoke
national bank charters and States have the authority to
revoke State bank charters, although this too solves no
problems. In the last 2 decades, as far as we could determine, OCC has not revoked a bank's charter for not correcting its problems.
FREQUENCY OF ENFORCEMENT
ACTIONS TAKEN BY AGENCIES
The table below show- the percentage of sampled
banks for which the su ? Lvisory agencies took various informal and formal enfoicement actions.
Our tabulations are based on agency actions documented
in examination reports and correspondence files. In interpreting the tabulations, the reader should recognize that
the agencies would hardly ever need to use all types of actions with any one bank. We are not suggesting that the
figures should be 100 percent, even for problem banks.
The tabulations show how differently the agencies
treated problem banks from banks in the general sample.
They also show differences between actions t)ward banks
considered problems in 1970 and actions toward banks considered problems in 1975.

8-12

General sample
banks_inote_a)
FDIC FRS OCC
Number of banks
Informal
actions:
Request for
formal
response to
reported
deficiencies
Request for
periodic
progress
reports
Request for
meetings
with bank's
board of
directors

161

192

201

Dec. 1970 problem sample banks
(note b)
FDIC FR! OCC
53

Dec. '975 problem sample banks
(note b)
FDIC FRS OCC

--------- (percent of sampled banks)-------------

22
1

35
2

30
4

34
2

27
11

43
33

54
6

50
10

58
18

Written

communications
Bank visits
Special
examinations

Branch application rejections

Public disclosure

Threat of
legal action

Formal actions:
Written
greements
vnd
]e.i ,t orders

- -

.1 of
.nangqemcnt

inancial
assistance

Cr.ncellation of
deposit insurance

Revocation of
charter

Since earliest report of examination.

Since second most recent report of examination.

8-12a

As the above table shows, the frequently used enforcement actions were requests for formal responses to reported
deficiencies, requests for periodic progress repnrts, requests for board of directors meetings, and written communications. For the mast part the above actions were used
more frequently on problem banks than on general banks.
Compared with their treatment of 1970 problem banks, in
1975 the agencies requested more formal responses and petiodic progress reports and used more written communications.
FDIC's increase was the largest.
As far as ti~. remaining enforcemert ?ctions, including
formal actions, are concerned, their use vas limited.
Results of enforcement actions
We reviewed a sample of 149 banks which were on the
supervisory agencies' problem lists at Decem.br 31, 1970,
to determine how effective the agencies were in getting
bank management to correct problems. We used the 1970
sample of problem banks because the agencies had had 5 years
to get the banks to correct their problems. As of Decenmbe£ 31, 1975, the status of the 149 banks was as follows:
FDIC
Num- Percent
ber
Removed from prohlem
bank list (105)
Converted to a
national or State
charter (5)

FRS
Num- Percent
ber

Withdrawn from FRS
membership (7)

OCZ
Num- Percent
ber

Merged with another
bank

(7)

Failed (4)
Remained on problem
list (21)
Total

100

8-13

For the 105 banks which had beer taken off the problem
lists we determined the length of time spent in problem
status:

Years

FDIC
Num- Perber
cent

FRS
Num- Perber
cent

OCC
Num- Perber
cent

Under 1
1 to 2
2 to 3
3 to 4
4 to 5
5 to 10

6
13
9
7
4
5

14
30
20
16
9
11

1
1
2
4
1
6

7
7
13
26
7
40

12
18
5
2
3
6

Total

100

26
39
11
4
7
13
100

The supervisory agencies used primarily informal enforcement actions against the 149 banks. OCC and FDIC had
the greatest degree of success using informal action, returning 84 and 80 percent respectively nf the problem banks to
nonproblcm status, while FRS was successful with only 38
percent of its problem banks.
OCC hea the greatest success in getting problems
resolved quickly. About 65 percent of its banks which returned
to nk.nproolem status did so within 2 years. Only 44 percent
of the FDIC banks and 14 percent of the FRS banks which returned to nonproblem status di- so within 2 years.
What tynes of proolensa can formal

actions be uced to correct?
We analyzed the use of certain formal enforcement
actions to determine what types of problems they were intended to correct and whether our sample of problem banks
exhibited these same types of problems. During 1971-75 the
agencies used cease and desist orders 56 times and written
agreements 57 times to obtain corrective action on problems
in banks. The agencies used these two actions to correct
many of the same types of problems identified in our sample
of problem banks. The following table shows the percentage
of cease and desist orders and written agreements that ,eere
used to deal with specific problems. The reader should note
that each formal action usually addresses more than one type
of problem.

8-14

Problem

Cease and
desist orders

Capital adequacy
Violations of laws
and regulations
Loans--collections,
policies, and procedures
Loans--condition and
classified
Management--effectiveness
Management--selfserving
Liquidity/borrowings
Internal controls/
operating policies
Loans--concentrated,
excessive, and out
of territory
Loans--extension of
credit

Written
agreements

29
20

40
-

As the above table shows, the agencies used cease and
desist o-ders and written agreements to correct many different types of problems. A high percentage of problem tanks
exhibited these same types of problems. For example, 92 peccent of the problem banks which we reviewed had classified
loan problems; 81 percent had loan collection, policy and
procedures problems; and 78 percent had violated laws and
regulations. Yet each of these two formal actions was taken
against less than 4 percent of the banks on the problem list
during the 5-year period. We believe the agencies could have
used cease and desist orders and written agreements more
than they did to correct the problems noted in our sample
of problem banks.
What happened when formal actions were used?
The supervisory agencies used cease and desist orders
and suspension of managers 18 times against 17 banks in our
problem sample. As of November 30, 1976, eight of these
banks were classified as nonproblems by the agencies. The
following tables show a chronology of events for the banks
which were returned to nonproblem status and for the banks
which were still problems as of November 30, 1976.

8-15

Banks Returned to Nonoroblem Status

Bank

Months before
Date
designated formal action
Epoblem
taken

12/74

2/74

4/69

5/69

9/75

2/67

11/67

5/70

Average months

Type and
date of Montts before
formal
problems
action
resolved
Suspension
(5/75)
Cease and
desist order
(6/75)
Cease and
desist order
(5/7,2)
Cease and
desist order
(12/71)
Suspension
(9/75)
Cease and
desist order
(11/70)
Cease and
desist order
(10/72)
Cease and
desist order
(1/72)

Date
designated
nonproblem

Total
time on
problem
list

5/76

7/7F

9/72

12/72

10/76

6/74

8/74

6/74

8-16

-15

Banks in Problem Status at NovemDer 30, 1976
Date
designated
Problem

Months before
formal action
taken

3/55

196

8/75

5/68

9/73

2/66

Bank

90
6

6/71

1/75

4/73

6/65

Average months

Type and
date of
formal
action

Number of
months in
Months
problem
since action
status

Cease and
desist order
(7/71)
Cease and
desist order
(3/76)
Cease an]
desist order
(8/7J0
Cease and
desist order
(3/76)
Cease and
desist order
(6/72:)
a/ Suspension
(8/73)
Cease aid
desist order
(9/74)
Cease and
desist order
(10/75)
Cease and
desist order
(5/76)
Suspension
(5/73)

260

102

129

137

Data for this action nct included in the averages.

8-17

Conclusions
The supervisory agencies can use a variety of informal
and formal enforcement tools to get bank management co correct problems. The agencies rely on informal tools much more
heavily than on formal tools.
The agencies were somewhat successful in getting bank
management to correct the problems of the banks in our 1970
problem sample. Primarily through informal enforcement
actions, 70 percent of the banks had reached nonproblem status as of December 31, 1975. What concerns us is the banks
that were in problem status for over 2 years and the remaining
banks which the agencies had been unable to return to nonproblem status as of December 31, 1975. We believe that
there is a need for the agencies to use stronger formal
actions against these banks.
The agencies could have used their formal enforcement powers more than they did to correct problems that
we identified in a sample of problem banks. On the average,
when the agencies did use formal action, the sooner the action
was taker the faster the problems got corrected.
We recognize that every problem situation has to be
evaluated on a case by case basis and that formal enforcement action would not always be applicable. However, we
believe that the agencies should use formal enforcement
action as much and as soon as possible to get problems
corrected, especially when the problems exist over long
periods of time.
Recommendation
We recommend that the Board of Directors, FDIC, the Board
of Governors, FRS, and the Comptroller of the Currency establish more aggressive policies for using formal actions. Written guidelines should be developed to identify the types and
magnitude of problems that formal actions could appropriately
correct.

8-18

Aienny comments
FDIC stated:
"Congress granted cease and desi,;t powers in 1966
with the enactment of Section 8(b) of the Federal
Deposit Insurance Act. For several years thereafter, there was some reluctance to utilize Section
8(b) powers due mainly to a general misunderstanding
of its purpose and usefulness. Prior to enactment
of Section 8(b), the FDIC's only experience with
formal administrative corrective 'measures was the
termination of insurance proceedings, a severe form
of action which ~ould result in the removal of the
deposit insurance coverage of a bank. Because of
its severity, the Section 8(a) proceeding was used
judiciously and only after all other means for
accomplishing correction were exhausted. Apparently,
albeit erroneously, that same rationale was largely
applied to Section 8(b) proceedings. In addition,
there was to a lesser extent an unwillingness to try
something new. Commencing in 1970, a program to educate
FDIC personnel as to the usefulness of Section 8(b)
action was begun. The FDIC first used its cease and
desist authority in 1971 and between 1971 and 1975
issued 38 cease and desist orders and three formal
written agreements. In contrast, in a recent renewed
effort to foster the use and to test the effectiveness
of cease and desist powers, in calendar year 1976
alone FDIC issued 24 such orders and five emergency
orders. In addition, at year-end 1976, 18 more
cease and desist actions were in various stages of
process.
"While cease and desist action is in most cases
effective as a corrective measure, there are some
instances where it may be of little or no use and
could perhaps be counterproductive. For example, the
recently experienced worst economic period since the
great depression caused severe problems to the
banking industry, many of which did not lend themselves to correction through use of the cease and
desist powers. In short, it is not a panacea for
the removal of all problems experienced by the
banking community.

8-19

"The recommendation foz adoption of criteria for use
in formal actions, contained in the last sentence of
the recommendation, is troublesome. We would recommend against adopting formal criteria for use of
Section 8, because the statutory criteria are adequate.
The facts and circumstances of bank problems seem
so varied, and the remedial actions can differ so much
according to the problem, it would he inhibiting to
Live to work within the confines of additional written criteria. The adoption of such criteria could
give the banks additional bases for contesting
Section 8 actions."
FRS stated:
"In this section the report notes that each problem
situation has to be evaluated on a case-by-case basis
and formal action would not always be appropriate.
The report goes on to recommend that more aggressive
policies be used for formal actions and that written
guidelines be developed to identify the types and
magnitude of problems that formal actions could
appropriately correct.
In this regard, we note that
the report confirms that all of the agencies have
already markedly expanded their formal enforcement
activities. On November 3, 1975, the Board issued
a policy statement emphasizing its intention to take
formal action where appropriate in connection with
violations of the Bank Holding Company Act.
"Further, we do not believe that adequate weight has
been given in the report to existing hindrances to
formal action under the Financial Institutions Supervisory Act of 1966.
The chapter does, however,
support the Board's existing recommendations for
changes to the Financial Institutions Supervisory
Act which would enable the supervisory authorities
to remove bank officers for gross negligence and
to assess civil penalties for violations of laws
and regulations.
These legislative recommendations
were made in response to procedural and substantive
problems inherent in making effective use of the
present formal procedures set forth in the
Financial Institutions Supervisory Act.
In this
regard, the Board's letter of September 5, 1975, to
the banking committees of both Houses of Congress

8-20

setting forth the legisiative proposals made it clear
that there were a number of situations in which the
existing formal regulatory remedies would have little
or no value in preventing or ameliorating problem
bank situations. We believe that those recommendations,
embodied in H.R. 9743 and S. 23C4, would help to substantially reduce the incidence of problem banking
situations. Further, the Board has continued to
review areas in which it appears that changes may
be of substantial aid. The Board intends to submit
further legislative proposals to this erf in the very
near future, In this regard, Chairman Proxmire has
introduced legislation in the 95th Congress which
encompasses the earlier recommendations.
"The Board is further concerned that the discussion
in this chapter of the manner in which the agencies
are handling problem bank situations may not present
an accurate view in all respects. The major shortcoming in this regard stems from the fact that the
different agencies utilize problem bank lists for
varying purposes. Furthermore, even between agencies
with similar goals, different judgments may occur as
to the severity of an institution's problems and
the length of time monitoring is required. Meaningful
comparison between agencies' enforcement activities
in this area is therefore impossible. We would,
however, note that the report's conclusions relating
to the agencies' effectiveness in returning institutions to nonproblem status are not supported by the
tables since the percentages used excluded institutions withdrawing from membership and merging.
Presumably, the approving agency found in the case
of the mergers, as required by the Bank Merger Act,
that the financial and managerial condition of the
resulting bank was satisfactory and, in the case
of withdrawals from membership, supervisory pressure
may well have contributed to such withdrawals.
Further, as noted in the table, withdrawals anld mergers
are disproportionately high in the sample for the
Federal Reserve."
OCC stated:
"We believe that in supervising the vast majority
of national banks, our most effective remedy continues
to be the examination process and the meetings held

8-21

as part of that process between the board of directors
of the bank and OCC personnel. Since December 23, 1975,
the OCC has required meetings with boards of directors
of each national bank at least once every calendar
year and, in certain cases, fcllowing every examination.
We believe that the increased use of such meetings
together with our new examination procedures and early
warning system will ,,aKe our first-line, informal
supervisory techniques even more effective.
"As the GAO report elsewhere notes, our informal supervisory techniques even without the improvements noted
above, nave proven effective in rehabilitation of most
of the so-called problem bank situations. For example,
over the period reviewed by GAG informal procedures
utilized by OCC were successful 84% of the time.
Nonetheless, we agree that increased use of formal
agreements and cease and desist orders under the Fin ancial Institutions Supervisory Act may acceilrate
correction of problems in the nore recalcitrant institutions.
"OCC use of such formal agreements and orders has increased tenfold from 1970 to 1975. The OCC has originated slightly more than half of the combined total (179)
formal agreements and cease and desist orders issued
by all three agencies during the last five years. The
OCC, however, supervises fewer than half the number of
banks supervised by the other two agencies combined.
When compared to the numbe: of banks supervised, the
OCC over the past five years has used the formal enforcement tools of Financial Institutions Supervisory Act
about two and one half times as often as the oTher two
agenciesn
"It should also be noted that the three banking agencies
jointly requested Congress in 1975 to refine and increase
the agencies' formal enforcement powers. Congress
'ailed to pass the necessary legislation.
"The OCC has developed as part of its National Bank
Surveillance System a severity anomaly ranking system
which identifies every three months the national banks
most likely to require special supervisory attention. A
computerized action control system is designed to assure
that the OCC responds promptly anC appropriately to
these situations. The criteria built into these systems
identifies more systematically and promptly those cases
in which formal enforcement action is appropriate."
8-22

CASE STUDIES--HOW AGENCIES DEALT
WITH BANKS TO RESOLVE PROBLEMS
The following six case studies illustrate how the supervisory agencies dealt with specific banks. These cases
are reasonably typical of the agencies' efforts. The reader
should look for the problems which the examiner identified,
the enforcement actions which the agencies took to get the
problems corrected, any differences in enforcement action
for problem and nonproblem banks, and evidence of the existence of the same problems at subsequent examinations.
The reader should also look to see whether the agencies
intensified or varied their use of followup actions when
the same problems appeared from one examination to another.

Case 1--FDIC Problem Bank
January 1974 examination

the

The first examination report which we reviewed cited
following problems and recommendations:
(1)

Inadequate capital---the board of directors
should adopt their proposed $3.5 million capital
enhancemer.t program.

(2)

Classified loans totaling $1i.4 million, compared
to adjusted capital and reserves of $5.1 million.

(3)

Overdue loans had increased substantially and
were 4.4 percent of gross loans--collection and
renewal policies need to be reviewed.

(4)

Concentrations of credit total $10.3 million,
violating the sound principles of diversification

(5)

Violation of various laws--early correction is
warranted

FDIC rated management
bank "nonproblem."

"satisfactory" and classified

8-23

the

The examiner-in-charge discussed the above problems with
the bank's officers at the close of the examination.

March 1974
The transmittal letter forwarding the examination
report to the bank discussed asset problems, requested
a response to the reported problems, and requested plans
for corrective action.
September 1974
The examiner visited the bank to review 1nans made
to an individual.
January 1975
The examiner visited the banK a second time to review
several loans including the above-mentioned loans.
He noted a discrepancy between the bank's records and
the amount due for one of the loans.
April 1975 examination
The next examination report cited the following problems and recommendations:
(1)

A capital to asset ratio of 5.6 percent--the
board of directors should formulate a plan to
raise from $3 to $5 million additional capital.

(2)

Classified loans totaling $21 million compared
to adjusted capital and reserves of $8 million-the bank should put; a moratorium on all future
real estate
uQ,istruction loans and initiate a
comprehensive loan policy.

(3)

Overdue loans amounting
portfolio.

(4)

Non-i.nterest earning loans totalinc' $8 million.

(5)

Violations of laws and regulations.

8-24

to 27 percent of the roan

FDIC rated management "unsatisfactory" and classified
the bank as a "serious problem."
At the close of the examination, the examiner-incharge, an assistant regional director, a headquarters
official, and the chief examiner from the 3tate banking
agency met with the bank's board of directors to discuss
thesr problems.
July 1975
The transmittal letter to the bank expressed concern
about the deterioration in the loan portfolio and the
potential for a liquidity problem. The regional director
requested (1) a plan of action to correct the problems
noted and t2) progress rep¢,rts.
Members of the board of directors met at the FDIC regional office to discuss the April examination. They failed
to present specific plans to correct prc¢lems. The assistant regional director prepared a letter of understanding
which required the board to meet and submit prcgress reports twice monthly. The letter of understanding was later
signed by the board members.
Auqust 1975
The bank sent a progress report to FDIC.
September 1975 examination
T_
i·

following problems and recommendations were cited:

(1)

Inadequate capital and earnings as a result of
loan losses--the infusion of capital is necessary

(2)

Classified loans totaling $18.7 million, over
twice the amount of adjusted capital and reserves.

(3)

Twenty-three percent of total loans are overdue.

(4)

Concentrations of credit totaling $8.4 million.

(5)

Improperly recorded interest income accruals.

(6)

Sxcessive cash dividends.

8-25

FDIC again rated management "unsatisfactory" and classified tLe bank as a "serious problem."
The examiner-in-charge discussed the abov.-, problems
with the bank's board of directors at the close of the
examination.
November 1975
The bank sent a progress report to FDIC.
December 1975
The transmittal letter to the bank discussed the above
problems, requested a meeting with the bank and State
banking officials, and requested that progress reports
be continued.
January 1976
Two meetings weit held with bank and State banking
officials to discuss the bank's request to make further
dividend payments. The request was denied.
March 1976
The bank sent a progress report to FDIC.
April 1976 examination
The fourth examination was conducted in April 1976;
however, FDIC was unable to locate the examination
report for our study. In a memorandum to the files,
the regional director had cited the following problems:
-- Rapid growth has caused a serious capital
deficiency. The capital assets ratio is a low
5.4 percent and classified assets a-e 193 percent
of the capital structure.
-- Overdue and classified loans are excessive.
representing 22.9 and 22.2 percent respectively,
of total loans.
-- Concentration of :redit among real estate speculators, developers and builders has resulted in a
grossly unsatisfactory asset condition.
8-26

-- Loans were hastily made without written lending
policies. Lending deficiencies include a lack
of equity in collateral, no repayment programs,
undercapitalized and inexperienced borrowers, and
poorly documented loans.
-- Liquidity is a serious problem.
-- The president is considered liberal and unimpressive. Lack of directorate involvement is one of the
primary reasons for the bank's current condition.
-- The parent holding company is regarded as a serious
problem by FRS.
FDIC rated management "unsatisfactory" and classified
the bank as a "serious problem."
My_1976
A meeting was held with bank officials to discuss
their proposed plan to raise capital.
July1976
A meeting was held with bank directors, parent company
directors, and the State banking commissioner to discuss
proposals to raise $3 million in capital.
September 1976
The Director, Division of Bank Supervision, requested
approval to seek the bank's coisent to a cease ant, desist
order. The bank's attorney wr' te FDIC tnat a cease and
desist order would be "counter productive" and that
cAditional time was needed to complete the capitalization
program.
A meeting was held with bank officers and State banking officials to discuss cease and desist proceedings
against the bank. Afterwards, the bank agreed to
comply with the cease aitd desist order. The order
was issued to stop "hazardous lending and lax collection
practices."
The bank sent a progress report to FDIC.

8-27

October 1976
The bank wrote to FDIC and said it was complying with
the consent cease and desist order.
Our comments
This bank has had the same basic problems since the
January 1974 examination. FDIC ased informal enforcement
actions for 32 months without success. In September 1976,
FDIC took formal action.
This case illustrates that the agencies do not always
discuss the results of the examination with the banks'
boards of directors.
(See ch. 6.) FDIC officials did not
meet with the bank's directors until 15 months after continuing problems were found. The examiners did not criticize the bank's loan policies until the amount of classified loans had increased substantially. (See ch. 5.)
Case 2--FRS Problem Bank
July 1974 examination
The first examination report which we reviewed cited
problems and rr commendations as follows:
(1)

Overdue loans of 5.2 percer' o'- total loans.

(2)

Classified assets totaled $125,000, with
adjusted capital totaling $1.7 million.

(3)

The bank should review its current lending
procedures.

(4)

Credit files should be updated.

In the confidential section of the report, the examiner-in-charge noted that the general condition of the
bank was satisfactory. He noted also that capital ratios
were well below generally acceptable levels and that
earnings showed a moderate decline from the previous year.
At the conclusion of the examination, the examiner-inharge met with two of the bank's executive officers to
iscuss the above matters.

8-28

FRS rated management "satisfactory" and classified thel
bank as a "nonproblem."
August 1974
The Federal Reserve Bank, in ito transmittal letter to
the bank, cited the various criticisms noted in the examination report and recommended that the bank increase
capital by $1 million.
May_1975
The bank responded to the above recommendation and informed the FRB of its intention to raise $1.3 million of
additional capital.
June 1975 examination
In the report, the examiner-in-charge said that the
bank's condition had deteriorated since the last examination. He cited the following problems:
-- Overdue loans of 3.4 percent of total loans.
-- Classified assets totaling $1.7 million, with
adjusted capital only $1.4 million.
-- Inadequate capital.
-- Violations of laws.
The examiner-in-charge mentioned that the bank's
plans to increase capital might well prove inadequate
in the future.
In the confidential section of the report, the examiner-in-charge said two former executive officers were
primarily responsible for the "swift deterioration of
the quality of the bank's assets." He noted that the bulk
of the classified loans were of "poor quality at inception
or rapidly proved to be." He stated, "it was not known
why the two officers, whose previous records had not been
tne subject of criticism, quite obviously embarked on a
program of lending liberalism."
One officer had resigned
and the other had become inactive.
According _o the examiner-in-charge, the present officers had yet to demonstrate the ability to deal with the
many problems presented. In addition, he said that earnings

8-29

were below the average of other banks of similar size in
that State.
At the conclusion of the examination, the examiner-incharge met with the bank's active officers and available
board members to discuss the bank's asset problems.
FRS rated management "fair" and classified the bank as
a "problem."
August 1975
The FRB's transmittal letter to the bank emphasized
the need for strict adherence to the bank's recently
strengthened lending procedures. It requested monthly
status reports and a meeting with senior managers.
September 1975
FRB officials met with the bank's board of direc rs
to discuss the loan situation. They noted minor improvement
in the bank's loan portfolio.
February 196 examination
In the report, the examiner noted a more favorable
condition but cited the following problems:
--classified assets totalinu $1.4 million, with
adjusted capital of $2.8 million.
-- Violations of laws.
-- Heavy loan losses.
--Poor earnings.
In the confidential section of the report, the examiner-in-charge noted that the general condition of the bank
was "unsatisfactory" and that earnings were poor as a
result of heavy loan losses.
An :internal FRB memorandum referring to the February
1976 examirition stated, "Management may be improved but
it is appa ently unimpressive and believed to lack adequate
depth to administer the improved policies."

8-30

The FRh met with the board of directors at the close
of the examination to discuss the bank's problems.
FRS rated management "fair" and classified the bank
as a "nonprobiem."
April 1976
The transmittal letter indicated that further effort
was needed to reduce classified loans and again requested
monthly status reports. The letter also mentioned that
capital ratios were low despite the addition of capital.
As of April 1976, the bank had sent nine progress
reports to the FRB.
August 1976
Between April and August, the bank sent five more
progress reports to the FRB.
Our comments
After the February 1976 examination, FRS removed the
bank from problem status, even though classified assets
had decreased only $300,000 since the last examination.
The ratio of classified assets to adjusted capital was
more favorable because over $1 million of capital had
been added.
This case demonstrates that the examiners often make
important observations about the bank's condition without
including them in the portion of the report sent to the
bank.
(See ch. 6.)
In the confidential section of the
first examination report, the examiner noted that the
bank's capita] ratios were below acceptable levels.
Although the transmittal letter commented on the capital
deficiency, such comments were not included in the portion of the examination report going to the bank until
the second examination report--ll months later. Also, the
agency did not attempt to discuss the problems with the
bank's directors until after the second examination.
The same problems have been in evidence for almost
2 years yet FRS has had little success in using informal
enforcement action to get the problems corrected.

8-31

Case 3--OCC Problem Bank
July 1974 examination
The first examination report which we reviewed disclosed the following problems:
-- Violations of laws.
-- Increasing classified assets.
-- Inadequate credit files.
-- Low liquidity.
-- Internal control deficiencies.
Following the examination, OCC classified the bank as
a "nonproblem" and rated management "satisfactory."
September 1974
Regional officials wrote to the bank expressing concern with the sharp increase in classified assets and the
violations of laws cited in the report. OCC requested the
bank to submit progress reports.
The president of the bank and officials of its holding
company visited the OCC regional counsel to discuss a group
of loans criticized in the July report. As a result of the
meeting, the examiner-in-charge visited the bank's mortgage
loan department and found that classified loans had increased since the July examination.
Because of problems disclosed in the July examination and the visit, the bank's president and three
officials of the mortgage loan department resigned under
pressure from the bank's board of directors.
November 1974 and January_1975
The bank submitted a progress report to the regional
office.

8-32

February 1975 examination
The report cited:
-- Violations of laws.
-- Increasing classified assets.
-- Inadequate credit files.
-- Low liquidity.
-- Overdue loans.
OCC classified the bank as a "problem" and rated
management as "fair."
AEril 1975
At the close of the examination, the examiner-incharge and the deputy regional administrator met with
the bank's board of directors to discuss the deficiencies.
May 1975
The regional administrator sent the bank's board of
directors a letter reemphasizing the bank's violations
of laws, classified assets, poor credit information,
and low liquidity. He requested monthly progress reports
to the region and to headquarters.
July 1975
The bank submitted a progress report.
August 1975
Regional officials noted that liquidity had dropped
below acceptable levels and they held a meeting with bank
officials to discuss plans for improving liquidity.
The bank submitted another progress report.
September 1975 examination
The report cited:

8-33

-- Violations of laws.
-- Classifi:' assets are decreasing but still are considered high.
-- Low liquidity.
-- High volume of overdue loans.
OCC classified the bank as a "problem" and rated
management "fair. "
The barik submitted another progress report.
October 1975
The bank submitted a progress report.
November 1975
The regional administrator wrote to the bank's board
of directors, citing violations of laws. classified assets,
overdue loans, and low liquidity.
He a-.o asked that
progress reports be continued.
December 1975, JanuarX and-February 1976
The bank submitted progress reports.
March 1976
The bank's president and an official of the parent
holding company visited the regional office to discuss
problems experienced by the bank.
The bank submitted progress reports.
April 1976 examination
The report cited:
-- Violations of laws.
-- Classified assets are decreasing but are still high.
-- Inadequate credit files.
-- Overdue loans.
8-34

OCC classified the bank as a "problem" and rated
management "fair."
The bank submitted a progress report.
June 1976
The regional administrator's transmittal letter to the
bank's board of directors referred to the problems cited
He again
in the report and mentioned pending litigation.
continued.
be
reports
requested that progress
Jul_

1976

The deputy regional administrat-:
board of directors.

with the bank's

The bank submitted a progress report.
August 1976
The bank submitted another progress report.
Our comment

For 2 years OCC has used mostly the same types of
informal enforcement actions to get the bank to correct
its problems, yet many of the problems continued.
This case also shows that altnough the agencies find
problems, they sometimes do not address the basic causes.
For four consecutive examinations, the
(See ch. 5.)
several problems with loans and yet,
cited
examiners
loan policies and procedures-causes--poor
the probable
The agency did not meet with
problems.
as
cited
were not
until after the bank was
directors
of
board
the bank's
though similar problems
even
problem,
a
designated as
(See ch. 6.)
earlier.
months
10
found
were

Case 4--FDIC Nonpoblem Bank
April 1973 examination
The first examination report which we reviewed cited
problems and recommendations as follows:

8-35

(1)

Increase in classified loans due to weak
lending policies, collection practices, and
credit analyses--certain classified loans
should be written off.

(2)

Adjusted capital below State and national
averages for comparable banks--capital should be
increased.

(3)

Internal control weaknesses--management's atteition is needed.

In the confidential section of the report, the examiner stated:
-- The bank's lending policies were liberal.
-- Management wa' unwilling to accept his recommendations.
-- The loan function was totally decentralized and
working space was too limited.
--The president was too preoccupied with texpansion
plans.
Following the examination, FDIC tated management as
"fair" and classified the bank as a "nonproblem."
August 1973
The State supervisory agency wrote to the bank and
recommended an increase in capital and better control and
supervision of lending and collection policies. The bank
responded to the State that it had increased its capital
as recommended.
Se2tember 1973
The bank wrote to FDIC regarding the deficiencies
mentioned in the examination report.
March 1974 examination
The report cited the following problems and recommendations:
(1)

Excessive classified assets; primarily loans.

8-36

(2)

Weak credit supervision, loan portfolio management, and collection efforts--corrective action
required.

(3)

Adjusted capital well below State and national
averages of comparable banks, despite the recent
injection of capital.

(4)

Internal control deficiencies.

%5)

Violation of State banking

laws.

Again in the confidential section of the report, the
examiner stated that the president was more concerned
with expansion than with daily banking activities.
Following the examination, FDIC rated management as
"fair" and classified the bank as "nonproblem."
August 1974
FDIC wrote to the bank asking for its actions or plans
to increase capital and reduce the volume of classified
and delinquent loans.
September 1974
The bank reported to FDIC on

its planned actions.

May_1975
The bank submitted, for FDIC's approval, a proposed
circular for issuing capital notes.
June 1975
FDIC approved the circular.
July 1975 examination
The report cited problems and recommendations as follows:
(1)

A 98 percent increase in classified assets, primarily loans, due mainly to ineffective supervision and collection of loans.

(2)

Losses in real estate and securities--bank
managers should obtain additional capital.

The examiner noted other deficiencies similar to those
of the two previous examinations and said the bank was having
problems issuing its capt..l notes.
8-37

Again, the examiner cemarked in the confidential section that the bank's president devoted 100 percent of
his time promoting his "bank's image" for growth, through
mergers and branching. The exa.,;iner stated that the bank's
financial condition was less than average as the quality
of its assets continued to depreciate.
Following the examination, FDIC rated management
"fair" and classified the bank as "nonproblem."
October 1975
FDIC's transmittal letter
report action taken or planned
problems.

requested that the bank
to correct a!1 cited

December 1975
The bank responded to
taken on them.

[action

the reported deficiencies and

Our comment
The bank has had the same problems for 2-1/2 years,
yet FDIC has not varied or increased its followup activity. It could have used more informal enforcement action
or considered using formal action to coriect these
problems.
The agencies rarelr met with the boards of directors
of banks unless the banks were considered to be problems.
(See ch. 6.)
In this case, despite an apparently
unresponsive management, FDIC representatives did not
meet with the bank's directors during 2-1/2 years.
The
examiners were highly critical of management in the
confidential sections of the reports but not in the portions of the reports the bank received.

Case 5--FRS NonproblemBank
October 1973 examination
The first examination report which we reviewed
two problems:

-- Substantial decline in net

8-38

income.

cited

-- Substantial decline in net income.
-- Low capital position.
FRS rated management as "satisfactory" and classified
he bank as "nonproblem."
March 1974
FRS wrote to the bank and requested its formal response
to and its action taken on the examination deficiencies.
2Eril 1974
The bank informed FRS of the action it had taken to
correct the examination deficiencies.
June 1974 examination
The report cited four problems:
(1)

Capital continues to be somewhat low.

(2)

Increasing classified and specially mentioned
loans.

(3)

Violations of law.

(4)

Serious internal control deficiencies--it is imperative that immediate corrective action be taken

FRS rated management as "fair" and classified the bank
s a "nonproblem."
November 1974
FRS wrote to the bank requesting that it formally state
what actions it would take to correct the examination
Deficiencies.
December 1974
The bank informed FRS of its efforts to strengthen
internal controls and gave its assurance that the other
Jeficiencies would be corrected.
May 1975 examination
The report cited four problems:
-- Capital funds continue to be low.
8-39

-- Classified loans have again increased.
-- More violations of law were committed.
-- Internal control weaknesses still existed.
In the confidential section of the examination report,
the examiner stated that the bank's general condition was
satisfactory; however, he noted that the capital structure,
the classified assets including loans, and the violations
of law were unsatisfactory.
The examiner discussed the examination deficiencies
with the bank's managers at the close of the examination.
FRS rated management as "satisfactory" and classified
the bank as "nonproblemo"
September 1975
FRS sent the examination report to the bank and
requested response to its criticisms.
October 1975
The bank responded that it was acting to correct the
defic ienc ies.
Our comment
Even though the same problem has existed for 2 years,
FRS has not increased its use of informal enforcement
action or considered using formal action.
Although the reports of examination indicated that
the bank was not solving its problems, the FRS did
not discuss the examinations with the bank's board of
(See ch. 6.)
directors.

8-40

Case 6--OCC Nonproblem Bank
Auust 1973 examination

The first examination report which we reviewed cited
the following problems and recommendations.
(1)

Inadequate capital--the bank should secure
additional capital.

(2)

Poor liquidity--liquidity should be improved.

In the confidential section of the examination report,
the examiner recommended that OCC headquarters formally
request that the bank secure additional capital.
OCC rated management as "satisfactory" and classified
the bank as "nonproblem."
Sj!ptember 1973
The regional administrator wrote to the bank's board
of directors expressing concern over the capital position
and suggesting that the board (1) study ways to correct the
problem and (2) advise him of the results.
November 1973
The bank responded to OCC, agreeing that capital
should be strengthened and providing a plan for improvement
After reviewing the bank's financial report, the
regional administrator wrote to request its plans for
improving its liquidity position.

8-41

The regional administrator wrote to the bank stating
that OCC would not pursue the capital adequacy matter
until the next examination.
December 1973
The bank responded to OCC that it was aware of its
liquidity situation and was making every effort to keep it
within a satisfactory range.
July 1974 examination
The report cited the following problems and recommendations:
(1) Inadequate capital--capital should be increased.
(2) Poor liquidity--liquidity position should be
improved.
(3) Internal control deficiencies.
For the second time the examiner recommended that OCC
headquarters request that the bank increase its capital.
OCC rated management as "satisfactory" and classified
the bank as "nonproblem."
October 1974
The regional administrator wrote to the bank and suggested that the bank adopt a program to increase capital
and inform him of its plans.
November 1974
After reviewing the bank's financial report, the regional administrator wrote to the bank about its low liquidity position and requested plans for improving liquidity.
December 1974
Bank officials agreed with the need to increase capital.
They said the increase could not come from external sources
due to market conditions and presented a plan for increasing
capital from internal sources.

8-42

The regional administrator wrote to the bank stating
that OCC would not pursue the capita] adequacy matter
until the next examination.
July 1975 examination
The report cited the following problems and recommendations:
(1) Inadequate capital--capital should be increased.
(2) Poor liquidity--liquidity should be improved.
The examiner, for the third time, mentioned that the
bank would increase its capital if OCC headquarters would
make the recommendation.
OCC rated management as "satisfactory" and classified
the bank as "nonproblem."
Sep .

er 1975

The regional administrator wrote to the bank about the
problems noted and the need for a program to add more
capital. He requested a formal response from the board
of directors.
October 1975
The bank's president responded that the hank was making
every effort to correct its problems.
The regional
administrator decided not to pursue the capital adequacy matter until the next examination.
Our comment
Even though the same problems have existed for over 2
years, OCC has not altered or intensified its use of
followup activity.
In addition, coordination is
apparently lacking between the regional office and headquarters in getting the bank to take corrective action.
OCC could have increased its use of informal enforcement
actions or considered using formal actions to correct
these problems.

8-43

The agencies do not have definitive criteria for
assessing the adequacy of a bank's capital.
(See ch. 4.)
In this case, the examiner and regional administrator
seemingly did not agree on the seriousness of the bank's
capital problem.
Judging by actions it took, OCC's position on the bank's capital was at best confusing.

Conclusions
The supervisory agencies dealt with the above "probblem" and "nonproblem" banks in basically the same way and
had little success in getting them to correct their problems.
Even though the same types of problems existed from
one examination to another, the agencies frequently did not
vary or intensify their use of enforcement action to get
the problems corrected.
We believe the agencies could have
made more use of their formal enforcement powers to correct
some of the problems, because formal powers had been used
in the past to correct some of these same types of problems.
Problem banks presumably present a greater risk of
financial loss than do nonproblem banks.
We believe, therefore, that in order to fulfill their responsibility to maintain soundness in the banking system and to protect depositors, supervisory agencies should followup on problem banks
more aggressively than they do on nonproblem banks.
If the
supervisory agencies find that certain followup actions are
not working, they should try something else or at least
intensify their actions in order to get the problems
corrected.
HOW THE AGENCIES DECIDE WHICH BANKS
REQUIRE SPECIAL-SUPERVISORY ATTENTION
After every examination, the supervisory agencies evaluate the effects of the problems identified on the soundness
of the bank.
If agency officials judge the bank's problems
as serious enough to affect its soundness, they designate
it as a problem bank or one requiring special supervisory
attention.
A bank's rating is not always the determining factor
in deciding whether it is a problem bank.
Not all banks

8-44

with poor ratings are designated as problem banks, nor are
problem banks only those with poor ratings. The supervisory agencies say they consider a bank's overall condiditioi--capital adequacy, asset quality, earnings, liquidity, quality ;f management--and do not always rely on any
specific rating factor in determining whether a bank is a
problem bank.
The regional offices and district banks have primary
responsibility for monitoring problem situations in banks,
whether or not they are designated problem binks.
If
the bank is designated as a problem bank, the supervisory
agencies' headquarters also become involved in the monitoring process.
FDIC problem classifications
FDIC classifies banks according to the severity of
their problems so its Board of Directors can assess the degree and dollar volume of potential threat to the insurance
fund. The classifications follow:
-- Serious problem, potential payoff:
FDIC has no
specific guidelines for placing a bank in this
category. It is reserved for serious problem banks
(see below) which are in advanced deterioration
that could result in failure and which present a 50percent chance of requiring FDIC financial assistance in the near future.
-- Serious problem: a bank that threatens to involve
FDIC in a financial outlay unless drastic changes
occur. These banks are usually those in which the
nature, prevalence, and trends of weaknesses are
such that correction is urgently needed. Their net
capital and reserves position (the second element of
the FDIC rating) is likely to be substantially negative.
In addition, management (the fourth element
of the FDIC rating) is usually rated unsatisfactory
or poor.
-- Other problem: a bank that has major weaknesses
but a lesser degree of vulnerability and that requires more than ordinary concern and aggressive
supervision. These banks' net capital and reserves
position is generally low or negative. Banks also
can be placed in this category because of excessive
loan delinquencies, a rapid rate of asset deterioration, significant violations of laws or regulations,
8-45

an unusually low adjusted capital position (the
first element of the FDTC rating), an undesirable
liquidity posture, pronounced management deficiencies, or other adverse factors. Usually, management is rated unsatisfactory, with a rating of
fair or satisfactory the exception.
FRS problem classifications
FRS classifies banks which have composite ratings of
"3" or "4" as problem banks. However, a bank which is
rated "2" can also be designated as a problem bank if FRS
judges that its problems could ultimately affect its soundness. The composite rating is one of the four elements of
the FRS rating. A bank rated "3" requires special supervision and a bank rated "4" usually requires prompt and ex-

tensive attention to restore it to a satisfactory condition.
OCC problem classifications
Since 1970, OCC criteria for problem banks have varied.
Until late 1974, problem banks were those banks whose classified assets totaled 40 percent or more of the bank's gross
capital. An OCC official said problem banks were probably
those with an overall rating of "3" or "4".

In November 1974, OCC initiated the "Victor program."
Initially, the Vict)r program included all banks with a
composite rating of "3" or "4" and any other banks which
OCC believed warranted special attention. In December 1974,
OCC changed the criteria for including banks in the Victor
program. Examiners were reauired to include banks when
they judged that any condition existed which could lead
to ins-lvency or when criticized assets were 65 percent or
more of adjusted capital.
In late 1975, OCC began a "special projects/bank
review program." The special projects group supervises
banks with total resources of $100 million or more and
the bank review group supervises banks with total
resources below $100 million. The criteria for selecting
banks for the program are as follows:
-- Banks are designated by the regional administrators
according to their judgment of the quality of assets,
adequacy of earnings, quality of management, capital
adequacy, and other factors.

8-46

-- Banks having criticized assets totaling 65 percent
or more of adjusted capital, as well as other deficiencies, are reviewed by the regional administors for possible inclusion.
--All other banks with assets exceeding $100 million
and criticized assets that total 65 percent or more
of adjusted capital are reviewed by the special
projects group for possible inclusion.
-- Still other banks are designated by banking operations, special projects, and the National BanK Surveillance System group using the above criteria.
--All banks operating under a formal written
agreement or a cease and desist order are included.
OCC classifies banks included in the program as follows:
-- Critical:
a bank which exhibits a combination of
weaknesses and adverse financial trends which
endanger its liquidity and solvency.
The probability
of failure is high for such banks and they require
the most intense supervision and m.nonitoring.
-- Serious: a bank whose weaknesses and financial
trends are not so severe as to immediately threaten
the liquidity and solvency of the institution. The
potential for failure is present but is not pronounced.
Such banks require continuous monitoring,
supervision, and attention.
-- Special levels of supervision:
a bank that may
be experiencing a combination of adverse factors
to the same or lesser degree than those banks in the
serious category. However, banks in this category
possess certain characteristics more favorable than
banks in the critical and serious categories. They
are less vulnerable; their strength ard financial
capacity is such as to make a failure a remote
possibility. OCC maintains that these banks are
not problem banks but require more than ordinary
supervisory concern and monitoring.

8-47

Different crif

ia--different problem banks

As shown above, each supervisory agency uses its own
criteria to identify problem banks and the bank's rating
is not always The determining factor.
OCC included 255 of the 4,744 national banks in the
"special projects/bank review program" as of December 31,
1975.
Of that number 85 were problem banks which required
more than ordinary supervisory concern and monitoring. OCC
said that while the remaining 170 banks were monitored under the program, they did not receive the same degree of
monitoring as did the 85 banks or were monitored for reasons
other than the fact that they were problem banks.
Of the 85 banks, 22 had composite ratings of "1" or
"2," 46 had composite ratings of "3," and 17 had composite
ratings of "4."
Since all national banks are members of
FRS, it also is interested in the condition of those banks.
FRS does not maintain a list of problem national banks,
but it would have so classified 267 national banks--those
which OCC rated as composite "3" or "4."
The banks so
classified would have included 63 banks identified by OCC.
All national banks are also insured by FDIC, so it, too,
is interested in their condition. FDIC, using its criteria,
classified 52 national banks as problem banks, including
32 of those identified by OCC.
Of the 1,046 State member banks as of December 31,
1975, FRS classified 65 as problem banks.
Since
all State member banks are insured by FDIC, it is
concerned about the condition of those banks.
FDIC
classified only 17 of these State member banks as problem
banks. FDIC's rating of national and State member banks,
however, is based on financial risk to the insurance fund.
The difference in the number of designated problem banks
could also be partially due to a difference in judgment by
the ag' ncies in identifying problems in areas such as capital, liquidity, and management.
We believe there should be some consistency among the
supervisory agencies in determining whether or not a bank
is a problem bank.
OCC included 22 national banks as problem banks which FRS did not include and 53 national banks
as problem banks which FDIC did not include. On the other
hand, FRS included 204 other national banks as problem
banks but OCC did not include them and FDIC included 20

8-48

national banks not included by OCC. The same holds true
for FRS and FDIC. FRS included 48 State member banks as
problem banks which FDIC did not include.
Conclusions
Because the supervisory agencies are responsible
for maintaining soundness in the banking system and for
protecting depositors, they should agree on which banks
are problem banks needing extra attention.
The use of
different criteria to identify problem banks results in
some differences in the agencies' problem bank lists.
As a result, some banks may be receiving more attention
than they need and some less. The reader would have had
difficulty concluding which of our case studies were problem banks and which were not, if we had not labeled them
as such.
We believe that uniform criteria are necessary
to assure that the agencies are identifying and monitoring
the right problem banks.
Recommendation
We recommend that the Board of Directors, FDIC, the
Board of Governors, FRS, and the Comptroller of the
Currency develop uniform criteria for identifying problem
banks.
Agency comments
FDIC stated:
"We believe our general comments clarify the posture
of the three federal bank regulatory agencies with
respect to problem banks,.including those which pose
supervisory problems as well as those which present
inordinate financial risk to the FDIC.
Moreover,
we do not believe there is confusion or wide disagreement among the bank regulatory agencies as to
which banks should be accorded close surveillance
and supervision by the respective agencies and that,
except in a failing bank, and to a limited extent
in a bank holding company situation, there is
virtually no overlap of regulatory jurisdiction
at the federal level.
Furthermore, the need to
develop common criteria for problem banks is not
obvious and indeed may not be appropriate.

8-49

"It is, we believe appropriate and useful for the FD'C
as an insurer to view what constitutes a problem bank
from a somewhat different perspective than the other
two federal bank regulatory agencies.
In addition, the
extent to which the three federal bank regulatory agencies use somewhat different approaches to the issue of
banks in need of increased and intensified supervision
could foster a greater degree of innovation in this
area of supervisory endeavor and could serve as a check
and balance in the promotion of the widest coverage of
such banks.
Finally, the objectives and detached
review process conducted by FDIC of all types of examinations, in order to assess the degree of financial
exposure to the insurance fund, provides an overall
review of all banks without imposing across-the-board
guidelines which may not be suitable for the three
agencies on individual basis."
FRS stated:
"As previously noted in earlier responses, the rating
systems are utilized for different purposes within
different agencies.
However, we believe there is
certainly room for much common ground in this area.
The legislative proposals for a Federal Bank Examination Council referred to earlier would aid in
this development, though judgmental evaluation of
any common critieria will likely lead to some
diversity."
OCC stated:
"The term 'problem bank' is barking agency jargon
for many different fact patterns.
To an outsider,
it appears reasonable and logical to expect a uniform
definition of the term.
The agency staff person
recognizes the difficulty of reducing all the variables
to a single definition.
At the same time, he has
little difficulty in communicating with colleagues
in other banking agencies on particular bank situations.
"OCC's approach is to computerize to the greatest
extent possible the many variables which characterize a
bank's condition and management from time to time.
This results in a capability to rank all banks in relation to their peers.
The final selection of banks

8-50

needing special supervision can only be done subjectively by trained personnel using all the tools available and the results of our revised examinations.
The dividing line on the spectrum between 'problem'
and 'non-proDlem' status is hard to define but OCC
is more than willing to consult and cooperate with
the other agencies in seeking such dividing lines."
DYNAMICS OF THE PROBLEM BANK LIST:

1971-75

In the early 1970's problem banks were decreasing,
however, by the end of 1975, they had increased substantially. At the same time, more banks with deposits of
over $100 million began appearing on the supervisory
This is illustrated by the
agencies' problem lists.
following schedule:

Date
12/31/70
12/31/71
12/31/72
12'31/73
12/31/74
12/31/75
9/30/76

Problem Lists
FRS
FDIC (note a)
Total no. Large
Totai no. Large
of banks banks
banks
of banks
190
183
145
124
144
275
288

39
48
36
29
38
65
65

2
3
1
4
14
16

4
6
6
5
7
18
19

OCC -no. Large
of banks banks
123
119
73
109
187
267
219

9
10
5
7
33
58
48

a/FDIC includes national and State member banks on their
problem lists, in addition to State nonmember banks--for
which they have supervisory responsibility. However, these
figures represent only the State nonmember banks on FDIC's
problem list.
We analyzed the number of problem banks at the supervisory agencies for the 5-year period ended December 31,
OCC's criteria varied during the period, and it
1975.
could not identify for us all banks which had been conAn OCC official said that until
sidered problem banks.
December 1974, problem banks were mostly those with comTherefore, we are showing
posite ratings of "3" or "4."
those national banks with composite ratings of "3" or "4"
as OCC problem banks.

8-51

Number of problem banks.
at 1.2/31/70
Number added from
1/1/71 thru 12/31/75
Total number of problem
banks during the 5-year
period
Number returner to nonproblem statut during
the period
Number merged with another
bank
Number closed
Number converted to a
national/State charter
Number that withdrew
from FRS membership

FDIC

FRS

OCC

190

123

528

563

718

(100%) 128 (100%)

686

(100%)

414

( 58%)

392

( 57%)

14 (
15 (

2%)
2%)

Number removed from list

443

Number of problem banks
at 12/31/75

275 ( 38%)

Total number of
banks at 12/31/75
Percentage of problem banks
among total banks supervised at 12/31/75

( 62%)

38 ( 30%)
9 (
2 (

7%)
1%)

8
11

(
(

1%)
2%)

1 (

1%)

(

1%)

13 ( 10%)

63 (_49%)

419

( 61%)

( 51%)

267

( 39%)

8,594

1,046

4,747

3.2

6.2

5.6

8-52

The following analysis shows, for the 844 banks
returned to nonproblem status, the length of time they were
classified as problem banks.

Years

Total
NumPerber
cent

Number

Under 1
1 to 2
2 to 3
3 to 4
4 to 5
5 to 10

395
248
e8
45
21
45

149
136
59
26
14
28

36
33
14
6
3
7

414

100

10 or more

844

47
29
11
5
3
5
-

100

FDIC
Percent

FRS
Num- Perber
cent
12
8
6
4
2
6

32
21
16
10
5
16
-

100

OCC
Num- Perber
cent
234
104
23
15
5
11

60
26
6
4
1
3

392

100

Of the 844 problem banks that returned to nonproblem
status, 76 percent were problem banks for 2 years or less.
Nineteen percent were problem banks from 2 tc 5 years;
5 percent, from 5 to 10 years; and 2 banks, for over 10
years.
In addition, 15 banks were on the problem list during
the entire 5-year period of our study. As of December 31,
1975, these banks had been problem banks for an average
of 9.2 years. Of these, one State nonmember bank had been
on the problem list for 20 years; one State member bank,
for 26 years; and one national bank, for 10 years.
Conclusions
The supervisory agencies' success in getting bank
problems corrected depends largely on how willing and
cooperative bank managers are to change those practices
and policies which caused the problems. Those banks
which are receptive to the agencies' identification of
problems and suggestions for soiling them stand a better
chance of correcting their problems sooner.
Therefore,
movement off the problem list results from the banks'
as well as the agencies' actions.

8-53

Most banks (55 percent, -sere returned to nonproblem
status during the 5-year period--most of them (76 percent)
within 2 years.
Informal enforcement action worked for
these banks. The banks remaining on the list (40 percent)
probably had come on the problem list near the end of the
5-year period, too late to have already had their problems
corrected. The problem list as of December 31, 1975, included
only 4 percent of all banks in the system.
What concerns us are those banks which were problem
banks for long periods of time; e.g.. those that were
problem banks for over 2 years. We believe that the
agencies have to use more formal enforcement actions
when dealing with them.
We also question whether banks which have been on the
agencies' problem lists for extended periods of time are
really problem banks. Obviously some banks were able to
remain in existence even though they were on the agencies'
problem lists for a long time.
ENFORCEMENT ACTIONS AGAINST

BANK

5LDIN dOMPANIE-

FRS deals with bank holding company problems the same
way the three agencies deal with problem banks. When
FRBs identify holding company problems. they use informal
enforcement methods. Formal methods can be used when
informal ones fail.
We reviewed 20 holding companies and found that FRBs
used the following types of enforcement actions from
January 1. 1973. through September 30, 1976. to induce holding company management to correct its problems:

8-54

Enforcer

Number
of actions

At action

Informal:
Phone calls and letters
Visits
Special inspections or examinations
Requests for progress reports
Analytical checks
Threat of cease and desist orders
Disapproval of expansion applications
Formal:
Cease and desist order (note a)

13
11
9
8
4
2
6
1

a/Cease and desist order authority was not given to
FRS until October 1974.
As the above table shows, FRBs primarily used informal
enforcement actions when they dealt with bank holding companies.
DO THE SUPERVISORY AGENCIES
HAVE APPROPRIATE POWERS?
Earlier in this chapter we discussed the formal powers
available to the supervisory agencies. Closing a bank or
canceling its insurance does not save it or solve its
problems. although the threat of these actions can influence
managers to take corrective action.
Short of these
procedures, the agencies' formal powers that can be actually
used to influence a bank are removing officers and issuing
cease and desist orders.
Officials at all three agencies said removing bank
officers is now too cumbersome to be useful. The agencies
must prove that the officers have committed acts of
personal dishonesty. and they say such proof is difficult.
In addition. OCC cannot proceed directly against a bank
officer.
it must present its evidence to FRS and rely
on that agency to take action. Consequently. the agencies
do not use their removal power as frequently as they would
like to.
Agency officials said further that cease and desist orders
are not always a deterrent to bank mismanagement, since they
require a bank to stop performing an act or to take affirmative
action to correct the conditions resulting from any such
violation or practice.

8-55

Another problem pointed out by the agencies is
that available legal measures do not get at the individuals
causing banks problems. This is because the measures
are aimed at banks, not bank officials. except for the
unwieldy removal procedure.
The supervisory agencies requested additional statutory
authority in a bill (S. 2304) which was considered
in the second sessicr of the 94th Congress. Among other
provisions, the bill would authorize the three agencies
to initiate removal proceedings against a bank official
whose acts stem from either personal dishonesty or gross
negligence. The bill would have also authorized civil
penalties against banks and officials who violate sections
22 and 23A of the Federal Reserve Act, or regulations
pursuant to them, These sections deal with (1) purchases
of securities from directors, (2) interest on deposits
of directors, officers, and employees. (3) loans to executive officers. and (4) loans to affiliates.
The agencies made only limited studies of the need
for specific legal powers.
In response to the failure
of Franklin National Bank. FRS formed a task force to develop
requests for more statutory tools, but made no quantitative
analyses of bank problems. The agencies used their supervisory experience to decide what. measures could aid them
in dealing with banks. Agency officials do not expect
to use the requested powers very often. but they feel
that the extended authority would be useful when needed.
In our study of 30 banks that failed. we found that
the examiners often sta-ed that the failures were caused by
bank managers who followed self-serving loan practices or
who were incompetent. Also, among our sample of problem
banks on December 31. 1975. management effectiveness was
cited as a problem in 57 percent of the banks at the time
the banks were put on the problem list. Therefore, the
ability to apply penalties or to remove individuals could
have been helpful in dealing with these bank officials.
As for the types of violations mentioned in section
22 and 23A of the Federal Reserve Act, we found that the
percentages of banks in our samples that had these violations
cited after the most recent reports of examination were
as follows:

8-56

Violation
Purchase of
securities
Interest on
deposits
Loans tc insiders
Loans to affiliates

Un
1vZ-rs-aT
--------

Sample
Probl
em-l-_(percent---------

6
10

8
10

4
22

While relatively few banks committed these violations the
authority to levy penalties could be a deterrent.
Conclusions
Although in the past the supervisory agencies have not
used their legal powers often enough. additional powers
could enhance their ability to deal with bank problems.
Specifically. the authority to remove bank officers for gross
negligence and to levy civil penalties for certain violations
could be useful. Therefore, we would support legislation
which would authorize the agencies to remove bank officials
for gross negligence and to assess civil penalties for violations of laws and regulations.
We would also support legislation to allow OCC to present
evidence and argument at removal proceedings conducted by
FRS.

8-57

CHAPTER 9
AN ANALYSIS OF BANKS THAT HAVE
FAILED IN THE LAST 5 YEARS

Overview

9-1

What is a failed bank?

9-4

What happens when a bank fails?
How does FDIC handle closings?
Deposit assumption
Statutory payoff
Deposit insurance national bank
What are the effects of a bank failure?

9-4
9-4
9-4
9-5
9-5
9-6

_'hy did banks fail?

9-9

How early did the agencies identify
the causes of failures?

9-13

How did the agencies try to resolve
the banks' problems?

9-14

Conclusions

9-16

CHAPTAk 9
AN ANALYSIS OF BANKS THAI HAVE
FAILED IN THE

LAST 5 YEARS

OVERVIEV

For the first time since the massive Dank failures of

the 1930s, the public is concerned about the health of the
banking system. One direct result of tnose earlier failures
was the creation of the Federal Deposit Insurance Corporation in 1933, to protect depositors and prevent mass withdrawals. Since 1933, banks have continued t-o fail, but
until 1966 these failures involved relatively small banks.
(The largest had deposits of $48.8 million.)
However, several larger banks have failed since 1965.
The Public Bank of Detroit, with deposits of $93 million,
closed in 1966. In 1971 it was Sharpstown State Bank of
Houston with $66.8 million in deposits; in 1973, U.S,
National Bank of San Diego with $932 million; in 1974,
Franklin National Bank of New York with $1.4 billion; in
1Y75, American City Bank and Trust of Milwaukee with $99.5
million; and in 1976, Hamilton National Bank of Chattanooga
with $341 million.
The graphs on the following page show the number of
failures and the total deposits of banks that closed between
January 1960 and December 1976. Although the number of
failures is still small, the total of failed banks' deoosits
has risen dramatically.
Placing the figures in perspect ve, the largest number
of failures in any year shown was 16 during 1976. This represents about 0.1 percent of the total number of banks. At
the end of 1975 the three supervisory agencies listed a
total of 607 different banks needing special attention;
and the number of failures during 1976 was only 2.6
percent of that figure.
FDIC studies of 92 bank failures from 1960 through
September 1976 indicate self-serving and improper loans
caused 57.6 percent of the failures; defalcations, such as
embezzlement and fraud, 27.2 percent; and other management
weaknesses, 15.2 percent.

9-1

NUMBER OF BANKS CLOSED 1960-1976
Number Of Closings
16
150
14
13
12
10"

1
1960

YEAR

TOTAL DEPOSITS OF CLOSED BANKS 1960-1976

Total Deposits (millions)

900800
700
60
500

300

200

1960

YEAR

9-2

we selected for detailed review 30 of the 42 banks that
Of
were closed between January 1971 and June 30, 1976.
and 2
OCC,
9
by
FDIC,
Dy
supervised
were
19
these 30 banks,
avert
to
others
with
merged
banks
27
An additional
by FRS.
probable failure.
Adverse economic conditions in the early 1970s contributed to some of the bank failures. However, the primary
cause of each failure was the practices followed by the
These practices left the banks more vulDank's managers.
fluctations.
economic
to
nerable
Among the 30 cases we reviewed, 14 banks' problems
were related to self-serving loan policies, which had been
pointed out by examiners well before the banks failed.
Illegal acts such as embezzlements caused eight of the
failures and in seven of those cases examiners had criticized the banks for poor internal controls. Examiners
actually discovered illegal acts at three of those banks.
The remaining eight failures were caused by general loan
mismanagement.
Accoraing to FDIC, one factor common to banks that
failed was the lack of supervision by the banks' boards of
The directors did not fulfil' their responsidirectors.
set and enforce bank policies.
to
bilities
Faced with incompetent or dishonest managers and with
boards of directors that often did not become involved
enough in bank operations, bank supervisors used informal
Managers of banks that
persuasive techniques in vain.
eventually failed did not respond to the supervisory agencies methods and did not correct their problems.
Short of closing a bank the regulators have formal
legal methods available to them, such as terminating insurance and issuing cease and desist orders. (See ch. 8.)
However, the supervisory agencies used their legal powers
in only 8 of the 30 cases we studied, and only after the
Notwithstanding their
banks' problems had become critical.
recent requests for additional powers, we believe the agencies should have used the ones they have sooner and more
often.

9-3

WHAT IS A FAILED BANK?
For purposes of our report, a failed bank is one which
closes due to financial or other problems. A bank can vol-'
untarily liquidate, or, if the Comptroller of the Currency
becomes satisfied that a national bank is insolvent, he may
appoint a receiver. Although State laws vary, State chartering authorities can similarly close State banks. Our
charts on page 9-2 include banks both voluntarily and involuntarily closed.
Some banks in imminent dancer of failing are merged
with or are purchased by other banks. Each supervisoiy
agency can approve such mergers or purchases on an emergency
basis. OCC approved 14 such mergers during the period covered by our study, FDIC approved 10 and FRS 3. If a purchaser
cannot be found and the bank is considered vital to a community, the regulators may give direct financial aid to keep
it open.
WHAT HAPPENS WHEN A BANK FAILS?
When a national bank closes, FDIC is appointed receiver
with power to liquidate assets of the closed bank, enforce
the liability of the stockholders and directors of the bank,
and wind up the bank's affairs. Usually FDIC is appointed
receiver for insured State banks that fail.
How does FDIC handle closings?
FDIC can choose from three basic methods of handling
closings, depending on the potential cost to the Corporation
and the needs of the community.
Deposit assumption
FDIC can assist a sound bank to ansorb a failed bank,
when such action will reduce risk or avert a threatened loss
to the Corporation. It can do this by purchasing assets of
the failed bank, granting a loan to the assuming bank evidenced by a capital note, or indemnifying the assuming bank
against actual or potential losses.
Often, the transaction works as follows:
(1) FDIC, as receiver of a failed bank, solicits bids
to assume deposit liabilities of the bank.
9-4

(2) The winning bidder, which could be a newly
chartered bank, assumes the failed bank's
deposits and perhaps other specified
liabilities. The assuming bank may also
purchase assets of the failed bank from the
receiver.
(3) If liabilities assumed exceed the assets
purchased and the premium paid, the failed
bank's receiver pays the assuming bank the
difference in cash with funds from FDIC for
for its purchase of the remaining assets of
the failed bank.
Twenty of the thirty banks we studied were handled as
deposit assumptions. For example, the newly chartered First
Tennessee National Bank was the winning bidder for the deposit liabilities of the defunct Hamilton National Bank of
Chattanooga. First Tennessee tcok over $385 million in deposits and other liabilities. It paid a premium of over
$16 million, and accepted about $314 million in assets. To
complete the transaction, FDIC as receiver paid over $54
million. FDIC also purchased a capital note of $24 million.
Statutory payoff (straight receivership)
FDIC pays insured depositors out of the insurance fund.
It acts as receiver for the failed bank. The 30 cases we
reviewed included 8 statutory payoffs. One such case was
the Elm Creek State Bank of Nebraska. This bank had total
deposits of about $2.9 million, including those of 23
uninsured depositors. All insured depositors were paid,
and even the uninsured depositors had received 95 percent
of their money at the t .me we made our study.
Deposit insurance national bank
If FDIC finds that it is advisable and in the interest
of the depositors of the closed bank, OCC may charter a
Deposit Insurance National Bank (DINB). For a period of up
to 2 years the DINB services deposits and may, if its charter allows, extend loans. The manager of the bank is appointed by FDIC and is under its direction. FDIC may make
a public offering of the DINB, but if a buyer cannot be
found within 2 years FDIC must wind up the affairs of the
DINB.

9-5

DINb's were established in 2 of the 30 cases we studiea.
One was the Swope Parkway National Bank of Kansas City,
Missouri.
The DINB assumed all insured deposits us to
$40,000 and also assumed cash and "due irom banks" accounts,
along with certain investments.
As assets are liquidated,
uninsured deposits and other creditors are being paio off.
The stockholders have lost their investments, out they have
the first chance at buying into the DINB.
Insured deposits
were aoout $4.9 million, and FDIC nas established a loss
reserve of $1.5 million for this case.
What are the effects of a oank failure?
The financial effects of a bank closing vary according
to the method used to handle it.
A deposit assumption may offer the least inconvenience
to the bank's former customers.
Banking services often reremain uninterrupted for members of the community.
No deposits are lost, and at least some borrowers may continue to
have creidit available from the assuming oank.
Generally,
'DIC acquires the unassumed loans and continues to collect
them.
Most creditors other than depositors must await the
outcome of FDIC liquidation proceedings before they know what
their losses are. They are left to any legal remedies they
might have against the receivership. The banK's stockholders
can lose their investments out may recoup something as a
result of liquidation by FDIC.
In a statutory payoff, only insured depositors are paid
off quickly. Uninsured depositors, other creditors, and
stockholders must await the outcome of liquidation.
bank

customers, of course, mnust try to find services from another
bank.
The full financial impact of a closing is not calculaole until the liquidation process is completed. This process may take several years after the closing, so we could
not determine tne tull effects of each failure we studied.
However, according to FDIC, tor banks that failed since
1934, over 99 percent of all depositors--insurea and uninsured--have been paid in full or nave had their funds made
available to them, as in a deposit assumption.

9-6

FDIC's costs include the amount it pays to depositors
a
payoff, or the amount it pays to facilitate an assumpin
tion; tne interest income lost on the money it pays out; and
the expenses of acting as receiver for the failed bank.
FDIC may recover money from the liquidated assets of the
bank; proceeds from fidelity bonds; and proceeds from direc-

tors' liability.
When a Dank tails, FDIC estimates the potential losses
assets
on liquidating the assets it assumes. As the bante's
are liquidated, the reserve establishea for the losses is
had approved
7,'IC
aajusted semiannually. As of June 30, l75,
the following reserves for banks that failed during the period we studied:

FDIC Reserves for

Losses on Closed Banks

Reserve

t.aine of bank

(000 omitted)
Payoffs:
Sharpstown State Bank
Houston, Tex.
Farmers State Bank of
Carlock, 111.
First National Bank ot
Cripple Creek, Colo.
Surety Bank & Trust Co.
Wakefield, Mass.
Swope Parkway National Bank
1/
Kansas City, Mo.
FranKlin Bank
Houston, Tex.
Peoples Bank of the
1/
Virgin Islands
Mt. Zion Deposit BanK
1t. Zion, Ky.
Coronado NJational Bank
Denver, Col.
Citizens State Bank
Carrizo Springs, Rex.

Deposit Insurance National

Bank

9-7

$1,050
300
140
4,100
1,500
3,025
2,350
100
200
300

Name of bank

Reserve
(000 omitted)

Deposit assumptions:
Skyline National Bank
Denver, Col.
U.S. National Bank
San Diego, Cal.
First National Bank of
Eldora, Iowa
American Bank & Trust
Orangeburg, S. C.
Tri-City Bank
Warren, Mich.
Northern Ohio Bank
Cleveland, Ohio
Algoma Bank
Algoma, Wisc.
Bank of Chidester
Chidester, Ark.
State Bank of Clearing
Chicago, Ill.
Astro Bank
Houston, Tex.
American City Bank & Trust Co., N.A.
Milwaukee, Wis.
Peoples Bank
Wilcox, Ariz.
Bank of
Bloomfield, N. J.
Bank of Woodmoor
Monument, Col.
South Texas Bank
Houston, Tex.
Northeast Bank of
Houston, Tex.
First State Bank of Hudson County
Jersey City, N.-J.

130
350,o00
85
2,700
2,100
5,725
825
620
8,700
440
13,530
125
600
330
950
680
570

Not all the banks that failed during the period we studied are on the preceding list, because FDIC did not project
losses for them. For example, FDIC does not anticipate losses on Franklin National Bank, so no reserve was established.

9-8

FD1C derives most of its income from assessments (similar to insurance premiums) paid by insured banks and from
investments in U.S. Government securities.
From
tne total assessments due each year FDIC subtracts its expenses, insurance losses, and net increases in loss reserves.
Two-tnirus of the remainder is credited back to
insured DanKs to offset forthcoming assessments.
Therefore,
the more Danks that fail and the larger their assets,
the less is credited back to the banks still operating.
In tnis way, all insured oanks oear the costs of failures
-- the concept of risk-spreading through insurance.
FDIC officials said failures, especially of small
oanks, have usually had little impact on the communities
involved.
Of concern to many is the effect of large bank
failures on the public's confidence in our banking system.
Although it is apparent that the economy can tolerate the
number of failures that have occurred in recent years, we
cannot determine at what point an intolerable situation
would develop.
For example, if the number of large bank
lailures were to increase, the economy coula be seriously

affected.
WHY DID BANKS FAIL?

From 1934 to the early 1960s, illegal acts--such as
fraud and embezzlement--were the major cause of bank
failures. Some failures also resulted from extremely
oad management.
The Chairman of FDIC I/ has pointed out that in the
late 1960s some banks began expanding their activities
into riskier areas, such as real estate, direct lease
financing, and foreign operations. These banks were primarily concerned with rapid growth and high profits, and they
adopted more liber~e lending policies. With the relatively
stable growth and moderately stable prices of that period,
no noticeaole harm was caused by these new banking
philosophies.
1/Robert E. Barnett, in a speech before the 92nd annual
convention of the Texas Bankers Association, El Paso,
(May 3, 1Y76).

9-9

But the early 197Cs provided a tougher economic climate. Bankers faced not only a major recession but also
tight credit and high borrowing costs. These economic conditions contributed to the increase in bank failures.
However, our study of examination records of failed
banks revealed that the failures were primarily caused
by the policies used by the banks' managers. Examiners
in 17 of the 30 cases we studied had criticized the
banks' managers for following self-serving loan practices.
In 26 cases examiners considered managers incompetent.
In 17 cases examiners had warned that the banks were
overconcentrating their loan risks in a single industry
or to a single borrower. And in 27 of 30 cases we
reviewed, examiners stated that the banks' loan records
were inadequate.
In other words, management practices were unusually
risky even under good economic conditions, since poor
loans were often made. Therefore. the banks were more
vulnerable to economic fluctuations.
A recent FDIC study of 92 bank failures between January
1960 and September 1976 showed that 57.6 percent were caused
by improper loans to officers, directors, or owners, or by
loans tc out-ot-territory borrowers; 27.2 percent resulted
from embezzlement or manipulation of funds; and 15.2 percent
were due to general loan management weaknesses. Compared
with an earlier FDIC study through 1974, this one showed
proportionately more failures caused by poor loan management
and fewer caused by embezzlement.
The 30 banks we reviewed that failed from January
1971 to June 1976 followed a slightly different pattern.
Fourteen of the banks (46.7 percent) failed because the
management made improper or self-serving loans.
Eight
of the cases (26.7 percent) involved general loan management
weaknesses. Eight other cases involved embezzlement or other
crimes. The differences in our statistics reflect an increase in mismanagement as a cause of failure, because our
study covered the most recent cases.

Typical of the cases of self-serving or improper loans
is the following one, which we shall call State Bank.
State Bank opened in the i960s and shared ownership with
9-10

In the first examination we studied,
three other banks.
examiners criticized tl:- self-serving tendencies of the
bank's management. The (examiners stated the bank's directors had borrowed one-fourth of all the money loaned by the
bank, over twice the bank's adjusted capital and reserves.
Subsequent examinations divulged problems such as loans
secured by affiliated banks' stock, affiliated banks
financing each other, an overconcentration of large
speculative advances to real estate developers, and
unsecured credits to heavily indebted borrowers.
When it closed State Bank had assets classified as
"loss" that exceeded its total capital and reserves.
Another bank owned by the same group failed a year later.

A bank which we shall call Capital Bank illustrates
failures caused by the mismanagement of loans in general.
Capital Bank was closed in the 1970s. Some years
earlier the State's capital city experienced a boom in
the real estate market, and developers started many new
housing projects. Some of these projects were aided
by a Federal program promotinr low-income housing.
The bank's directors, according to Federal examiners,
were eager for the bank to grow. They approved large
loans to several developers, thereby overextending the
bank in the real estate area. Examiners believed that many
of these loans were made on the assumption that the real
estate market would continue to expand and that the bank's
officers paid too little attention to the creditworthiness
of the borrowers. Some of the construction projects did not
have s fficient fl,:ids to complete them.
The Federal Government announced plans to phase out
its low Income housing subsidy, and the real estate market in t;eneral also suffered a R.cline. Loans made by
Capital Bank became overdue, w..ik some borrowers unable
to meet their interest payments. Capital Bank made new
loans to some of these borrowers so they could make the
overdue payments on the previous loans. The bank accepted
insufficient collateral for these new loans, according
to examiners.

9-11

Rumors of the bank's financial troubles caused many depositors to withdraw their funds, severely affecting the
bank's liquidity. In spite of a loan from FDIC and a line
of credit at ancter bank, Capital Bank had to close.

The crimes that lead to failures are exemplified by a
bank we shall call Country Bank.
Country, the only bank in a small town, suffered from
a variety of problems. Its management had been rated unsatisfactory by the examiners over most of the last 5 years
of its existence. Examiners had been criticizing the bank
for classified loans, overdue payments, poor internal controls, and violations of regulations. During that time a
new owner took over as president.
As Country Bank was apparently beginning to improve,
its principal correspondent bank informed the State banking commission that Country Bank had been exposed to a
massive check kiting scheme. Federal and State examiners
determined that the scheme involved a substantial sum to
one of the bank's customers and that the same customer had
other unsecured credit at the bank.
A kiting scheme is one in which a depositor with accounts in two or more banks draws on nonexistent funds by
taking advantage of the time required for checks to clear
in order to obtain unauthorized credit. This scheme can
function only if depositors are allowed to draw against
checks which have not yet cleared--a commonly extended
courtesy.
In this case the custcmer maintained checking accounts
at Country Bank and at severa. other banks. He wrote
checks on his Country Bank account and made deposits to
that account using checks of a corporation with an account
at one of the other banks. The cashier at Country told examiners these checks were mailed to the bank at various times
so that enough would be on hand to keep the account
in the black. Once the other banks involved cut off the
kite, Country Bank was unable to recover from its losses.

9-12

A bank's board of directors is responsible for setting
policies and overseeing bank operations. According to FDIC,
one factor common to many banks that failed was that their
boards of directors did not carry out their responsibilities
properly. Examiners had criticized the lack of director
involvement '
O20
of the 30 cases we reviewed.
HOW EARLY DID THE AGENCIES IDENTIFY
THE CAUSES OF FAILURES?
The examiners identified the underlying problems which
led to most bank failures. In 21 of the 30 cases we reviewed, the agencies identified the banks' problems at least
2 years before they closed. Moreover, the examiners usually
commented to bank managers on the problems in reports or
meetings.
Supervisors readily identified continued self-serving
tendencies and poor loan policies. The problems were usually cited in examination reports for several years before
banks failed. For example, OCC examiners criticized credit
practices of the Swope Parkway National Bank almost 4 years
before it closed. Although managers were replaced, losses
from the original loans so depleted the bank that it never
recovered.
Even among the eight banks we studied which failed
because of frauds, examiners had noted problems with internal controls in seven long before they were forced to
close.

OnCit
example is a bank we shall call National Bank.
In the 5 years we studied, examiners had made 9 examinations and 22 visits, and a public accounting firm had
audited the bank.
In one report examiners disclosed that the salaries
of both the bank's vice president and its cashier were
"dangerously low"; however, both men indicated they had
"outside resources or assistance." The bank had a history of problems, including poor internal controls.
But the examiners stated they waived normal control requirements since the bank had only a few employees.
Following the discovery of a shortage by an employee of an affiliated bank, the vice president and
9-13

cashier were found dead in what was termed a mutual selfdestruction pact. Subsequently, the authorities found
substantial shortages and determined that irregularities
had existed for at least 3 years. According to examiners
the two employees had kept two sets of records to hide
the misapplications of funds from examiners. Unfortunately
for the bank, its bonding insurance had been canceled
earlier, and it could not recover from the loss.

HOW DID THE AGENCIES TRY
TO RESOLVE THE BANKS' PROBLEMS?
Supervisory agencies could use both informal and
formal action when dealing with banks having problems.
(See ch. 8.) First they attempted to influence bank
managers and owners with informal techniques. For example, in some of the cases we reviewed, the supervisory agencies male periodic visits to the banks in
addition to regular examinations. Some of the banks
were required to report periodically on progress in
solving their problems.
In one case we studied, OCC
even placed examiners in the bank full time to monitor
its progress.

A bank which we shall call Town Bank will help
illustrate agency actions.
Town Bank served a rural community and was not highly
rated when it was purchased by a new owner.
After the
bank was closed it was alleged several persons used illegal
means to finance highly speculative real estate ventures.
This line of credit comprised almost half of Town Bank's
loan portfolio when it closed.
Examiners had cited the concentrated loans and selfserving tendencies in one of their examinations. Some
months later the bank was sold again, but examiners felt
the new owner was inexperienced. Both Federal and State
banking authorities stepped up their activity. Federal
regional officials met with bank officials, and they conducted a special examination. Town Bank also agreed to
submit progress reports on its efforts to solve its problems.
Federal authorities considered issuing a cease and
9-14

desist order or terminating the bank's insurance, but the
State Commissioner of banking recommended against it,
reasoning that the offending individual had gone and the
offensive acts had ceased. In addition, the Commissioner
felt that such an action would discourage efforts to
resell the bank.
The bank requested that FDIC grant it a loan to stay
open.
FDIC declined, suggesting the bank was not really
essential to the community, and began proceedings to terminate Town Bank's deposit insurance.
A hearing had been
scheduled when the bank finally closed.
In the last few
months both Federal and :icate authorities had tried to
help arrange a merger between Town Bank and another bank,
but their efforts proved futile.

Agency field r rsonnel preferred to use informal
enforcement techniques and usually found them effective.
Regional officials stated they can even influence a
bank's directors to force an undesirable officer to resign.
For example, one bank we reviewed changed managers at the insistence of OCC, but the bank still failed.
When informal measures fail to elicit corrective
action, formal legal authority is available to the
supervisory agencies:
-- FDIC may terminate a bank's insurance.
-- FRS may expel member banks.
-- Any of the agencies may remove offending managers
(OCC must rely on FRS for action).
-- Any of the three agencies may issue a cease and
desist order.
In 7 of the 30 cases we reviewed, the agencies threatened to either close the banks or terminate deposit insurance.
FDIC actually began to terminate the insurance of
four banks we reviewed.
The agency removed an officer of
one bank.
However, he owned a controlling interest in the
bank and so remained influential.
Since 1966 the Federal regulators have had thie power
to issue cease and desist orders. Proceedings were
9-15

initiated in only 4 of the 30 cases we reviewed. Two
were begun 18 months or more after the problems had
first been identified. None of the proceedings went
to the hearing stage because all the banks involved
consented to the orders.
In addition to the actions discussed above, FDIC and
FRS can each render financial assistance to banks in
trouble.
Under section 13(c) of the Federal Deposit Insurance Act (12 U.S.C. 1823(c)), FDIC may make loans,
purchase assets, or make deposits to prevent the closing
of an insured bank which is essential to its community.
Under section 13(e) of the Federal Deposit Insurance
Act (12 U.S.C. 1823(e)), to facilitate a merger, the FDIC
may make loans to the acquiring bank, purchase assets, or
guarantee any other insured bank against losses on purchasing assets.
Such actions were taken to avert a
closing for the first time in 1975, when FDIC loaned $10
million to assist the merger of the failing Palmer First
National Bank and Trust Company.
The Federal Reserve can also make cr.edit available
to banks in trouble. FRS loaned Franklin National almost $2 billion to keep it operating until a permanent
solution could be found to its problems. None was
found and Franklin ultimately closet
CONCLUSIONS
Most bank failures we studied were caused by bad manoqement practices that were readily identified by the
supervisory agencies' examiners. Although economic condit:ons worsened the banks' problem.s, the primary causes
of the failures were the management decisions that left
the banks inordinately vulnerable.
The difficulty confronting the agencies in most of
the cases we studied was not in identifying the problems
but in influencing the banks to solve them.
Although
agency personnel said informal persuasive techniques are
usually sufficient to convince a bank's managers to solve
its problems, persuasion obviously did not work with the
banks that failed. This was usually because the bank
officials followed self-serving loan practices and were
incompetent, as stated in examination reports and correspondence. In addition, the banks' boards of directors
did not meet their responsibilities.
9-16

Faced with this situation, the agencies could have
turned to their legal powers. However, we noted a
tendency by each supervisory agency to delay formal
action until a bank's problems had become so severe as
to be difficult at best to correct. The regulators kept
waiting for the banks to take action they had promised,
and we found bank managers would break those promises
several times before the agencies began legal steps.
Judging the appropriate time :o take formal measures
against a bank's management is dif,:icult. Nevertheless,
in the cases of failed banks we studied, supervisory
agencies did not use their cease and desist authority as
effectively as they might have.
Since 1975, the agencies have begun to initiate more
cease and desist orders. Issuing cease and desist orders
early, when a bank's problems are still manageable, should
increase the supervisory agencies' effectiveness.

9-17

CHAPTER 10

EXAMINER CAPABILITY AND INDEPENDENCE
Pae
Overview

10-1

Recruitment policies and practices
Sources of bank examiners
Standards for beginning examiners

10-4
10-4
10-4

Development of career examiners
Types of training
Conclusion
Recommendation
Agency comments

10-5
10-5
10-6
10-6
10-6

Adequacy of training
Improvement needed in FRS training
Conclusions
Recommendations
Agency comments

10-8
10-9
10-11
10-11
10-11

Performance evaluation
Qualifying for examiner-in-charge
Conclusion
Recommendation
Agency comments

10-13
10-14
10-15
10-15
10-15

Advancement and compensation of examiners

10-15

Assuring examiner objectivity
Restrictions on examiners' outside activities
Financial disclosure requirements
Rotation of examiners
Examiner turnover
Conclusion

10-1d
10-19
10-19
10-19
10-20
10-21

CHAPTER 10
EXAMINER CAPABILITY AND INDEPENDENCE
OVERVIEW
The quality of bank supervision depends largely on the
competence and objectivity of the bank examiners.
In responding to our questionnaire mailed to 1,678 banks,
commercial bank officials generally reported favorably on
the competency of examiners. Senior examiners' understanding of the specialized examination areas of trust and international was rated adequate or more than adequate by 89 percent of the bankers while 11 percent thought it was borderline
or less. Toward examinations of electronic data processing,
however, bankers were less favorable. Here, approximately
25 percent thought senior examiners' understanding was borderline or inadequate. Opinions concerning each of the three
agencies were similar.
An examiner's competence, or examining skill, is his/her
ability to analyze a commercial bank's operations and judge
its soundness. Competence is based on knowledge of banking
practices and of the supervisory agency's policies and regulations. Examiners may acquire this knowledge from colleges,
from employment with banks, and from training and experience
provided by the agency. Agency training and experience
are probably the most important elements to help the examiner
understand and evaluate banking practices.
TIi., agencies are not legally subject to Civil Service
Commission (CSC) rules and regulations governing Federal personnel practices; however, FDIC follows them in recruiting,
compensating, and promoting examiners. OCC uses CSC's General Schedule in paying its examiners. For the most part,
Federal Reserve district banks set their own personnel
policies.
Although the agencies' personnel policies are similar
FDIC
in many respects, there are important differences.
and OCC are more centralized than FRS; therefore, they have
Each Federal Reserve
more uniform policies and practices.
district bank has primary responsibility for recruiting,
training, evaluating, and paying examiners, and, as might
be expected, policies and practices vary considerably.

10-1

Most of the examiners hired by the three agencies have
undergraduate degrees in business-related subjects, and some
have worked in banks or as bank examiners. During 1971-75,
FDIC, FRS, and OCC hired 912, 594, and 1,147 examiners,
respectively, from the following sources:
FDIC
FRS
OCC
------ (percent)-------College
Commercial Banks
Other a/

81
2
17

58
12
30

71
12
17

a/ Private sector, Federal agencies, intra-agency
transfers, reemployed military.
The agencies operate internal schools which instruct
examiners in various aspects of bank examination, such as
commercial banking, trusts, international banking, and
electronic data processing. Bank examiners we questioned
generally rated the internal courses as useful or very useful; however, many thought they needed additional training,
particularly in law, EDP, and accounting.
In the specialized areas of EDP and international banking operations, FRS has not provided much training in recent
years. Its EDP school was not held in 1975 or 1976 though
plans have been formulated for a school in 1977.
Its international school was held once in 1972, 1974 and 1976. FRS
officials note however, that the New York Federal Reserve
Bank provides continuing training in international topics.
FDIC offers three EDP schools which are available to
examiners at various stages of their careers.
It does
not have an international school; officials said that the
banks supervised by FDIC tend to be small and are therefore
unlikely to be engaged in international banking.
FDIC uses
OCC's schools or instructors to provide international training when needed for its examiners. OCC annually operates
one EDP and three international schools for its examiners.
In 1975, the three agencies spent the following amounts
for internal and external training of their examiners, including tuition, books, fees, space rental, and GttCents' and
instructors' subsistence and travel:

10-2

FDIC
FRS
OCC

Training
expenditures

Examining staff

$946,450
321,836
636,000

1,712
709
1,968

Average
expenditure
per examiner
$552
453
323

All three agencies periodically evaluate the job performance of their bank examiners. FDIC and OCC require
employees to complete a formal evaluation process before
they can take charge of bank examinations. The process
emphasizes the skills needed to analyze a bank's management, assets, and soundness. FRS does not have such a
process.
All three agencies have policies to guard against actual
or potential conflicts of interest among their examiners.
The policies generally prohibit examiners from owning stock
in banks or bank holding companies, from having loans or
credit cards with banks that they may be asked to examine,
and from examining banks where their relatives work.
Each agency requires examiners to file statements of
financial and personal interests when they are hired but
only FRS requires annual updates. We have been requested
by the Chairman, Subcommittee on Commerce, Consumer and
Monetary Affairs of the House Committee on Government
Operations to examine, in a separate study, the financial
disclosure practices of the three agencies.

10-3

RECRUITMENT POLICIES AND PRACTICES
Sources of bank examiners
The three bank supervisory agencies generally hire
college graduates with bachelor's degrees in businessrelated subjects such as finance, accounting, and economics;
however, they also consider applicants without degrees who
have worked in banks. Most of the positions are filled at
the entry level, although the agencies hire some individuals
at higher levels who have prier work experience, usually
with banks or with other Fede al or State bank supervision
agencies.
Methods of filling examiner positions vary among the
three agencies. OCC regional offices typically recruit at
local colleges and universities.
In addition, they accept
walk-in applicants and referrals from bankers and OCC employees. FDIC regional offices fill positions from CSC job
registers. Individual Federal Reserve district banks fill
their positions by various methods: recruiting at colleges,
accepting referrals from employees and bankers, contacting
employment bureaus, advertising in newspapers, etc.
Standards for beginninaexaminers
Minimum qualification requirements for examiners hired
by the three agencies are generally an undergraduate degree
in a business-related major or at least 3 years work in
banking or bank examining.
In addition, FDIC requires mo
applicants to pass CSC's Professional Administrative Career
Examination 1/ and OCC requires its applicants to pass a
general abilities test. Each Federal Reserve district bank
sets its own qualification requirements for examiner positions. Some require an undergraduate degree as a minimum
while others accept bank experience in lieu of the degree.
Of the 325 examiners interviewed at the 3 agencies, 301 had
college degrees.

1/Thiose with experience who apply for higher than entrylevel positions must pass CSC's mid of senior-level
examination.

10-4

DEVELOPMENT OF CAREER EXAMINERS
The three agencies' bank supervision duties are carried
out p. imarily by their field examining staffs. Examining
teams are composed of assistant examiners and those who have
reached the full examiner level. Typically, assistants are
apprentices who begin with the more mechanical tasks, such
as cash verification, and progress to more analytical ones,
such as loan evaluation. Those who have reached the full
examiner level are considered capable of conducting the
overall examinat'on and preparing the examination report.
Typically, it takes 4 to 5 years for an individual to
progress from entry level to full examiner.
Tyes of training
Bank examiners are trained by three mel.aods. The primary one is on-the-job training. New examiners are generally considered to be in training for 1 or more years while
more experienced examiners help them learn examining
skills through assignments with increasing responsibility
and progressively more complex tasks.
The second type of training is through formal schools
and seminars operated at agency headquarters or at regional
offices and Federal Reserve district banks. There examiners
receive training in the commercial, trust, international,
and EDP areas of bank operations. Examiners at each agency
learn fundamentals at commercial bank examining schools
during their first 6 months of employment. The agencies
also operate more advanced schools ir; the commercial area
to pepare assistant examiners to take charge of bank
examinations. These schools emphasize the more analytical
and evaluative aspects of examination--judging asset quality, management ef -ctiveness, and bank policies and preparing examination reports.
Each agency also offers basic and advanced courses for
examiners who will be specializing in trust examining or who
will be examining commercial banks with small trust departments.
In the international banking area, OCC operates three
schools for individuals who will be examining banks with
international departments or overseas branches or subsidiaries. FDIC does not have an international school because,
according to officials, the banks it supervises are typically

10-5

small ones which do not have international operations. FDIC
uses OCC schools or instructors to provide training in international examining for individuals who may need it. FRS
holds an international school every 2 to 2-1/2 years.
FDIC and OCC each offer introductory and more advanced
schools in examining the computerized aspects of bank operations. FRS used to have a 3-week basic EDP school, designed
to cover EDP examinations and provide guidelines for preparing an examination report. This course was not held in 1975
or 1976 though plans have been formulated for a course ih
1977.
Examiners in the three agencies may also receive jobrelated training from external sources. According to agency
officials, examiners are encouraged to enroll in correspondence courses offered by such firms as Dun and Bradstreet,
Inc., or by such industry groups as the American Institute
of Banking. Some examiners also enroll in industry-sponsored
banking schools such as the Stonier Graduate School of Banking at Rutgers University and the National Trust School at
Northwestern University.
Conclusion
Generally, the agencies operate examiner training
schools in the same areas of bank operations. Since their
schools cover generally the same topics, the agencies could
(1) realize economies by consolidating their schools and
(2) assure high quality instruction by exchanging information
and standardizing curriculums.
Recommendation
We recommend that where feasible the Board of Directors,
FDIC, the Board of Governors, FRS, and the Comptroller of
the Currency combine their examiner schools and standardize
their curriculums.
Agency_comments
FDIC stated:
"Although we find the comments and recommendations contained in the report on examiner training provocative,

10-6

on balance we believe they did not afford sufficient
treatment or depth to the various examiner training
and educational programs offered by the FDIC.
"We are especially dismayed by the fact that the GAO
study largely ignores the operation of the FDIC Division
of Bank Supervision (DBS) Training Center. The FDIC
Training Center is undoubtedly the best bank examiner
training program in the country. Nevertheless, because
of our burgeoning training needs, the FDIC is considering constructing its own, larger facility with resident
dormitory quarters. The FDIC has approached the FRS
and the OCC to join with the Corporation in a cooperative
training facility. Both the FRS and the OCC have
evidenced interest in this project and discussions
on a cooperative training effort are going forward.
A brief summary of the operation of the FDIC DBS
Training Center is included with our general comments."
FRS stated:
"The examiner schools were a combined effort of the
three agencies when they were established in 1952 by
the Federal Reserve. However, in 1962 the Office of
the Comptroller of the Currency withdrew from the program, believing it preferable to operate its own school.
In the early 1970's the number of FDIC students necessitated some sessions held for FDIC examiners only
and, when the FDIC enrollment needs continued at
this high level, it was decided that the only practical course of action for the FDIC and the Federal
Reserve System was to establish separate schools.
The Board believes that a joint effort in this area
would be appropriate and desirable. This is among
the reasons the Board supports the concept of a Federal
Bank Examination Council. Short of this proposal, the
Poard will explore with other agencies the feasibility
of conducting joint schools."
OCC stated:
"The OCC recognizes that a common training effort and
a combined examiners' school would be highly desirable
both in terms of expense and coordination of examination policy. Our Office stands ready to cooperate fully
Indeed, our Office is in rewith all such efforts.
ceipt Or a letter from Chairman Barnett of the FDIC
10-7

asking our cooperation and financial support for a
combined training facility to be constructed at a
Rosslyn, Virginia site. This matter is receiving
serious attention.
The practical difficulty is that our Office has implemented the Haskins and Sells Report which has
created fundamental changes in our examination process. These changes are so basic to our examination
process that it would be difficult to coordinate a
curriculum. A combined examiners' school is viable
only if the other agencies modernize their techniques
in line with those being implemented at the OCC.
It
would be possible, however, to offer jointly courses
in more generalized subjects such as Economics and
Accounting."

AdeguacFy_of training
We asked 325 examiners' opinions on the usefulness of
their agencies' training schools in increasing their banking
skills and helping them meet requirements of their work.
Most answered that the training they received was useful;
however, they said that more training would be helpful in
certain areas. The areas most often cited were law, accounting, EDP, management, fiscal management, corporate taxation,
and foreign exchange transactions.
The responses of commercial bank officials to our
questionnaire also support the need for additional training,
especially in EDP.
-- In response to a question about examiners' knowledge
of banking, approximately 92 percent of the bankers
thought it was adequate or more than adequate.
-- We also asked the bankers to rate the competence of
examiners-in-charge in 11 analytical and evaluative
areas, such as loans, inter-al controls, and bank
liquidity. In each of these areas, although approximately 85 percent or more rated the examiners' competence as adequate or more than adequate, up to
15 percent rated it as borderline or inadequate.
-- Regar]ing the specialized examination areas of trust,
international, and EDP, the bankers' opinions about

10-8

the competence of examiners-in-charge were mixed.
In the trust and international areas, approximately
89 percent of the bankers thought examiners' understanding adequate or more than adequate while 11 perThe
cent thought it borderline or inadequate.
bankers' opinions were less favorable on EDP examinHere, approximately 25 percent thought examiners'
ing.
This
understanding borderline or inadequate.
pattern of bankers' opinions was consistent among the
agencies.
OCC is improving its training for bank examiners, as
recommended public accounting firm of Haskins & Sells.
Beginning in January 1977, OCC headquarters will implement
an agencywide personnel development program consisting of
a continuing education segment and a career development
segment.
The education segment will consist of at least 80 hours
of formal, technical education annually in the first several
This training is intended to
years of an examiner's career.
assure that the examiners learn needed skills at appropriate
Training programs for the first,
points in their careers.
second, and fifth years of the examiner's career have so far
been developed.
The career development segment will provide management
oriented and technical training later in the examiner's
career.
OCC officials also believe that its on-the-job training
of examiners will be improved b 'the agency's adoption of a
new handbook of examination procedure " . ;,hieh describes the
various areas of banking operations and provic s instructions on the examining functions to be performed for each.
An official said that these procedures will provide new
employees with guidance about the examiner's role and
understanding of sound banking practices.
Improvement needed in FRS training
Federal Reserve examiner training also needs improvement, according to the findings of a 1975 FRS study of
examiner recruiting, training, development, and compensation done for the Conference of Reserve Bank Presidents.
10-9

Half of the district Reserve Banks considered
examiner
training inadequate, while most had reservations
about adequacy or expressed the need for expansion,
generally
or in
specialized areas. The study stated that
to
cope
with
current problems and new developments, examiners
would need
additional specialized skills in the areas
of EDP, international banking, bank holding company operations,
and consumer protection.
The Board has offered little or no training
in these
areas in recent years.
It has not offered its introductory
EDP school at all in 1975 or 1976 (plans have
been formulated
for a school in 1977).
It only held its introductory international school once in 1972, 1974, and 1976.
Officials note
however, that the New York Federal Reserve
Bank
provides
continuing training in international topics.
At
the time
of the study, FRS offered no courses in bank
examinaticns and only a few hours on examiningholding company
for compliance
with various laws affecting consumer credit.
The FRS study recommended that the Conference
of Reserve
Bank Presidents urge the Board of Governors
to
reevaluate
its examiner training program and insure that
examiners
learn to deal effectively with current banking
practices
and developments. The study specifically
recommended
-- a school for examiners who inspect bank
holding
companies,
-- a refresher program for full examiners,
and
--a reappraisal of district Reserve Bank budget
planning policies which have limited examiner and
training programs.
In January 1976, the Board appointed a
education to study training needs. A result omm.itLee on
has been the estab ; 4 hnent of an FRS school of this study
for bank holding
company examiners, the first cession of which
was held in
October 1976.
Further, the Federal Reserve Board's Division
of Consumer Affairs has designed a school
for examiners who
check on commercial banks' compliance with
the various consumer protection laws. This school began
Officials said these schools will be held in September 1976.
regularly to build
up a cadre of examiners knowledgeable in these
examining
areas. The FRS education committee is also
considering establishing a new EDP school and a seminar
for higher level
examiners to inform them of new developments
in banking and
other subjects of interest.
10--]0

According to the Board's staff, it has long been aware
of the need for a complete review of the curriculums for the
the examiner schools but the pressure of the work has not
permitted this. Similarly, the Board staff has recognized
a longstanding need for teaching experienced examiners about
new developments in banking. The officials responsible for
the Board's schools are in its Division of Banking SuperIn the
vision and Regulation, where they have other duties.
small portion of time they can devote to training, they
cannot do the planning needed to revise current schools.
Conclusions
FDIC's training program seems to be providing its
examiners with most of the skills needed to assure highquality supervision of banks. OCC has recognized problems
with its program and has acted to improve it. Although
the Federal Reserve Board has improved its program as a
result of a recent FRS study, we do not believe that training can receive enough attention as a part-time responsibility of the Board's Division of Banking Supervision and
Regulation.
l subjects such as EDP, law, and
Additional training
accounting would be useful for examiners in the three
agencies.
Recommendations
We recommend that the Board of Governors, FRS,
(1) establish a full-time training office to operate its
examiner training program and (2) carry out the revision
of examiner school curriculums which it has recognized
as needed for sometime.
We also recommend that the Board of Directors, FDIC,
the Board of Governors, FRS, and the Comptroller of the
Currency increase their training in EDP, law, and accounting,
as desired by their examiners.
Agency comments
FDIC stated:
"We plan to give further attention to this apparent
need. It is worth pointing out in passing, however,

10-11

that, at least with respect to EDP training, in addition -- the regular basic EDP courses (Course in
Examii..ng a Computerized Bank (CECB) I and II), and
advanced eight-week technical EDP school, known as
Field Examiner Advanced Automation Training (FEAAT),
is presently offered to examiners who have a desire to
become highly proficient technically in FDP matters."
FRS stated:
"One individual currently administers the various
Federal Reserve examination schools held in Washington.
In addition, one full time staff
is assigned to
handle preparatory and procedural member
aspects such as registraticn, printing and distribution of instructional
materials and day-to-day dealings with instructors and
students. Other responsibilities for the different
schools have been assigned to various members of the
Board's staff who are experts in each field of training.
For instance, the curriculum for the newly established
Holding Company School was devised by members of the
Federal Reserve staff expert in matters relating to
holding companies and the new Consumer Regulations
School is handled by individuals who have been actively
involved in implementing the recent consumer legislation.
The Board believes that this system has met its needs.
If the report's recommendation for a joint school
adopted, this would reduce the need to consider a is
separate office at the Board.
However, if such arrangements cannot be worked out, the Board will consider
establishing such an office.
We might note that the portion of this recommendation
relating to a revision of examination curricula had
been started prior to the report. At the direction
of the System Education Committee, the curricula for
the schools for assistant examiners and examiners were
updated and revised in the spring and summer of 1976
and the curriculum for the EDP school was revised in
the fall.
The Holding Company and the Consumer
lation School have been recently established and Regutherefore have new curricula.
With respect to that portion of the recommendation
relating to additional training in specific areas,
the Board has a previously scheduled session of the
EDP school set for 1977 which will use a recently
10-12

updated curriculum. The laws relating to consumer
affairs are extensively covered in schools developed
by the Office of Consumer Affairs now conducted in
Washington as part of the overall examination program.
The Board will study the question whether additional
training in the areas or law and accounting should be
provided to examiners."
OCC stated:
"As part of our acknowledged need for specialized
training, and consistent with the advice of our consultants, the Training Division of the Personnel Management Department has identified a multitude of different specialized courses which selected examiners
will take; they include 7 different commerical examination schools, 3 trust examination schools, an EDP
school, an International school and a consumer examination school. That program has now been implemented
and is in full operation. The schools are programmed
for examiners at different stages of their professional
development. Among the many courses that will be
offered by skilled personnel, both from within the OCC
and, where necessary, from outside, are ones in EDP,
Law and Accounting. Among the other areas that will
be covered in that curriculum development will be specialized work in Economics , Bank Marketirg, Finance,
Auditing and similar topics."
PERFORMANCE EVALUATION
Each agency has procedures to evaluate the performance
of its examiners. Generally, examiners are rated annually
on the promptness, quality, and quantity uf their work;
their ability to plan, organize, and lead; their interest,
attitude, and interpersonal relations; and their judgment.
Newer examiners are rated more frequently. Assistant examiners in FDIC, for example, are evaluated every 6 months.
Agency officials said supervisors discuss performance
appraisals with examiners. They also said they emphasize
these performance evaluations when considering individuals
for annual salary increases and for promotion.

10-13

Qualifyinfor examiner-in-charge
The examiner-in-charge is the key member of the bank
examination team, the agencies' front line of bank supervision. This individual's duties require the ability to
analyze. and appraise factors affecting a bank's condition,
such as quality of assets, degree of liquidity, competency
of management, and adequacy of internal controls. The judgment of the examiner-in-charge is important in determining
the scope, depth, and results of the examination. The
examiner-in-charge also deals with bank managers and prepares
FDIC examiners-in-charge
and signs the examination report.
are responsible for
banks
Reserve
and those at some Federal
procedures.
agencies'
their
to
rating banks according
Examiners-in-charge are individuals who the agency
believes have acquired the experience and skill needed to
conduct bank examinations. These individuals may advance to
the higher examining positions and to management positions.
One way the agencies determine if an assistant examiner
is skillful enough to conduct bank examinations is through
job performance ratings. FDIC and OCC also have formal
evaluation processes, lasting 3 to 4 days, which are administered by one or more full examiners. In these processes
¢:andidates
-- answer oral and written questions on banking terms,
regulations, arid examination procedures,
-- analyze and evaluate bank loans from an actual examination, and
-- prepare the confidential section of an examination
report, based on analysis of bank operational data
from an actual report.
Generally, an assistant examiner must pass the performance evaluation to be promoted to full examiner status.

1C-14

Federal Reserve district banks do not use such a formal
evaluation process. Assistant examiners are advanced to
full examiner status when their performance has demonstrated
that they are ready.
Conclusion
We believe that formally evaluating examiners, as FDIC
and OCC do, is a sound practice for assuring that examiners
have received the necessary training and experience to make
the appropriate decisions and judgments in the bank
examination process.
Recommendation
We recommend that the Board of Governors, FRS also establish a formal evaluation process to measure the competence
of persons seeking advancement to examiner status.
Agency comments
FRS stated:
"We note that this recommendation is not based upon
a conclusion that the examiners of any one agency
are more or less competent than those of another
agency. Standardized tests are merely one way of
arriving at a formal evaluation, and we would not
want to rely on them exclusively. However, there is
something to be said in favor of formal tests as a
supplementary evaluation device, and the Board intends to investigate their feasibility."
ADVANCEMENT AND COMPENSATION OF EXAMINERS
Bank examiners are hired and employed at FDIC and OCC
regional offices and at district Reserve Ban- .
Generally,
examiners are not recruited and assigned 'o ~eadquarters for
active examining work. Individuals hireG . :.hout prior banking or bank examining experience start as 4ssistant examiner
trainees at salaries ranging from $9,685 to $11,544, depending on the agency or Federal Reserve district bank. Each of
the 12 district Reserve Banks sets its own salaries, titles,
and grades. The agencies report no difficulty in attracting
qualified applicants at their starting salaries.

10-15

The career path fre a bank examiner is typically through
two or three levels as assistant examiner to the first full
examiner position in 4 to 5 years, at which point his/her
salary would be $17,056 at FDIC, $17,625 at OCC, and from
$14,000 to $18,980 at tne various Federal Reserve district
banks. Thereafter, individuals may advance to the higher
e- Iner positions depending on their job performance.
At FDIC and OCC, qualified individuals may reach the
top examiner positions with a salary of $33,789, in 10 to
12 years after reaching the first full examiner position.
Time required to reach the top examiner positions is approximately 8 years in the Federal Reserve banks; however beginning salaries for these position are lower than the other
two agencies, ranging from $17,407 to $24,500.
The following chart compares the agencies' starting
salaries for entry-level positions, for the first full
examiner positions, and for top examiner positions.

1.0-16

TOP EXAMINER POSITIONS

DOLLARS
30,000

33.789

•g

33,789

RANGE

24,500

FIRST FULL
EXAMINER POSITIONS
20,000

case18.980
17.625
17,056

1.7407

ENTRY-LEVEL POSITIONS

11 544

11,413

10,543

10,000
9,685

FDIC

FRS

OCC

FDIC

10-17

FRS

O.C

FDIC

FRS

OCC

FDIC and OCC use a career ladder procedure to advance
thei. examiners from the entry level to the second full
examiner position (GS-12).
Individuals are generally
promoted annudlly if they perform satisfactorily.
FDIC
uses a formal competitive promotion system for advancement
to higher positions. This system requires advertisement
of vacancies, within a regional office for GS-13 examiner
positions and throughout the agency for uS-14 and GS-15
positions.
OCC has a less formal competitive promotion
procedure which does not advertise vacancies agencywide.
Federal Reserve banks d& not use career ladder or competitive promotion riocedures
Instead, employees are promoted
when their job performance demonstrates they are ready to
assume the duties of the next position.
In response to recommendations of the 1975 Haskins &
Sells study, OCC has developed a new compensation and
benefits program in ended to encourage high performance.
I includes:
-- Comprehensive position descriptions listing specific
qualifications.
---Results-oriented performance appraisals intended to
strengthen the concept of ba-cng salary increases
on merit instead of on time-in-grade.
-- A new salary administration procedure to replace the
GS system currently used.
An annual salary survey
will be taken to establish compensation levels and
ranges competitive with positions of comparabl
responsibility in other government agencies and in the
private sector.
OCC hopes to have the program in operation by early 1977.
ASSURING EXAMINER OBJECTIVITY
A bank examination could be biased by an examiner's
financial or personal interests in the bank or his/her
over-familiarity with bank managers. Each agency therefore
restricts its examiners' outside financial and personal
interests, and limits the number of consecutive examinations
at a bank by the same examiner-in-charge.

10-18

Rest ictions on examiners' outside activities
Various laws and agency policies restrict the outside
financial activities and personal relationships of bank examiners. They may not engage in any outside employment. or
accept any fees, gifts. or payments of expenses, which could
cause actual or apparent conflicts of interest.
The agencies generally prohibit the ownership by examiners and their immediate families of stock in banks,
their affiliates, and bank holding companies. At FDIC.
the prohibition applies to banks insured by the agency.
Federal Reserve Board policy forbids ownership of stock
in any bank, affiliate, or holding company. OCC prohibits
its examiners from investing in national banks.
Bank examiners are prohibited from accepting a loan
or gratuity from any bank which they examine or have authority
to examine. This prohibition applies also to credit
cards of banks or their affiliates.
Each FDIC and OCC regional office and Fede-' Reserve
district bank sets its own restrictions on assigning examiners to banks where their relatives work. In general.
examiners are not a.lowed to examine banks that employ
close relatives.
Financial disclosure requirements
At the three agencies. er-)loyees in certain sensitive
positions must file statements, listing any outside work,
stock holdings. and indebtedness. Each agency requires
its examiners to file these statements when they are hired
and FRS requires examiners to file annual updated statements.
In this study. ¥w did nct review the agencies' imple.
mentation of their , i.cies regarding outside financial
and personal interests; however. we have been requested to
do this as a separate study by the Chairman. Subcommittee
on Commerce. Consoimer. and Monetary Affairs of the House
Committee on Goverrnment Operations. We expect to complete
that study in mid-1977.
Rotation of examiners
The agencies have policies intended to - ntain ar. "ar. s
length" relationship between examiners-in-cihargt and bank
officials by limiting the number of consecutive examinations
an examiner may make at the same bank. OCC has a genera'
10-i.

policy that examiners-in-charge may not make more than five
consecutive examinations at one bank. Each FDIC regional
office and each Federal Reserve district bank sets its own
policy. Four offices and district Reserve Banks where we
inquired limited consecutive examinations to two or three.
We reviewed the last three examination reports on
200 banks supervised by each of the agencies and found that
the above policies are generally followed.
Examiner turnover
During 1973-75, the turnover rate of examiners in each
of the agenciec was approximately 10 percent. Most examiners
who leave the Lhree agencies do so either to take jobs with
commercial banks, other private firms or organizations, or
other government agencies or to continue their education.
Most departures occur during the first 5 years of employment.
Examiners who left during 1973-75 numbered 506 at FDIC,
218 at FRS, and 603 at OCC.
Examiners who left for commercial banks accounted for
29, 37, and 41 percent of total departures at FDIC, FRS, and
OCC, respectively. We checked at the agencies to determine
how many fuV- examiners--i.e., th se who can be in charge of
examination. -were hired by banks which they had examined
shortly before resigning.
At FDIC during 1974 and 1975, 19 full examiners went to
work for banks which they had examined during the year pr. .eding resignation.
Eleven of these had assisted on the examination and eight had functioned as examiner-in-charge. At
two Federal Reservc district banks that we checked, no full
examiners left during these 2 years to join banks which they
had examined. During 1974 and 1975, 24.full examiners left
OCC to go to work for banks which they had examined in the
3 years preceding their resignation. Of these, 15 had assisted in and 9 had been in charge of the examinations.
The three agencies recognize that many of their exai,.iners leave to go with commercial banks. They consider this
to be beneficial because former examiners are a source of
aual.fied bank managers who understand the importance of

10-20

sound banking practices and the regqllaory function of the
agencies. Agency officials do not believe that the objectivity of examinations is lessened by examiners going to
work for banks they examine.
Conclusion
Since few examiners left to work for banks they examined,
we see no threat to their objectivity as long a
..ie agencies
continue rotating examiners-in-charge among banks examined
and reviewing examination reports at regional offices and
district banks.

10-21

CHAPTER 11
POTENTIAL FOR B~ETER
INTERAGENCY 1MOC PERATION

Overview

11-1

Problems in interagency - operation
blew approaches to ).)nk ex:amination
Examination for c.,.mpliane with consumer
protection laws
Development of monitoring systems
Examiner trainiag
Qualifying for examiner-in-charge
Joint evaluation of foreign loans
Joint examination of foreign branches
Data processing
Supervision of bank holding companies
Joint evaluation of shared loans to large
corporations
Criteria for identifying problem banks

11-4
11-4

Conclusions

11-8

Recommendation

11-8

Agency comments

11-8

11-4
11-5
11-5
1.1-5
11-6
11-6
11-6
11-7
11-7
11-8

CHAPTER 11
POTENTIAL FOR BETTERINTERAGENCY- COOPERATION
OVERVIEW
The legislation establishing the three agencies created
several overlaps in authority.
The area with the greatest
potential for duplication of effort i.s bank examination.
FDIC has statutory authority to examine all insured banks
(including national banks and State-chartered FRS members);
FRS has statutory authority to examine all member banks
(including national banks and State-chartered member banks
that are insured by FDIC); and OCC has statutory authority
to examine all national banks. (See ch. 4.)
m

e three agencies have other
Dllities:

inter-related

:esponsi-

-- OCC is responsible for closing national banks
which have become insolvent and FDIC is responsible foL liquidating these banks.
--FRS has primary responsibility for inspecting bank
holding companies, but FDIC may examine a nonmember
insured State bank subsidiary and its parent holding
company, and OCC may examine a national bank subsidiary and its parent holding company.
-- All banKs are required, under the Securities Exchange Act of 1934, as amended (15 U.S.C. 78a et
seq.), to report to FRS on extensions of credi-for
the purchase of stock.
If any bank fails to furnish such information, FRS may inspect such bank
in order to obtain the information.
In addition

conduct many similir

legislative overlaps,

dctivities,

the

three agencies

and they coordinate their

activities to var-ing degrees. The three agencies have
operated under a unif¢orm agreement--signed in 1938 and
amended in 1949--for classifying bank assets and for
appraising certain secaLities during bank examinations.
According to a former OFRB Governor, the first interagency
coordination committee began in 1952 and fJnctioned until
about 1960.
Formal mechanism Eor coordination was resumed in 1964,
when President Johnson expressed concern about the lack
114--

of coordination among the Federal bank regulatory agencies
and instructed the Secretary of the Treasury to establish
procedures to insure that they act in concert and resolve
their differences.
The Secretary established a procedure
for the exchange of information among the bank regulatory
agencies.
The 1964 procedure was revised in 1965 to establish a
Coordinating Committee on Bank Regulation composed of the
Chairman of the FRS Board of Governors or a designated
Governor, the Comptroller of the Currency, the Chairman
of FDIC, and the Chairman of the Federal Home Loan Bank
Board. The Commihtee meets at the call of any member, but
not less than quarterly. Under the procedure, the Committee
chairman is to report to the Secretary of the Treasury any
instance where the Committee cannot agree on conflicting
rules, regulations, or policies.
We were told that eight meetings were held during 1975
and six meetings were held from January 1, 1976, to October
31, 1976.
We were advised that the Committee does not
maintain minutes of its meetings.
We ware fu-nished an agenda for all but two of the
Coordinating Committee meetings. Approaches and techniqucs
of bank examination were apparently discussed on several
occasions in connection with changes in call and other
reports, fair lending in housing, and classification of
certain bonds. Most of the topics, however, related to
various types of accounts a bank might nffer, such as
individual retirement accounts, corporate savings accounts,
telephone transfers to and from savings accounts, overdraft protection for checking accounts, and experiments
with deposit rate ceilings in New England. According to
a Treasury official, no conflict among the Committee members
has ever been reported to the Secretary of the Treasury.
Coordination also occurs through meetings and discussions with senior management at the three agencies. In
addition, the Comptroller of the Currency is by law a member
of the FDIC Board of Directors and thus is directly involved
with that agency.
Effective cooperation between the three Federal bank
regulatory agencies is important to:

11-2

-- avoid duplication of effort,
-- afford equal treatment to all classes of banks,
and
-- maximize economy and efficiency of operations.
The agencies have to a large extent--through formal and
informal coordination efforts---avoided duplication of effort
The
and provided equal treatment of all classes of banks.
current framework for coordinating the activities of the
three regulatory agencies provides a forum for exchanging
information about possible conflicting rules, regulations,
or policies, but it does not provide a mechanism for the
three agencies to combine their forces in improving the bank
supervisory process or in resolving problems common to the
three agencies.
We identified several areas where, in our opinion,
the agencies could benefit by working together, sharing
experiences about innovations in bank supervision, and
undertaking activities jointly or on a reciprocal basis.

11-3

PROBLEMS

IN INTERAGENCY COOPERATION

In some areas similar activities were being carried
out differently by the three agencies and, as a result,
from an overall Federal viewpoint, did not provide for
efficient operation.
In some cases these differences
resulted in treating different classes of banks unequally
under similar conditions.
The foliowing examples, which are generally discussed
in other sections of this report in greater detail, illustrate areas where greater cooperation could benefit the
agencies. The Coordinating Committee apparently did not
consider any of these areas during 1975 or 1976.
New approaches

to bank examination

While all three agencies have recently made changes
in their examination approaches, OCC's changes are the most
extensive.
OCC's new examination approach, which places
more emphasis on bank policies, procedures, practices,
controls, and audit, resulted primarily from several recommendations in Haskins & Sells' May 1975 report.
The new
examinatior procedures were developed during the fall of
1975 and sptrng of 1976 and were field tested in mid-1976.
(See ch. 7.)
OCC made a large investment in
supervision. Y % there is no formal
the results among the agencies. Not
did OCC present its r.ew approach in
FRS.

a major step in bank
mechanism for sharing
until November 1976
detail to FDIC and

When one agency plans major changes in its activities
which may be applicable to the other agencies, early consultation and exchange of views would benefit all agncies
concerned. We believe that the three agencies should
jointly participate in testing and evaluating the new
approach.
Examinations for compliance with
consumer protection laws

The agencies have recognized

that their past approaches

for examining banks' compliance with consumer protection
laws needed improvement, and all three are modifying their
examination approaches. We believe, however, that they
should work together more closely in refining their approach
to consumer credit compliance examinations. (See ch. 7.)
11-4

Development of monitoring

systems

Each of the three agency headquarters and several
Federal Reserve Banks, generally independently of each
other, have developed or are developing monitoring systems
to identify banks that may require close supervision.
(See ch. 7.) A cooperative effort among the agencies
might have reduced the developmental effort and--through
"cross fertilization" of concepts--speeded development.

The agencies are still working on these systems, and the
need for coordination continues.
Examiner trainin_
The three agencies have generally provided forma'
training to its bank examiners through their own operated
sc'iools and seminars. Much of the training in the past has
covered the sameLtopics at each agency. (See ch. 10.) While
we recognize that OCC is implementing new examination approaches tha: are conceptually different than those of the
other two agencies and thus, some of their current training needs may be somewhat different, we are also suggestiin.
(see ch. 7) that the agencies jointly evaluate the OCC's
new approaches and determine whether they should be
adopted by all three agencies.
We believe, therefore, where feasible, that the three
agencies should combine their examiner schools and standardize their curriculums.
(See ch. 10.)
Qualifying for examiner-in-charge
FDIC and OCC use a formal evaluation process in addition to performance evaluation for determining whether an
assistant examiner is skillful enough tc bo in charge of a
bank examination. At FRS assistant examiners are advanced
to full examiner statlis on the basis of their performance.
(See ch. 10.)
We believe that, in addition to performance evaluation,
a formal evaluation process is desirable to measure the
competence of assistant examiners to assume the responsibilities of a full examiner. The agencies should work
together to develop a uniform approach to the formal
-valuation process.

11-5

Joint evaluation of foreign loans
FRS and OCC independently evaluate the soundness of
loans to foreign governments and businesses. Loans to the
same foreign borrower were rated differently by the various
Reserve Banks and by OCC.
(See ch. 4.) This practice results in duplication of effort and inconsistent treatment of
credit to foreign borrowers. The Federal agencies should
coordinate their efforts to avoid these problems.
Joint examination of foreign branches
The foreign branches and subsidiaries of U.S. banks
should be examined, but such examinations are costly because
of the travel involved. (See ch. 4.) OCC's London office
employs six _.-,aminers who are in charge of examining branches
and subsidiaries in Europe. In addition, FRS maintains
staffs of international examiners in New York, Chicago, and
San Francisco, and OCC maintain staffs in all their regions
who make onsite examinations of foreign branches and
subsidiaries.
OCC and FRS should consider coordinating their examinations of foreign branches and subsidiaries so that examiners
visiting a foreign city could examine branches of both State
and national banks.
Data processing
An interagency agreement assigns responsibility for processing data on all national and State member banks to FRS
and responsibility for processing data on State nonmember
banks to FDIC. FDIC subjects all of this data to edit-checks.
However, according to an OCC official, the interagency system
for processing data was inadequate because among other reasc s, banks were not meeting established reporting deadlines,
and FDIC was taking approximately 4 months to keypunch and
computer-edit the data. Therefore, in connection with implementation of the National Banik Surveillance System (see
ch. 7), OCC began in December 1975 to process and edit data
on national banks shown in reports of condition and reports
of income, even though--pursuant to the interagency agree
ment--FRS already processes this data, FDIC edits it, and
OCC responds to errors noted by FDIC. A coordinated effort
would avoid this duplication.

il-6

Stervision of bank helding comranies
FRS has primary responsibility for supervising and
regulating bank holding ccmpanies. Banks under the control
of these holding companies may he either State member,
r'nmember insured, or national banks, and may therefore
be examined by FRS, FDIC, or OCC. However, procedures
for coordinating efforts among the three agencies on holding
companies and their subsidiary banks are not fully effective.
(See ch. 4.)
Because bank holding companies and their subsidiary
banks may substantially affect one another, the three agencies should establish better procedires for coordinating
their supervisory responsibilities.
Joint evaluation of shared
loans to large corporations
Some loans, especially those made to large corporations,
involve several parti:ipating banks, which may be either
national or State-chat tered.
Even though only one extension
of credit is involved. the three agencies reviewed the loan
differertly and. in so.ne cases, evaluate it differently.
(See ch. 7.)
OCC recently initiated a program to review these loans
at a single location, thus assuring consistent treatment of
the loans at all participating national banks. This evaluation is then incorporated into regular examinations of all
national banks which have participated in the loan.
Both FRS and FDIC had been in contact with OCC about
the uniform review of shared national credits. However,
at the time of our review neither had used OCC's uniform
evaluations in examining participating banks. As a result,
loans which had been reviewed at the lead bank by OCC were
also reviewed at individual participating State baiks
by other FedeLal agencies; and the same loans in some cases
received different classifications from the three Federal
supervisory agencies. On December 21, 1976, FDIC headquarters advised its regional staffs to use the OCC classifications when they examine the State participating banks.
Full and prompt coordination among the three agencies
on the review of shared loans would allow more efficient
use of supervisory staff and fair and consistent treatment
of involved banks.
11-7

Criteria for identifyin_prEoblem banks
The three regulatory agencies do not have common criteria
for determining which banks are designated as problem
banks.
(See ch. 8.) Since FDIC, FRS, and OCC all have an interest
in the condition of national banks, and FDIC and FRS
both
have an interest in the condition of State-chartered member
banks, we believe that the three agencies should work
together to develop uniform criteria for identifying problem
banks.
CONCLUSIONS
While the agencies have to a large extent
reasonably effective in minimizing problems from the been
overlap of
Federal supervisory jurisdiction over commercial
banks, no
mechanism exists to insure that the agencies act
in concert
to operate effectively and efficiently. There are
several
alternatives under which this could be achieved.
One
would be to establish a permanent interagency working
level
group. This group could monitor the agencies' operations
to identify areas where interagency cooperation would
be
beneficial and to make appropriate recommendations
to the
agency heads.
RECOMMENDATION
We recommend that either (1) the Board of Directors,
FDIC; the Board of Governors, FRS; and the Comptroller
of
the Currency jointly establish a more effective mechanism
to combine their forces in undertaking significant
initiatives to improve the bank supervisory process or
in attacking and resolving common problems, or (2) the Congress
enact legislation to establish a mechanism for more
effective coordination.
We would be glad to assist the committees
in drafting appropriate legislation.
AGENCY COMMENTS
FDIC stated:
"We recognize the merit of resolving common problems of the three agencies through closer coordination and cooperation.
Indeed, there is at the
present time a substantial exchange of information
between the agencies' headquarters as well as at
the field levels.
However, if there is any merit

11-8

to the concept of separate federal supervisory
agencies, and to a dual banking system with State
and federal supervision of banks, the benefit
would seem to be the opportunity to try different approaches and to have a diversity of examination and supervisory procedures. The possibility of useful innovation and improvement in
the bank examination and supervisory processes
is greater if there are several agencies trying
different approaches than if every change in
examination methodology required approval of all
Nevertheless, the possibility
the agencies.
of establishing a particular vehicle for the
agencies to resolve common pcoblems and take
joint efforts in new Initiatives will receive
serious consideration."
FRS stacd:
hat this portion of the
"The Board is pleaseprevious conclusions and
report supports it
initiatives in this area and favors the legislative approach.
"In December, 1975, Governor Holland testified
before the Senate Committee on Banking, Housing
and Urban Affairs and in that testimony made
reference to the concept of a joint Bank ExamInation Council which at that time had received
In that
substantial support within the Board.
regard, he stated:
Such a Council would be focused on the areas
that we believe are most in need of improvement; that is, efficient and uniform modernization of bank examination and vigorous and
consistent follow-up procedures when bank
Such a Council could
weaknesses are revealed.
be established administratively or by statute.
Its statutory authorization would undoubtedly
give more impetus to the establishment of such
a Council, and would also provide it with
clear-cut authority to take definitive action
within its statutorily defined areas of
administration.

11-9

The Federal Bank Examination Council should have
authority to establish standards and procedures
for bank surveillance, examination and follow-up,
applicable to all the Federal banking agencies,
and it should review significant problem cases
when and a!' they develop. All three Federal
banking acencies should be represented on th%
Council.
"Subsequently, at our suggestion, Senator Stevenson
introduced the Federal Bank Examination Council Act
(S. 3494).
Such a Council would establish mandatory
uniform standards and procedures for Federal examination of ba-ks and uniform reporting systems and
conduct joint schools for examiners. The Board
believes that a proposal along these lines could
accomplish most of the objectives set out in the
report's recommendations in the examination area."
OCC stated:
"The OCC has always stood for the strongest possible
working relationships between federal supervisory
authorities.
At the December, 1976 meeting of the
Interagency Coordinating Committee, Mr. Robert Bloor.,,
Acting Comptroller of the Currency, asked that the
committee take up at its next meeting the subject of
strengthening coordination of examination procedures.
It will be proposed that a permanent staff group be
set up for this purpose.
We anticipate modification
and refinement of our newly implemented examination
approach on an ongoing basis.
Review and evaluation
-uch changes as they affect problems common to the
,t, e agencies would be most useful."

11-10

r'~APTER 12
SCOPE AND APPROACH OF GAO STUDY
Page
Chartering of national banks

12-2

Bank supervision and examination practices
Failed oanks
Problem banks
Banks in general

12-2
12-3
12-3
12-3

Survey of commercial bankers

12-6

CHAPTER 12
SCOPE AND APPROACH OF GAO STUDY
During 1976 we evaluated the way FDIC, FRS, and OCC
supervised the Nation's commercial banks.
Since we do not have audit authority at FRS or OCC
and our access to bank examination files of FDIC has
long been contested, we had to negotiate an agreement with
each supervisory agency to review itb records.
Although
the agreements contain some differences, the scope and
approach of our study remained the same at all three
agencies.
Key provisions of the agreements which affected
our scope and approach follow:
-- The agencies allowed full access on their
premises to bank examination reports, correspondence files, and other records.
In return, we
agreed not to publicly disclose any information
about specific banks or their officers, affiliates,
and customers. We also agreed not to evaluate the
accuracy c the examiners' factual findings by
independently examining the banks involved.
-- We further agreed to consider the agencies' supervisory practices, procedures, and policies that
existed from 1971 through 1975 and some of their
planned changes.
The FRS agreement barred us from evaluating certain
regulatory functions, such as the policies and procedures
for implementing the Bank Holding Company Act of 1956, as
amended, and the consumer protection statutes. FRS monetary policy functions and certain FRS operations, such
as check clearing and electronic funds transfer, were also
excluded from review.
Our access to information on bank holding companies
was limited to those whose subsidiary banks had holdingcompany-related problems and were included in our samples
of banks selected for :eview.

12-1

We reviewed legislation, rules and regulations, and
administrative and operating policies and procedures.
We interviewed numerous agency officials, bank examiners,
and employees at various organizational levels, and we
visited 6 FDIC and 9 OCC regional offices and 12 Federal
Reserve district banks to discuss the bank supervisory
process and review examination reports, workpapers, and
other records.
In our study, we considered
-- current practices and planned changes in the
agencies' bank supervision policies and procedures,
-- bank examination polici-- and procedures, as described in manuals and explained by examiners and
officials, and
-- status reports on supervisory activities to the
agencies' headluarteLs from the regional offices
or district banks.
CHARTERING OF NATIONAL BANKS
Our work entailed analyzing 75 of the 322 ba-k charter applications acted on by OCC from January 1974 through
April 1976 and all 71 charter conversion applications acted
on from January 1972 through April 19/6. Tn addition, we
determined how many national banks chartered from January
1958 through December 1972 were still operating as national
banks by April 30, 1976.
We reviewed criteria and procedures for considering
national bank charter applications. We surveyed State
banking authorities to compare their chartering processes
with OCC's. We also reviewed several files on applications
for FDIC insurance and FRS membership.
BANK SUPERVISION AND EXAMINATION PRACTICES
~W discussed the bank supervisory process with examiners and agency officials; reviewed examination reports,
supervisory files, and other supporting documents; and
analyzed and summarized the data collected on more than
900 banks of all sizes and locations.

12-2

We drew samples representing
-- banks which failed during a 5-year period,
-- banks that had been designated as having
problems serious enough to require more than
normal supervision by the agencies, and
-- banks from the total universe of about 14,400
which are supervised by the three Federal
agencies.
Failed banks
Our study included 30 insured banks closed by their
chartering authorities between January 1971 and June
1976. In that period, 40 insured and 2 uninsured hanks
had failed. We analyzed examination reports and related
files covering the last 5 years of each bank's existence.
We also considered studies and congressional hearings
on failures of cwo banks--Franklin National Bank and
U.S. National Bank of San Diego.
Problem banks
We selected two statistical samples of problem banks-149 banks at December 31, 1970, and 145 banks at December
31, 1975. For each bank selected we noted the problems
identified by the examiner and the agency's efforts to
obtain corrective action. For each bank in the 1970
sample, we reviewed the most recent examination report
before December 31, 1970, and reports on subsequent examinations until the bank returned to nonproblem status.
For each bank in the 1975 sample, we reviewed the examination report before the one which designated the bank as a
problem and subsequent examination reports up to June
30, 1976.
Banks

in general

Using statistical sampling techniques, we selected
a total of 600 banks supervised by the 3 agencies.
For each of the banks selected, we identified the problems
noted by the examiners and the recorded followup actions
taken by the Federal and State agencies and we summarized
financial and operational data using supervisory files
and the three latest reports of examination.
12-3

The following table summarizes our samples of banks.

Total

Spervisory agency
FDIC:
Failed banks
Problem banks:
At 12/31/70
At 12/31/75
Banks in general
FRS:
Failed banks
Problem banks:
At 12/31/70
At 12/31/75
Banks in general

Number
reviewed

190
275
8,594

55
55
199

39
65
1,046

39
40
200

123
85
4,744

55
50
201

352
425
14,384

149
145
600

OCC:

Failed banks
Problem banks:
At 12/31/70
At 12/31/75
Banks in general
Total:
Failed banks
Problem banks:
At 12/31/70
At 12/31/75
Banks in general
Note:

In some cases the agencies could not locate
from storage facilities all the records we
This neither seriously limited our
requestea.
scope nor affected the reliability of our samples.
Regarding banks in general, we reviewed the latest
three reports of examinations when available.
A recently chartered bank 'night have been
examined only on:e by the appropriate agency.

12-4

Frcm our samples of banks, we found 20 bank holding
companies whose bank subsidiaries were identified as having
major problems caused by their affiliation. For these
20 companies, we reviewed available files of registration
statements, applications, memorandums, reports of inspection, annual financial reports, and related FRS analysis
and correspondence. We also reviewed the Bank Holding
Company Act of 1956, as amended (12 U.S.C. 1841 et seq.),
FRS policies and procedures for supervising holding companies, and pertinent literature.
Our study of international bank examinations included
a review of the last 3 reports of international examination
for 30 large banks. We discussed the process of evaluating
loans to foreign countries with officials of the ExportImport Bank, as well as with FRS and OCC.
For trust departments we reviewed and analyzed reports
of trust examination and related files on 33 banks. We
summarized data on violations and deficiencies reported
by examiners.
Our study of electronic data processing examinations
included collecting and analyzing data from the 3 latest
reports of EDP examination or 38 banks' data processing
centers or outside servicers. We considered examination
frequency and duration, the type of EDP system, applications, operations, internal audit and control, deficiencies
reported by examiners, and remedial action by the agencies.
We reviewed the efforts of the three bank supervisory
agencies to detect violations of consumer credit laws and
regulations. Considered were the examiners' training for
evaluating compliance, compliance examination procedures,
the reporting of violations, and the agencies' use of sampling techniques. We also evaluated the agencies' plans
to expand compliance examination efforts.
We studied the agencies' bank monitoring systems,
particularly their use of regularly reported data to identify certain trends within individual banks. We spoke
with representatives of the Federal Home Loan Bank
Board and other groups involved with bank supervision
about using monitoring systems to identify serious problems in financial institutions.

.12-5

We reviewed FDIC, FRS, and OCC policies and procedures concerning recruitment, career development, and
objectivity of bank examiners, to ascertain how they
affect the quality of bank supervision. Using a questionnaire, we obtained the views of 325 examiners at the 3
agencies.
SURVEY OF COMMERCIAL BANKER.
Part of our study was a survey of commercial bankers'
views on Federal supervision of banks. We mailed a questionnaire to 1,678 commercial banks, of which 1,501, or
89.5 percent, responded. We selected our samples so as
to include banks of varying deposit size. Each agency
provided a list of banks receiving special supervisory
attention, from which we selected other samples. The
following table summarizes the number of banks surveyed.

12-6

Banks
Supervisory agency and
(000,G00

deposits

Total

Number
surveyed

omitted)

FDIC:
$100 or more
$10 to $100
Less than $10
Special attention

FRS:
$100 or more
$10 to $i00
Less than $10
Special attention

OCC:
$100 or more
$10 to $100
Less than $10
Special attention

Total

216
4,105
3,993
280

108
216
210
131

8,594

665

112
606
263
65

54
151
131
33

1,046

369

510
3,105
1,047
85

251
205
149
39

4,747

644

14,387

1,678

Each bank's response to the questionnaire was
correlated with bank information routinely collected by
the three agencies--deposit size, supervisory status,
location, and rating. The responses are integrated
throughout the report and summarized in appendix IV.

12-7

APPEN;.IX I

APPENDIX I

Comptroller of the Currency
Administrator of National Banks
Washington, D,C.20219

Jar.uary 14, 1977
Honorablea Elmer B. Staats
Comptroller General of the
United States
General Accounting Office
441 G Street, N. W.
Washington, n). C. 20548
Dear Mr. Staats:
Enclosed find original and one copy of our comments on the
recommendations advanced in the draft General Accounting
Office Report entitled "Study of Federal Supervision of our
Nation's Banks".

X understand that in accordance with the usual procedures

our cowm.ents will be included in toto in the final report.
Sincerely,

Robert Bloom
Acting Comptrollar of the Currency
Enclosures

Note:

Page references have been changed to conform to the
final report.

APPENDIX I

PREAMBLE
Bank Examination and the Office of the
Comptroller of the currency
The Office of the Comptroller of the Currency (OCC) commends the General Accounting
Office (GAO) for the objective and workmanlike quality of GAO's report and for the
positive attitude shown by the GAO staff which prepared the report.
The GAO report correctly states that one important goal of bank regulation is
maintaining the soundness of the banking system; achievement of that goal requires
minimizing the number of bank failures. We agree with that goal, and suggest that
the banking agencies record over the last fcrty years has been a good one. For
example. 1974 witnessed a severe economic recession and the two laz 6 eat bank
failures in the history of the United States -- yet no depositors in these banks
The average annual
lost money and confidence in the banking system was maintci..ed.
bank failure rate since 1937 has been 0.'J8 percent -- s ,omarkably low failure rate
for any human endeavor.
But it is the other goal of supervision uhich is not stressed in the GAO report.
The ultimate measure of how well a bank supervisory agency operates is how well
the banking system operates. The OCC believes that one of its major functions
is to preserve a competitive, responsive and innovative system. Bank supervision's
role is to ensure that the banking system is able to provide the widest possible
array of banking services to both the depositor and the borrower.
Thus, the ba k supervisory agency has two contradictory goals: monitoring soundness
and sponsoriLg the competitive, inoovative response. It is this dual role which
presents the basic paradox for the bank supervisory agency. An intensely
competitive industry can nDver be completely safe.
Striking the balance between these two gcals is the basic problem of the bank
supervisory agency. According to a former Comptroller of the Currency:
One regulatory approach is to identify a problem in one area
and remedy across the board, taking no notice of the different
characteristics, or idiooyncracies of the components of the
whole. That approach is acceptable if the object is to produce
a "fail-safe" banking system. Believe me, I can screw down the
National Binking System with enough regulations to prevent bank
failure. But, under that regime, the banking industry would He
financing the capital needs of the country and its citizens at
about 601 of capacity, and that is not in the public interest.
Equally important, it is contrary to the economic principles of
our ration. Instead, I would advocate that we free up the system
to manage itself, loosen the bonds and take the quite limited
risks that some unit will slip through the supervisory net and
founder.

I-2

APPENDIX I

A well known critic of bank sipervision, economist George J. Benston, has addressed
the question of the costs of bank regulation -- both the direct cost of running
the agencies and the indirect costs of limiting competition by the banking industry -- and has suggested that the best solution is improved supervisory techniques. Specifically he recommended:
1. A primary responsibility of the supervisory agencies is to determine
the most effective method of examining banks.
2. Supervisory Pqencies should be able to use bank reporting as a Ruidd to
self-examination by the banks and as a preliminary examination tool.
3.

Models should be developed that predict possible problems.

Banks that are likely to get into trouble should be examined more
frequently and in greater depth.

That list, although not complete, is similar to the revisions of examination
procedures proposed by the consulting firm of Haskins & Sell and implemented by
the Office of the Comptroller of the Currency. Examination of the larger banks
has moved from a detailed examination of the bank's assets to an in-depth evaluaInstead of concention of the bank's management, auditing, and control systems.
trating on the bank's loan customers, the OCC has moved to an evaluation of the
bank itself. During 1976, the OCC began to use bank filaancial reports as a
preliminary examination tool, identifying potential difficulties at individual
banks.
GAO reviewed these and other new procedures being adopted by the OCC, and concluded:
As discussed in Chapter 4, we believe that the traditional examiz:tions of the three agencies have concentrated too smch on the review
of loans and not enough on bank policies, procedures, practices, controls,
and audit. The changes made by FDIC and FRS will not substantially remedy
this defect. In our view the new procedures being implemented by the
OCC offer the best opportunity for improvement. The OCC's revised
commercial examination procedures should provide the agency with more
meaningful information regarding the banks it supervises and .esuit in
More importantly, the new
more complete and consistent eraminations.
approach should result in early detection of situations which could
lead to deterioration in some aspect of banking operations. This approach could help avoid bank problems after they have occurred.
Thus the OCC is no, attempting to improve bank supervision through arbittary regulations which might limit bank services to the public. Instead the OCC is attempting
to foster procedures in each bank through which that bank can better manage itself.
The GAO report -- while endorsing the new OCC procedures -criticism of the OCC for not developing its new programs in
two other agencies. As pointed out in the OCC responses to
the OCC has attempted to share its new ideas with the other

I-3

makers the implied
c .,junction witl the
th. GAO recommendations,
Lt: agencies. The

APPENDIX I

OCC also endorses the GAO recommendation of more formalized communication among
the agencies concernfllg new examination techniques.
The OCC takes issue, however,
with the apparent CAO assumption that the best way to geLrtate new ideas is through
an interagency committ:ee (or, am some have proposed, through a giant monolith
combining the three aigencies). A primary virtue of three agencies, each with somewhat differing statutory responsibilltieu, is the ability of a single agency to
experiment with a new idea or procedure. It is doubtful that the new OCC examining
techniques endorsed by GAO could have 'een developed otherwise. A unified approach
is important and apprepriate after a new idea has been proved successful, not

when it is being first developed.
In summary, the purpose of .he OCC is to operate so that economic progress dnd change
is not inhibited while simultaneously, preventing unsound banking practices. It
is that fine line of promoting innovative response while supervising the banking
system that bakes bank supervision so difficult. The banking system has just come
through its first major economic crisis since the world wide depression of the
1930s. There were some casualties. But, in fact, the threatened financial crisis
did not develop, and the banking system seems to be stronger today than it was
before. New nrocedures have been developed by the bank.ng system and the continuing
dynamic future of American banking is assured. For the first time we are assured
that, just as the industry has changed, the teectics and techniques of a major bank
supervisor, the Office of the Comptroller of the Currency, has changed in a similar,
positive, fashion.

I-4

tPENDIX I
Recommendation

APPENDIX

(2-21)

Accordingly, we reccmmend Lhat the Comptroller of the Currency (1) develop
more definitive criteria for evaluating charter applications and (2) thoroughly
document the decision-making process, including an identification by reviewers
of each factor as fauorable or unfavorable.
OCC Response:
The OCC is the only federal agency with the responsibility for chartering
banks. It charters banks in all of the 50 states and in Puerto Rico and the
Virgin Islands. The widely differing banking environments found in the U.S.
make it almost impossible to develop definitive criteria which can be universally
applied such as in states like /,rizona, which has 6 National Banks, and in
Illinois which has over 400 National Banks. The diversity of criteria therefore,
is a function primarily of the differing political, social and economic onvironwents in which the OCC must operate. The OCC's chartering criteria, of necessity,
must be somewhat flexible. That is only to he expected since the OCC dbes not
charter in one n;tvironment. Also, under the terms of the kcFadden Act, the
OCC's actions are often affected by applicable state law.
The new corporate guidelines, development of which began in September, 1975, and
which became effective on Novek :r 1, 1976 answer many of the criticisms of the
GAO. Written opinions containing reasons are now sent to applicants receiving
denials, As examples, we quote from three recent letters sent to applicants
denying their charters. One letter in part, states:
Based upon the population and the median income per household, it
would appear difficult for many individuals in the primary service
area to qualify for a loan. Furthermore, income levels are inadequate
to provide a sufficient deposit base for the proposed bank to become
a viable institution.
In another case, we quote in part: In view of the Supreme Court decision
in Whitney and the Federal Reserve Board's decision in InterHountain Bank
Shares, it would be an exercise in administrative futility for this Office
to approve the present charter application...Should West Virginia change
itp statutes or should the statute be successfully challenged, then this
Office could consider a new application in light of these changed circumstances.
In still another case, the denial letter to the applicants stated: The
new guidelines state that a new banking office will not be approved, if
its establishment would threaten the viability of a newly chartered independent bank. Such protection will typically not exceed one year. As
you are aware, the new bank opened on September 27, 1976. It is the
opinion of this Office that this newly chartered independent state bank
is entitled to the protection set forth in the Comptroller's policy
statement.

I-5

APPENDIX I
Reconeandation

APPENDIX I
(2-21) Continued

Every attempt is now made to document thoroughly rt'e decision-making process.
Further efforts will '>e made by our Office to 'denfity each factor as fe--_rable or unfavorable,
Our decisions have Leen subject to -Jdicial review for many years.
In the long
series of rourt cas;s covering our chartring process, the Comptroller's
decision on a charter application has rever been finally overturned by a
reviewing court. See annotations to 12 U.S.C. 21 et seq.
Our Department of Research 6 Econoaf' Analysis has undertaken a market study
of 35 mational banks chartered betw:en 1969 and 1971. The economic study
attempts to identify, statistic-.ly, those factors which can be identified with
the growth or lack of growth of these new banks.
The results of that study,
if positive, will be incorporated into our decision-making process. We are
hopeful that quantificatiou. of a sufficient number of pertinent factors applicable to a majority of cases will result.
Recommendation

"-.7)

Therefore, we recommend that the Board of Directors, FDIC, the Board of
Governors, FRS, and the Comptroller of the Currency establish schedui'ng
policies and procedures which would avoid the setting of examination patterns.
OCC Response:
Historically, the OCC has viewed surprise as an important element of an
examination. However, a primary feature of our new examination approach
entails the pre-examination analysis wherein the examiner will determine
the adequacy of internal control and audit activity. The OCC feels the
best deterrent for fraud is not periodic unannounced visits by examiners
but rather the existence of sound bank policies, procedures, internal
control and audit L.ctivity on a continuing basis. The element of surprise
is neces
gary only im those cases where such factors are suspect.
Recommerdation

(4..k

We recommend thatt the Board of Directors, FDIC, and the Board of Governors,
FIS, adopt flexiNle policies for exaaiaation frequency which would allow
them to concentrate their efforts on banks with significant problems.
We recommend that the Congress amend the National Bank Act to allow the
Comptroller of the Currency to examine National Banks at his/her discretion.
OCC Response:
We supi,-t the recommendation of legislation to permit OCC discretion in
schedulit:
the frequency of examinations.
The current method of adapting
the depth of examinations to the needs of each bank, based aon
NBSS data
and pre-examination analysis, fully complies with law. However, greeter
statutory discretion would enhance our effectiveness in this regard.

1-6

APPENDIX I

APPENDIX I
Recommendat ion

(4-J)

We recommend that the Board ef Covernors, FRS, and the Comptroller of the
Currency develop and use a single approach to the classification of loans
subject to country rirk.
OCC Response:
The OCC has a well established procedure using a single approach to the
classification of country credits. This procedure makes use of information
from many governmental and non-governmental sources and examiners in all
fourteen national bank regions.
Copies of the minutes of our comi.lttee meetings and any resulting classifications
have always buen provided to members of the staff of the Board of Governors.
The process of country risk evaluation is more precisely an art than a science.
Most of t~ie evaluation process is judgemental. However, the interagency
meetinCa held to date have been beneficial in determining basic differences in
philosophies.
Recommendations

(4-38)

We recommend that the Board of Governors, FRS, and the Comptroller of the
Currency implement procedures whereby major foreign branches and subsidiaries,
including subsidiaries of Edge Act corporatiors, are examined periodically and
whenever adequate information about their activities is not available at the
home office.
Also, we recommend that the Board of Governors, FRS, and the Comptroller of the
Currency exchange each other's examiners' to cut expenses when conducting
examinations in foreign countries.
OCC Response:
a)

Overseas Examination

National Banks are required by Regulations K & M to provide examiners with
whatever credit and financial information the examiner deems necessary to
evaluate the condition of the bank's foreign branches and subsidiaries. Those
regulations require such information be transmitted to and maintained at the
bank's head office. The OCC has for practical purposes defined "head office"
to include any foreqgn or domestic office of the bank which is readily accessible
to its examiners. For example, all international credits of one large national
bank are examined from two domestic offices and four foreign offices located in
London, Caracas, Tokyo and Manila. All of that bank's many branches and Jubsidiaries located in Europe the Middle East and Africa are examined from duplicate
records in Londoi.

I-7

APPENDIX I
Recommendations

APPENDIX I

(4-^) Continued

Supplemental examLnatlons to determine the quality of the bank's operetioits
are made on-site overseas when necessary. For purposes of performing asset
and operational examinations, the OCC established in 1972 a London off:.ce
permanently staffed by six examiners. In fulfilling its overseas examination
obligations, the OCC in 1976 examined 141 overseas branches and subsidiaries
of 25 banks located in 37 countries; 154 on-site examinations were performed
by 215 National Bank Examiners.
b) Joint Examinations
The GAO reccnaendat/on has merit. As a bare minimum the physical support
of the three agencies could be jointly provided. Further arrangements could
be made so that any of the agencies could Jointly commission overseas examiners.
In this regard, the OCC is willing to seek a cooperative solution with our
sister agencies.
Under present statutes, however, such a sharing of examiner forces may be
difficult. Section 481 of Title 12 (12 U.S.C. 481) directs the Comptroller
of the Currency to appoint examiners who shall examine every national bank.
That same section empowers the Comptroller to make a thorough examination of
all the affairs of the banks under his jurisdiction including the affairs
of all affiliates of National banks "other than member banks", in order to
disclose fully the relations between the benk and its affiliates and the
"effect of such relations upon the affai;s of such bank". (Emphasis added.)
Recommeudation

(7-25)

We recommend that the Comptroller of the Currency invite FDIC and FRS to
jointly review and evaluate its new examination approach. Further, we
recommend that, in the event of a favorable assessment of the new process,
the Board of Directors, FDIC, and the Board of Governors, FRS, revise their
examination processes to incorporate the features of OCC's new examination
approach.
OCC Response:
Examination Approach
On November 23, 1976 OCC staff members made a presentation to approximately
20 FRS and FDIC staff members on the revised examination procedures. Copies of
our draft Handbook of Examination Procedures were furnished. Their review and
evalu& ton on an ongoing basis is welcomed. The Acting Comptroller has proposed
to the Interagency Coordinating Comuittee that a permanent staff group be set
up for this purpose.

I-8

APPENDIX I

Reconumell;a L ioL

APPENDIX I

t5
( -. W)

Additionally, we recomlnlcIud tlat tlhi Uoard of DIrectors, FDIC, the Board of
Governors, FRS, and the Comptroller of the Currency jointly staff a group
to analyze shared national aredits at State and National lead banks under
Federal supervision and that th; three agencies use the uniform classification of these loans when they examine the participating banks.

OCC Response:
Shared National Credits
In 1974, meetings were held with representatives of the OCC, FRS and FDIC
Present to discuss the possibilities of using a uniform program for the review
of selected large shared loans. Both the FRS and the FDIC found merit in the
program but they believed sufficient pitfalls existed to delay their participation In the program. Also, in March of 1974 this Office met with representatives of the Conference of State Bank Supervisors to discuss the proposed
program. They indicated interest and agreed to work out arrangements with
various bank supervisors.
In 1975, the Office of the Comptroller of the Currency conducted uniform reviews
of shared national credits in applicable National Banks. The loan write-ups
generated by these reviews were made available to both the FRS and .he FDIC
In March, 1975 FRS expressed their continued interest in the program.and hoped
they could participate if the "pitfalls" could be overcome. In November, 1975
FRS revealed they were instituting a test review program involving state member
banks paralleling our methods and procedures. In July, 1975 FDIC again expressed
intereut and a meeting was held in September, 1975 with representatives of the
FDIC. This Office indicated FDIC involvement would be welcomed in whateser way
they deemed appropriate.
During May, 1976 the second uniform review was conducted and again the data
generated was made available to the FRS and FDIC.
In July, 1976 the Comptroller of the Currency and the Vice Chairman of the Federal
Reserve Board tet to discuss the approaches of the two agencies to shared national
credits. It was agreed that the OCC should continue to provide FRS with the
information developed under its program and to explore at a staff level whether
uniform procedures could be developed between the two agencies which would be
acceptable to all of the Federal Reserve Banks. It is our understanding that
the New York Federal Reserve Bank is conducting a pilot project involving shared
credits which may assist in resolving some of the anticipated problems associated
with a combining of the approaches of the two agencies.

Recommendation

(7-.26)

We also recommend that the Board of Directors, FDIC, the Board of Governors,
FRS, and the Comptroiler of the Currency work together in refining their
monitoring systems and their approach to consumer credit compliance examinations.

I-9

APPENDIX I

OCC Response:
Monitoring
The OCC has met on several occasions with officials of the other two
federal supervisory agencies to present its NBSS system. Those orientations
were given both orally and with complete sui 'ission of all relevant documents.
Further, we have offered the other superviso- agencies computer programs and
technical knowledge to implement the programs.
Consumer Credit Compliance
With reference to consumer credit compliance examinations the draft report
does noM fully recognize that our new program is already operational. Over
6Z of our field staff is currently allocated to the consumer area. We have
conducted three two week schools which trained over 140 examiners in the new
procedures; a second series of three schools is scheduled for March and April,
and a third series will take place in the Fall. The schools stress examination
techniques and feature heavy reliance on case stadies to give experience in
examining for compliance. The procedures are tailored to spot problems most
likely to result in harm to consumers. We make use of sophisticated advanced
financial calculators, specially programmed for banking applications, and
sampling techniques designed to increased our effectiveness.
Eleven percent of the country's 4,700 national -.nks have been examined under
the new procedures. Preliminary analysis of these reports indicates that our
expanded efforts in this area are both justified and effective.
The draft report also does not reflect the extent to which other agencies have
cooperated in developing our new program. The Federal Reserve Board and h.U.D.
aided in reviewing our procedures. Speakers from the 7ederal Reserve Board,
H.U.D. and the Justice Department participated in our schools. Observers
from the Federal Reserve Board, FDIC, N.C.U.A. and H.U.D. attended the schools
to assess the new procedures. As a result many of our examination procedures
and teaching materials have been adopted b-, these four agencies. This experience has reinforced our awareness of te'a benefits ef such cooperative
efforts.
Recommendation

(8-Ze)

a). We recommend that the Board of Directors, FDIC, the Board of Governors,
FRS and the Comptroller of the Currency establish more aggressive policies
for using formal actions.
OCC Response:
We believe that in supervising the vast majority of national banks, our most
effective remedy continues to be the examination process and the meetings held
as part of that process between the board of directors of the bank and OCC
personnel. Since December 23, 1975, the OCC has required meetings with boards
of directors of each national bank at least once every calendar year and, in
certain cases, following every examination. We believe that the increased use
of such meetings together with our new examination procedures and early warning
system will make our first-line, informal supervisory techniques even more effective.

i-10

APPENDIX I
Recommeildation

APPENDIX I

lB
(8-t_ )

Continued

As the GAO report elsewhere notes, our informal supervisory techniques even
without the improvements noted above, have proven effective in rehabilitation
of most of the so-called problem bank situations. For example, over the period
reviewed by GAO iti'frmal procedures utilized by OCC were successful 84% of the
time. Nonetheless, de agree that increased use of formal agreements and cease
and desist orders under tfe Financial Institutios Supervisory Act may accelerate
correction of problems in :he more recalcitrant institutions.
OCC use of such formal agLeements anp. orders has increased tenfold from 1970 to
1975. The OCC has originated slightly more than half of the combined total (179)
formal agreements and cease and desist orders issued by all three agencies during
the last five years. The OCC, however, supervises fewer than half the number of
banks supervised by the other two agencies combined. When compared to the
number of banks supervised, the OCC over the past five years has used the formal
enforcement tools of Financial Inetitutions Supervisory Act about two and one
half times as often as the other two agencies.
It should also be noted that the three banking agencies Jointly requested
Congress in 1975 to refine and increase the agencies' formal enforcement powers.
Congress failed to pass the necessary legislation.
b). Written criteria should be developed to identify the types and magnitude
of problems that formal actions appropriately could correct.
OCC Response:
The OCC has developed as part of its National Bank Surveillance System a severity
anomaly ranking system which identifies every three months the national banks
most likely to require special supervisory attention. A computerized action
control system is designed to assure that the OCC responds promptly and appropriately to these situations. The criteria built into these systems identifies
more systematically and promptly those cases in which formal enforcement action
is appropriate.
Recommendatiun

4q
(8-.)

We recommend that the Board of Directors, FDIC, the Board of Governors, FRS,
and the Comptroller of the Currency develop uniform criteria for identifying
problem banks.
OCC Response:
The term "problem bank" is banking agency jargon for many differe-nt fact patterns.
To an outsider, it appears reasonable and logical to expect a uniform definition
of the term. The agency staff person recognizes the difficulty of reducing all
the variables to a single definition. At the same time, he has little difficulty
in communicating with colleagues in other banking agencies on particular bank
situations.
OCC's approach is to co;puterize to the greatest extent possible the many variables
which characterize a bank's condition and management from time to time. This resulte in a capability to rank all banks in relation to their peers. The final
selection of banks needing special supervision can only be done subjectively by
trained personnel using all the tools available and the results of our revised
examinations.
The dividing line on the spectrum between "problem" and "non-problem"
status is hard to define but OCC is more than willing to consult and cooperate with
the other agencies in seeking such dividing lines.

I-11

APPENDIX I
Recnu endation

APPENDIX I
(10-6)

We recommend that where teasible thel Comptroller of the Currency, Board ot.
nlrectorb, FDIC, and Board of Governors, FRS, combine their examiner schools
and standardize their curricula.
OCC Response:
The OCC recognizes that a common training effort and a combined examiners'
school would be highly desirable both in terms of expense and coordination
of examination policy. Our Office stands ready to cooperate fully with all
such efforts. Indeed, our Office is in receipt of a letter f.om Chairman
Barnett of the FDIC asking our cooperation and financial iupport for a
combined training facility to be constructed at a Rosslyn, Virginia site.
This matter is receiving serious attention.
The practical difficulty is that our Office has implemented the Haskins and
Sells Report which has created fundamental changes in our examination process.
These changes are so basic to our examination process that it would be
difficult to coordinate a curriculum. A combined examiners' school is viable
only if the other agencies modernize their techniques in line with those being
implemented at the OCC. It would be Fossible, however, to offer jointly
courses in more generalized subjects such as Economics and Accounting.
Recommendation

(10-IRe)

We recommend that the Board of Governors, FRS (1) establish a full-time
training office to operate its examiner training program and (2) carry out
the revision of examiner school curricula which it has recognized as needed
for some time.
We also recommend that the Comptroller cf the Currency, Board of Directors,
FDIC, and Board of Governors, FRS, increase their training in EDP, Law and
Accounting as desired by their examiners.
OCC Response:
As part of our acknowledged need for specialized training, and consistent with
the advice of our consultants, the Training Division of the Personnel Management
Department has identified a multitude of different specialized courses which
selected examiners will take; they include 7 different commercial examination
schools, 3 trust examination schools, an EDP school, and International school
and a consumer examination school. That program has now been implemented and
is in full operation. The schools are programmed for examiners at different
stages of their professional development. Among the many courses that will be
offered by skilled personnel, both from within the OCC and, where necessary,
from outside, are ones in EDP, Law and Accounting. Among the other areas that
will be covered in that curriculum development will be specialized work in
Economics, Bank Marketing, Finance, Auditing and similar topics.

I-12

APPENDIX I
Recommendation

~~~~~~~~~APPENDIX~APPENDIXI
(11-8)

We recommend that the Board of Directors, FDIC, the Board of Governors, FRS,
and the Comptroller of the Currency either (1) jointly establish a more
effective mechanism for the three agencies to combine their forces in undertaking significant new initiatives to improve the bank supervisory process
or in attacking and resolving problems coMnon to the three agencies, or
(2) the Congress enact legislation to establish a mechanism for more
effective coordination.

OCC Response:
The OCC has always stood tor the strongest possible working relationships
between federal supervisory authorities. At the December, 1976 meeting of
the Interagency Coordinating Comraittee, Mr. Robert Bloom, Acting Comptroller
of the Currency, asked that the committee ta,ke up at its next meeting the
It will be
subject of strengthening coordination of examination procedures.
proposed that a permanent staff group be set up for this purpose. We
anticipate modification and refinement of our newly implemented examination
approach on an ongoing basis. Review and evaluation of such changes as they
affect problems common to the three agencies would be most useful.

I1-13

APPENDIX II

APPENDIX 11

07..

-u~,/,~

CHAIRMAN OF THE BOARD OF GOVERNORS
FEDERAL RESERVE SYSTEM
',[: ,'

aWASHNGrION.

D. C. 20551

January 16, 1977

The Honorable Elmer B. Stoats
Comptroller General of the United States
Washington, D. C. 20548
Dear Mr. Staats:
We appreciate the opportunity to review the General Accounting
Office's draft report on the "Study of Federal Supervision of our Nation's
Banks."
The data contained in the report reflect favorably on the
Federal Reserve's supervisory performance with respect to both banks
and bank holding companies.
'swever,
the report does suggest a number
of refinements in examination procedures and urges more uniformity of
standards among the Federal bank regulatory agencies. In most instances,
the Federal Reserve had already taken steps to accomplish the objectives
of the .ecommendations.
The Board's specific comments concerning individual recommendations and its general comments concerning the GAO report are enclosed.
It is our understanding that our responses to specific recommendations
will appear verbatim in the report immediately following the applicable
recommendation and that our general comments entitled "Statement by
the Board of Governors of the Federal Reserve System" will appear in the
Highlight Section of. the final report.
Sincerely yours,

Arthur F. Burns
Enclosures

APPLNDIX

APPftNIL)X 11

STATE2EN'J' BY
THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
ON THE GAO REPORT

The agreement between the General Accounting Office and the
three bank regulatory agencies, pursuant to which the special GAO review
of the bank zupervisory process was commenced in May, 1976, provided
that each of the agencies involved would have an opportunity to comment
on the conclusions an; Lrcotnmendations set forth in that report.
addition to its speciti.

:nts on individual recommendations which

are set forth throughout the main body of the report, the Board also
believes that some introductory comments are appropriate.
--The report co~nfirms the basic health and soundness
of the banking system. The number of banks requiring
special supervisory attention is a small percentage
of the total number and the percentage which have
in fact failers is much smaller still.
--The report confirms the basic soundness of the
current system of supervision. Refinements, rather
than basic revisions in the current system, are
recommended. In most instances, the Federal Reserve
Board had already taken steps to implement such
refinements and we believe the same to be true of
the other agencies.
--The report confirms the necessity for the legislative
improvements in the bank supervisory and regulatory
area which the Board recommended to Congress as
early as September, 1975, as well as the Board's
proposals for a Federal Bank Examination Council.
The bulk of the GAO review focuses on banking institutions
which hav-'

required special supervisory attention and the responses

of the various agencies to this requirement.

Despite this limitation,

the report establishes that, at any one time, the percentage of banking

II-2

APPLNDIX

APPtIDX

institutions in the country which for vaLious reasons can be considered
to require special supervisory attention is extremely small, in the
neighborhood of 5 per cent.

The data in the report show that between

1970 and 1975, encompassing an exceptionally difficult economic period
for the country, only 42 of the approximately 14,000 commercial banks
in the country failed.

Most of those institutions were relatively small

and aggregate losses to depositors were minimal.
Also relevant to an evaluation of the supervisory process
is the conclusion cf the report that the group of banks identified as
requiring special supervisory attention is fluid.

The composition of

the problem lists changes with some frequency as the regulatory agencies
identify problems and the banks respond to the need for corrective action.
The recommendations made throughout the report indicate that
no need was found for any basic revisions in the country's present system
of bank regulation.

Rather, the report identifies a number of areas

which GAO believes need further attention by the agencies.

As noted

in our specific comments on the recommendations, in most instances the
Federal Reserve and the other regulatory agencies had already taken
actions in harmony with the basic thrust of the recommendations.

For

example, the Eoard was already focusing more of its supervisory resources
on institutions with known problems and less on those thought t- be
in good condition.
The majority of the recommendations in the area of bank examination and supervision relate to a desire for greater uniformity in supervisory

II-3

APP[NDIX

APPENDIX

treatment among the agencies.

These recommendations support the Board's

conclusions and initiatives in this area.

In December, 1975, Governor

Holland testified before the Senate Committee on Banking, Housing and
Urban Affairs and in that 'estimony made reference to the coIncept of
a joint bank examination council which at that time had received substantial
support within the Board.

In that regard, he stated:

Such a Council would be focused on the areas that
we believe are most in need of improvement; that
is, efficient and uniform modernization of bank
examination and vigorous and consistent follow-up
procedures when bank weaknesses are revealed. Such
a Council could be established administratively
Its statutory authorization would
or by stdtute.
undoubtedly give more impetus to the establishment
of such a Council, and would also provide it with
more clear-cut authority to take definitive action
within its statutorily defined areas of administration.
The Federal Bank Examination Council should have
authority to establish standards and procedures
for bank surveillance, examination and follow-up,
applicable to all the Federal banking agencies,
and it should review significant problem cases when
and as they develop. All three Federal banking
agencies should be represented on the Council.
Subsequently, at the Board's request, Senator Stevenson introduced
the Federal Bank Examination Council Act

(S. 3494).

Such a council

would establish mandatory uniform standards and procedures for Federal
examination of banks as well as uniform reporting systems and conduct
joint schools for examiners.

The Board strongly supports such legislation

and believes a proposal along those lines could accomplish most of the
objectives set out in the report's recommendations in the examination
area.

II-4

APPENDIX II

The report focuses extensively on the method by which the
agencies deal with problem bank situations and makes a number of recommendations for improvements in this area which will be discussed later.
Further, in a number of instances the report specifically supports enactment
of various legislative proposals made by the Board on behalf of the
regulatory agencies.

As Chairman Burns stated in a letter of September 5,

1975 proposing such legislation, "All of these recommendations arise
:'ram the agencies concern over 'problem bank' situations and are designed
to help prevent or correct such situations."

H.R. 9743 and S. 2304,

which embodied these recommendations, would have provided civil penalties
for violations of various provisions of Federal law by banks and bankers;
imposed new restrictions on a bank's transactions with insiders; and
placed the ago,icies in a position to make more effective use of the
Financial Institutions Supervisory Act of 1966.

The Board believes

that the report pzovides strong support for tiit legislation.

In this

regard, we note that Senator Proxmire has just introduced a bill in
the 95th Congress which encompasses these recommendations.
The GAO report stated that *Examiners found problems in nearly
all of the banks in our samples, including those not on the agencies'
problem lists . ..

The tables contained in the review of this element

of bank supervision showed that examiners applied strict. standards;
e.g.,

in 70 per cent of the banks ti.- examiners criticized the volume

of classified loans; violations of law and regulations, whether merely1
technical or substantive, were identified in 55 per cent of the banks;

II-5

APPLNDIX

II
1!

APPLNDIX

inadequate routines and controls we:e noted in 44 per cent of the banks.
We agree with the GAO and believe the report readily confirms that bank
examiners are effective in identify!ng problem areas in commercial banks.
We believe that the stud,, also demonstrates that the supervisory
agencies are effective in resolving significant problems once they have
been identified by the examiners.

We are not convinced that analysis

of the dynamics of so-called 'problem lists" -- one of the techniques
employed by the GAO -- is a proper basis for measuring supervisory effectiveness.

Tnus, we are somewhat concerned with the report'a focus on the

length of time an institution remains subject to special supervisory
attention as being c. indication of whether or not the supervisory process
is, in fact, working.

%h believe that substantial weight should also

be given to the percentage of banks which fail as an indication of whether
or not the process works.

During the period examined by the GAO, only

twu St.ate member banks failed, and they were relatively small.
However, we believe that even the focus of the report on the
dynamics of the list of institutions subject tc special supervisory
attention demonstrates the effectiveness of the present system.

The

report shows that the composition of the lists changes with some frequency
as problems are identified by the regulators and resolved by the institutions in conjunction with the regula ors.

During the period examined

by the GAO, 1,180 banks were added to t|hese lists and 897 were removed.
Furthermore, as set forth in more detail in our specific responses to
individual recommendatior.s, we believe the data gathered in chapter 8

II-6

APPENDIX I1

APPlNDIX II

demonstrate that the performance of the three agencies is roughly thp
same and, in fact, aood for all three agencie:s.
In addition to the recommendations

for greaser uniformity

in examination and follow-up among the agencies, the report makes a number
of recommendations relating to examination techniques and training.
As more specifically set forth in our responses to the particular recommendations, the Board has taken, or is in the process of taking, effective
action compatible with the major thrust of most of the recommendations.
For instance, a major portion of the recommendations deal with the desire
that the agencies focus more of their resources on institutions with
known problems.

In this regard, the Board requires all problem banks

to be examined at a minimum of six-month intervals.

Further, the Board

has recently adopted limited scope Asset Quality and Management Performance
Examinations to be used on banks thought to be in relatively good condition.
The Board believes that these procedures give us the needed flexibility
while at the same time minimizing the likelihood that problems will
be overlooked.
In the area of training, the Board has, among other things,
recently revised curricula for its various examiner schools and has
instituted new schools in the areas of consumer regulations and bank
holding company analysis.
The Board would also like to comment on the broad purposes
of the bank examination process lest the sum of the report's recommendations
be misconstrued.

We believe that bank examination and supervision should

11-7

APPLNDIX IIAPPINDIX

be directed at securing compliance with banking laws and regulations
and determining that a bank is operated soundly so as to assure, to
the greatest extent possible, safety and soundness of depositors' funds
and continued banking services to the community.

A system of bank regulation

which goes beyond these goals imposes certain social costs and dangers.
It is not the job of the supervisors to determine whether specific loans
should or should not be extended or whether a bank's resources should
be used in a particular tzanner unless such decisions contravene law
or affect the safety and soundness of the bank.

Rather, private initiative

should be encouraged to the greatest extent possible.
Finally, the report also comments on the Board's supervision
of bank holding companies.

The data in the report confirm that, as in

the case of banks, the percentage of problem institutions is relatively
small.

Even utilizing a sample biased toward problem institutions,

there were limited instances in which bank holding companies were found
to have caused problems in the subsidiary banks.

Out of the sample

of 344 which were affiliated with bank holding companies, there were
22 banks in which the report stated that the problem was caused by the
parent holding company.

This constitutes 6.5 per cent of the sample

banks affiliated with bank holding companies.

However, the Board's

examination of the parent bank holding company in each of these instances
demonstrates that, in fact, the actions of only five holding companies
could be said to have caused any serious problem in the subsidiary banks.
In addition, the Board believes that it is taking effective supervisory

II-8

APPENDIX

action in those cases where holding companies are causing problems for
the subsidiary banks.

In October, 1974, the Board's request for cease-

and-desist authority over bank holding companies was granted.

Since

that time, the Board has significantly expanded its supervisory efforts
with respect to bank holding companies, concentrating primarily on those
exhibiting problems.

With respect to formal actions, in the 26 months

the Board has had the authority, it has issued 12 cease-and-desist orders
and 12 written agreements against holding companies.
In concluding our general statement, we wish to note once
again that our banking system has weathered an extremely difficult period
successfully.

The bank supervisory process of this country, which by

no means is perfect, has materially contributed to this achievement.
*******************

The Board's further responses to individual recommendations
may be found throughout the body of the main report as follows:
Recommendations relating to

Page

Scheduling of examinations --------------

Flexible examination policies -------------

Use of State examinations --------------…-

4-13

Scope of examinations --------------------- 4-17

Examination workpapers -

Country risk evaluation --.-------.---------

433

Examination of foreign operations ---------

4.35

EDP examinations -------------------------- 4.39

1-9

-------------

4-19

APPENDIX II

APPENDIX 11

Page

Recommendations relating to
-- Supervision of holding companies ----------

4-51

-- Examiners' meetings with directors --------

6- 5

-- Examination report format -----------------

6-13

-- Evaluation of the Comptroller of the
Currency's examination procedures ---------

7-25

-- Analysis of shared national credits ------- 7-25
-- Policies for formal enforcement actions ---

8-18

-- Criteria for identifying problem banks ----

8-49

-- Combined examiner schools ----------------- 10- 6
-- Separate training office ------------------ 10-11
-- Evaluation of examiners ----------------- - 10-15
-- Uniformity in the supervisory process ----- 11- 8

II-10

APPENDIX

Recommendat ion
Therefore, we recommend that the Board of Directors, FDIC,
the Board of Governors, FRS, and the Comptroller of the Currency establish
scheduling policies and procedures which would avoid setting examination
patterns.
Comments
This recommendation is based upon the premise that the agencies
view surprise as an important element of an examination.

The Board

believes that,in many cases, there is serious doubt as to the benefits
to be gained and hence the desirability of surprise examinations.

those instances where surprise is considered important, it has been,
and will continue to be,our practice to schedule examinations so that
they cannot be predicted in advance.
Recommendation
We recommend that the Board of Directors, FDIC, and the Board
of Governors, FRS adopt flexible policies for examination frequency
which would allow them to concentrate their efforts on banks with known
serious problems.
We recommend that the Congress amend the National Bank Act
to allow the Comptroller of the Currency to examine national banks at
his/her discretion. We would be glad to assist the committees in drafting
appropriate legislation.
Comments
The Board already has established policies that are flexible
enough to allow us to concentrate our efforts on banks with known serious
problems.

Some years ago, the Board adopted the policy, which was reaffirmed

in 1975, that all banks considered to be in a problem status be examined
at a minimum of six-month intervals.

Howe-ver, we will continue to schedule

periodic examinations of all banks under our supervision
may deteriorate with the passage of time.
II-11

since a bank

As pointed out in the GAO

APPENDIX II

of Asset Quality and Management
report, the Board recently approved the usage
thought to be relatively
Peformance Examinations in the case of banks
free of major problems.

If this limited scope examination detects

is then commenced.
major changes or deterioration, a full scale examination
the same time insuring
These procedures give us flexibility while at
that problems are not overlooked.
Recominendation
and the Board
We recommend that the Board of Directors, FDIC,
to use State examinations
of Governors, FRS, extend their current efforts
they
that
recommend
also
we
do,
and, If they
State examiner
--develop minimum standards for acceptable
and
training and examination procedures
those standards.
-- use only reports of State examinations meeting
Comments
to eliminate
The report recognizes our current extensive efforts
and State examination
unnecessary duplication by utilizing StPte examiners
reports.

should
If experience with our existing program in Indiana

GAO's recommendations
indicate that expansion of this program is desirable,
regarding standards would be appropriate.
existing experimental program is

Indeed, the purpose of the

to develop such standards.

In this

that written standards
connection, however, it should be recognized
alone will not insure the success of any program.
Recommendation
and the Board
We recommend that the Board of Directors, FDIC
tha scope of each examination
of Governors, FRS, establish procedures to base
the bank's controls,
on the examiners' evaluation of the quality of
policies, procedures, and audit.

II-12

APPENDIX II

Comments
This recommenndation encompaasses what we are already doing.
We review the policies, procedures, and controls in connection
with
all bank examinations.

In moat large banks, our examiners currently

perform a prtexamination review specifically focusing on controls,
policies,
and procedures. The results of such review are used to determine
the
amount of scrutiny given to each area.

In smaller banking institutions,

a review of the controls, policies and procedures in effect at
the last
examination is used to develop the scope of the examination.
Recommendation
We recommend that the Board of Directors, FDIC, and the Board
of Governors, FRS, develop standards for the preparation, maintenance,
and use of examination workpapers.
Comments
We believe that, in the vast majority of examinations, the
examination workpapers and line sheets prepared are adequate to
meet
the System's needs.

The manner in which examination workpapers should

be prepared and maintained is extensively covered in connection
with
the training of our examiners.
Recommendation
We recommend that the Board of Governors, FRS, and the Comptroller
of the Currency, using all available information, develop and
use a
single approach to classify loans subject to country risk.
Comments
The evaluation of the country risk element in international
loans calls for difficult analysis and judgment at the time lines
of
credit are established or loans extended since 'country risk'
involves
II-13

APPENDIX II

an estimate of a country's political, economic, and social fortunes
over the life of the loan as they may affect the collectability of such
loans.

There is

serious question as to the validity of generalized

characterizations of credits based on the country of residency of the
borrower, particularly where the characteristics of the credit may well
vary with the borrower - private or governmental - as well as the nature
and extent of external resources available to support the loan.

For

a number of months now the Federal Reserve has had underway a review
of country risk problems in international lending as well as appropriate
This review has included an on-going

supervisory treatment of the problem.

appraisal of the system employed by the Comptroller of the Currency.
In this regard, we believe that, while there may be general agreement
on the desirability of uniform evaluation of the country risk element
in individual international credits, there is a real question as to the
desirability of rating individual countries.

It might be noted, for

instance, that the Comptroller's system focuses almost exclusively on
credits to individual governments.

In any event, we believe that we

should strive toward uniform treatment.

Of course, as with respect

to many of ';he recommendations, the Federal Bank Examination Council
proposal would accomplish this.
Recommendation
We recommend that the Board of Governors, FRS, and the Comptroller
of the Currency implement procedures to examine (where permitted by
the country involved) major foreign branches and subsidiaries, including
subsidiaries o,e Edge Act corporations, periodically and whenever adequate
information ab,ut their activities is not available at the home office,

II-14

APPi!DJI,\ I I

APNl.DIX 11

Also, we recommend that the Board of Governors, PRS, and the
Comptroller of the Currency utilize each others examiners to cut expenseP
when conducting examinations in foreign countries.
Comments
The development of widespread networks of foreign branches
and subsidiaries by the major banks has brought the question of the
supervision of the banks' international operations to the forefront
in recent years.

We concur with the principle that examinations, wherever

conducted, should be adequate to provide the necessary supervisory information.
However, one constraint with which the Board has had to deal is, as
noted in the report, that, in many cases examinations of foreign subsidiaries
are not possible because of host country laws which preclude direct examinations by other governmental authorities of banks chartered in those
countries regardless of the ownership.

The System has not only required

that banks maintain records at the head office adequate to appraise the
risk and exposure of the banks through their foreign operations, but the System
has also provided for direct visitations of examiners to major foreign
branches in those cases where such visitations have been legally possible.
The Board believes that, on the whole, this system has worked
well.

The information available at head offices has, in general, been

adequate to assure that the banks were not unduly exposed to loss or
serious financial difficulties.

At the same time, there has been a

continual search for better and more efficient ways of satisfying the
Federal Reserve's supervisory responsibilities in the international
field.

II-15

APPENDIX II

Beginning in the fall of 1976, on-site examinations were made
of foreign branches of State member banks where we had previously utilized
on-site inspections by State examiners or information at the head office.
Moreover, a number of foreign subsidiaries were directly examined for
the first time with the agreement of the host government.
of those examinations has not yet been completed.

A full evaluation

One preliminary result

of that exercise has been to provide assurance that a large portion
of the material needed for proper supervision of foreign branches and
bubsidiaries is in the management information systems at head offices.

In this connection, it should be noted that consultations are continuing
with foreign bank superisory authorities about the ways in which access
to foreign subsidiaries may be broadened to accommodate on-site reviews.
These consultations are part of a wider effort of international cooperation
in bank supervision.
Recommendation
We recommend that the Board of Directors, FDIC, and the Board
of Governors, FRS develop reports of examination for EDP operations
which present the problems found, corrective action needed and any necessary
explanatory data in a clear and concise manner.
Comments
The Board wishes to note that it believes its present EDP
examination report adequately presents the major problems found and
corrective action needed.

Furthermore, the System has already undertaken

a review of EDP examination procedures to :Determine whether there are
possible improvements, particularly in the review of internal controls,
and, in connection with that review, is preparing a revised examination
report.
II-16

APPENDIX II

APPENDIX II
Recommendation

We recoamend that the Board of Governors, FRS implement a
of
supervision which is based on o;site inspections of holding
system
companies and their major nonbanking subsidiaries. We also recommend
that the Board strengthen its oversight of holding company supervision
by establishing
--a systemwide manual of inspection procedures,
--a standard inspection report, and
--periodic onsite evaluations of Reserve bank supervisory
activities.
Comments
The System has for some time conducted on-site inspections of
selected holding companies.

Partly as a result of these inspections and problems

which came to its attention, the Board in late 1974 requested and was
granted legislative authority to impose the same supervisory remedies
on holding companies that were applicable to banks under the Financial
In early 1976,the Board directed

Institutions Supervisory Act of 1966.

that this inspection program be significantly expanded with initial
efforts directed toward holding companies requiring special supervisory
attention.
In addition, in 1975 the Board commenced work on a computer
based monitoring system in order to identify those holding companies
which might require special attention.
at the present time and is

This program is partially operational

expected to be fully operable within the

next few months.
A manual of inspection procedures is currently under dev=lopment.
However, completion of such a manual has of necessity awaited experience

II-17

APPi ..D1A 11

,j.ined from the direct on-site inspections which have been carried out.
we- believe that the recommendations relating to a standardized inspection
report as well as periodic on-site evaluations of Reserve Banks supervisory
activities warrant further consideration.

We might note that the initial

steps to set up such periodic evaluations already have been commenced
by the Board.
While we see no difficulty with the thrust of the recommendations,
the Board is concerned that the method used in the GAO report may lead
to unwarranted fears as to the general health of bank holding companies.
The sample chosen was one in which problem banks were at least six times
more likely to occur than in the industry as a whole.

A samp'.e biased

toward problem banks is naturally biased toward problem holding companies.
Under the heading 'Unsound Holding Companies' Expansion Applications
Approved" the report states that the Board approved applications by
15 of 20 'detrimental holding companies" to acquire additional banking
and nonbanking subsidiaries.

Our review of these companies indicates

that the problems of over two-thirds of these companies were problems
centered in the banking subsidiaries as opposed to problems in either
the parent holding company or a nonbanking subsidiary.

As such, these

problems would be most effectively handled by the primary examining
authority of the bank involved.

Furthermore, the majority of the applications

involving these institutions which are referred to were acted on in
the early 1970's, long before any of the institutions had experienced
difficulty or had been identified as requiring special supervisory attention.

I I-1

APPENDIX II

In fact, only three applications were approved at a time when any
of
the institutions involved was considered to be in a problem condition.
Two of these applications consisted of corporate reorganizations
having
no financial impact on the institution whatsoever.

The third application

involved permission to engage in a nonleveraged, potentially profitable,
operation which was considered to be a positive factor to improve
the
condition of the company involved.
The Board regards its policy, adopted in June 1974, of curbing
bank holding company expansion into nonbanking activities, particularly
with respect to bank holding companies with financial problems, as
being
an effective supervisory tool.

In fact, the Board has acted to deny

a significant percentage of applications on financial and managerial
grounds since this policy was introduced, and many more have been
withdrawn
by applicants after discussions with staff.

The Board believes it has

applied this policy responsibly and it remains in effect.
Recomme ndat ion
Therefore, we recommend that the Board of Directors, FDIC,
and the Board of Governors, FRS require their examiners to meet
with
the bank's board of directors or audit or examining committee
after
each examination.
Comments
The System has for many years been concerned that the board
of directors be particularly aware of the results of an examination.
Thus, the System has historically required that the examination
report
be considered and discussed at a meeting of the board of directors.
To insure that this is done, directors are required to sign
a statement

II-19

APPENDIX II

attached to the report that it has been so read and considered.

Further,

examiners are instructed to revieu the minutes of board of director
meetings to insure that the spirit of these requirements has been fully
carried out.
With respect to meetings, the Board in 1975 directed that
an earlier existing policy for most of the System be expanded to all
Reserve Banks.

This policy requires that Reserve Bank staff meet with

the board of directors of all so-called problem banks.

The Board believes

that such meetings are important where significant problems are revealed.
Recommendation
We recoafmend that the Board of Directors, FDIC, and the Board
of Governore, FRS, develop and use reports of examination which provide
the banks with the results of the examination and any necessary supporting
information.
Comments
We believe the bank examination report presently provides
the banks with the results of an examination and necessary supporting
information.

We also believe it

should provide the System with the

information it needs to carry out its

supervisory functions.

examination report adequately carries out these needs.

The present

It should not be

forgotten that the System also uses other methods of communicating its
views to its

member banks, such as correspondence,

consultations on applications.

Of course,

the System is

exploring methods of improving communications.

II-20

informal meetings,
continually

ant

APPENDIX II

Recommendation
We recommend that the Comptroller of the Currency invite FDIC
and FRS to jointly evaluate its new examination approach. We further
recommend that, in the event of a favorable assessment of the new process,
the Board of Directors, FDIC, and the Board of Governors, FRS revise
their examination processes to incorporate the concepts of OCC's approaches.
Comments
The Comptroller's new procedures are based in large part on
the Haskins and Sells report.

At the time that report was prepared,

the Comptroller furnished it to the other banking institutions in the
belief that some of the recommendations might be jointly applicable.
A task force at the Federal Reserve reviewed the report shortly after
its issuance and concluded that, in most instances, the Systeu had already
implemented those recommendations involved which would have been applicable
to the System.

Subsequent to that time, the development of new examination

procedures at the Comptroller's office has been substantially completed.
Recently, senior members of the Board's staff attended a briefing by
the Comptroller's office on these new examination procedures and the
report form to be used by that agency.

The Board believes that the

Comptroller has been most cooperative in sharing his new systems with
us and fully intends to use whatever benefits may be derived from the
Comptroller's efforts in this area in our on-going review of our examination
procedures.

II-21

APPI;I Dill 11

iPPLrUDIA( IX

Recommendation
We recommend that the Board of Directors, FDIC, the Board
of Governors, FRS, and the Comptroller of the Currency jointly staff
a group to analyze shared national credits at State and national lead
banks under Federal supervision and that the three agencies use the
uniform classification of these loans when they examine the participating
banks.
We recommend that the Board of Directors, FDIC, the -oacd
of Governors, FHS, and the Comptroller of the Currency work together
to refine their monitoring systems and their approaches to examining
for compliance with consumer credit laws.
Comments
A joint approach to shared national credits is clearly desirable.
In fact, in June 1976 the Board and the Office of the Comptroller of
the Currency entered into a preliminary agreement which provides for
a sharing by each agency of examiners' classifications of a ,oational
credit.
The second portion of this recommendation deals with the desirability
of uniform refinement of consumer credit enforcement and compliance
policies.

In the report, the GAO states that some agencies believe

there is a possible

oonflict between a bank's objective of financial

soundness and strict compliance with consumer credit laws."
does not agree with this statement.

The Board

On the contrary, we believe that

stringent enforcement of consumer laws and regulations will achieve
compliance and thereby reduce the likelihood that banks will incur
substantial liability as a result of consumer suits.
The Federal Reserve has had the major responsibility for drafting
regulations to implement the explosion of legislation that has taken
place in this area over the past two years.
II-22

In this connection, the

APPENDIX II

Board's Division of Consumer Affairs has worked very closely with the
other agencies.

It has formed a Federal Reserve task force to develop

approaches to the enforcement of newly enacted consumer credit laws.
A cadre of examination specialists who will concentrate tCn inspection
and compliance is being trained.

Two schools on consumer regulations

were conducted in 1976 and four have been planned for 1977.
Additionally, examination manuals that deal with the full
array of consumer regulations have recently been prepared.

A new examination

report form dealing exclusively with this area has been prepared and
is expected to be in use in the near future.
Recommendation
We recommend that the Board of Directors, FDIC, the Board
of Governors, FRS, and the Comptroller of the Currency establish more
aggressive policies for using formal actions. Written guidelines should
be developed to identify the types and magnitude of problems that formal
actions could appropriately correct.
Comments
In this section, the report notes that each problem situation
has to be evaluated on a case-by-case basis and formal action would
not always be appropriate.

The report goes on to recommend that more

aggressive policies be used for formal actions and that written guidelines
be developed to identify the types and magnitude of problems that formal
actions could appropriately correct.

In this regard, we note that the

report confirms that all of the agencies have already markedly expanded
their formal enforcement activities.

On November 3, 1975 the Board issued

a policy statement emphasizing its intention to take formal action where
appropriate in connection with violations of the Bank Holdir!g Company
Act.
II-23

APPENDIX II

Further, we do not believe that adequate weight has been given
in the report to existing hindrances to formal action under the Financial
Institutions Supervisory Act of 1966.

This chapter does, however, support

the Board's existing recommendations for changes to the Financial Institutions
Supervisory Act which would enable the supervisory authorities to remove
bank officers for gross negligence and to assess civil penalties for violations
of laws and regulations.

These legislative recommendations were made

in response to procedural and substantive problems inherent in making
effective use of the present formal procedures set forth in the Financial
Institutions Supervisory Act.

In this regard, the Board's letter of

September 5, 1975, to the banking committees of both Houses of Congress
setting forth the legislative proposals made it clear that there were
a number of situations in which the existing formal regulatory remedies
would have little or no value in preventing or ameliorating problem bank
situations.

We believe that those recommendations, embodied in H.R.

9743 and S. 2304, would help to substantially reduce the incidence of
problem banking situations.

Further, the Board has continued to review

areas in which it appears that changes may be of substantial aid.

The

Board intends to submit further legislative proposals to this end in
the very near future.

this regard, Chairman Proxmire has introduced

legislation in the 95th Congress which encompasses the earlier
recommendations.
The Board is further concerned that the discussion in this
chapter of the manner in which the agencies are handling problem bank
situations may not present an accurate view in all respects.

-,!;

The major

APPENDIX II

shortcoming in this regard stems from the fact that the different agencies
utilize problem bank lists for varying purposes.

Furthermore, even

between agencies with similar goals, different judgments may occur as
to the severity of an institution's problems and the length of time
monitoring is required.

Meaningful comparison between agencies' enforce-

ment activities in this area is therefore impossible.

We would, however,

note that the report's conclusions relating to the agencies' effectiveness
in returning institutions to nonproblem status are not supported by
the tables since the percentages used excluded institutions withdrawing
from membership and merging.

Presumably, the approving agency found

in the case of the mergers, as required by the Bank Merger Act, that
the financial and managerial condition of the resu.ting bank was satisfactory
and, in the case of withdrawals from membership, supervisory pressure
may well have contributed to such withdrawals.

Further, as noted in

the table, withdrawals and mergers are disproportionately high in the
sample for the Federal Reserve.
Recommendation
We recommend that the Board of Directors, FDIC, the Board
of Governors, FRS, and the Comptroller of the Currency develop uniform
criteria for identifying problem banks.

II-25

APPENDIX II

Comments
As previously noted in earlier responses, the rating systems
are utilized for different purposes within different agencies.

However,

we believe there is certainly room for much common ground in this area.
The legislative proposals for a Federal Bank Examination Council referred
to earlier would aid in this development, though judgmental evaluation
of any common criteria will likely lead to some diversity.
Recommendation
We recommend that where feasible the Comptroller of the Currency,
the Board of Directors, FDIC, and the Board of Governors, FRS, combine
their examiner schools and standardize their curriculums.
Comments
The examiner schools were a combined effort of the three agencies
when they were established in 1952 by the Federal Reserve.

However,

in 1962 the Office of the Comptroller of the Currency withdrew from
the program, believing it preferable to operate its own school.

the early 1970's the number of FDIC students necessitateei some sessions
held for FDIC examiners only and, when the FDIC enrollment needs continued
at this high level, it was

aecided that the only practical course of

action for the FDIC and 'the Federal Reserve System was to establish
separate schools.
The Board believes that a joint effort in this area would
be appropriate and desirable.

This is among the reasons the Board supports

the concept of a Federal Bank Examination Council.

Short of this proposal,

the Board will explore with other agencies the feasibility of conducting
joint schools.
II-26

'PL[i.DIA

APPL;I))Ix, 11

Recommendation
We recommend that the Board of Governors, FRS, (1) establish
a full-time training office to operate its examiner training program
and (2) carry out the revision of examiner school curriculums which
it has recognized as needed for sometime.
We also recommend that the Comptroller of the Currency, the
Board of Directors, FDIC, and the Board of Governors, FRS, increase their
training in EDP, law, and accounting, as desired by their examiners.
Comments
One individual currently administers the various Federal Reserve
examination schools held in Washington.

In addition, one full time

staff member is assigned to handle preparatory and procedural aspects
such as registration, printing and distribution of instructional materials
and day-to-day dealings with instructors and students.

Other responsibilities

for the different schools have been assigned to various members of the
Board's staff who are experts in each field of training.

For instance,

the curriculum for the newly established Holding Company School was
devised by members of the Federal Reserve staff expert in matters relating
to holding companies and the new Consumer Regulations School is handled
by individuals who have been actively involved in implementing the recent
consumer legislation.

The Board believes that this system has met its

needs.
If the report's recommendation for a joint school is adopted,
this would reduce the need to consider a separate office at the Board.
However, if such arrangements cannot be worked out, the Board will consider
establishing such an office.

II-XL7

APPENDIX II

We might note that the portion of this recommendation relating
to a revision of examination curricula had been started prior to the
report.

At the direction of the System Education Committee, the curricula

for the schools for assistant examiners and examiners were updated and
revised in the spring and summer of 1976 and the curriculum for the
EDP school was revised in the fall.

The Holding Compa&n

School and

the Consumer Regulation School have been recently established and therefore
have new curricula.
With respect to that portion of the recommendation relating
to additional training in specific areas, the Board has a previously
scheduled session of the EDP school set for 1977 which will use a recently
updated curriculum.

The laws relating to consumer affairs are extensively

covered in schools developed by the Office of Consumer Affairs now conducted
in Washington as part of the overall examination program.

The Board

will study the question whether additional training in the areas of
law and accounting should be provided to examiners.
Recommendation
We recommend that the Board of Governors, FRS also establish
formal evaluation process to measure the competence of persons seeking
advancement to examiner status.
Comments
We note that this recommendation is not based upon a conclusion
that the examiners of any one agency are more or less competent than
those of another agency.

Standardized tests are merely one way of arriving

at a formal evaluation, and we would not ,want to rely on them exclusively.

II-28

APPENDIX II

however, there is something to be said in favor of formal tests as a
supplementary evaluation device, and the Board intends to investigate
their feasibility.
Recommendation
We recommend that either (1) the Board of Directors, FDIC,
the Board of Governors, FRS, and the Comptroller of the Currency jointly
establish a more effective mechanism to combine their forces in undertaking
significant initiatives to improve the bank supervisory process or in
attacking and resolving common problems, or (2) the Congress enact legislation
to establish a mechanism for more effective coordination. We would
be glad to assist the committees in drafting appropriate legislation.
Comments
The Board is pleased that this portion of the report supports
its previous conclusions and initiatives in this area and favors the
legislative approach.
In December, 1975, Governor Holland testified before the Senate
Committee on Banking, Housing and Urban Affairs and in that testimony
made reference to the concept of a joint Bank Examination Council which
at that time had received substantial support within the Board.
that regard, he stated:
Such a Council would be focused on the areas that
we believe are most in need of improvement; that
is, efficient and uniform modernization of bank
examination and vigorous and consistent follow-up
procedures when bank weaknesses are revealed. Such
a Council could be established administratively
or by statute. Its statutory authorization would
undoubtedly give more impetus to the establishment
of such a Council, and would also provide it with
more clear-cut authority to take definitive action
within its statutorily defined areas of administration.

II-29

APPINDIX

APPENDIX

Such a Council would

establish mandatory uniform standards and procedures for Federal
examination of banks and uniform reporting systems and conduct
joint schools for examiners.

The Board believes that a proposal along

these lines could accomplish most of the objectives set out in the report's
recommendations in the examination area.

II-30

APPENDIX III

APPENDIX III
F^
EUERAI I)EPUSIFr IN';lHRANCt

, .'

.'~'

tlt ,

.:i,

ORPORATION,

'.I,,u4,
o t 21;li.,'i

~AIHM AtJ

January 17, 1977

Honorable Elmer B. Staats
Comptroller General of the United itates
Washington, D.C. 20548
Dear Mr. Staats:
I appreciate the opportunity to comment on the draft of your report
to Congress on federal supervision of the commercial banks in this country.
In general, I believe that the General Accounting Office has done a
workmanlike job with an extremely difficult task, made more difficult by a
relatively tight time frame. We feel that your comments as an impartial
professional observer should be studied carefully by us in an atmosphere
of cooperativeness and receptiveness. In that vein, I would like to comment
on a few points in the draft.
1. The day-to-day relationship which the FDIC has with -;tate banking
supervisors i3 extremely important in our supervisory effort. Unlike the
Comptroller oi the Currency, we supervise banks who are operating under
50 state laws as well as the Federal Deposit Insurance Act. Those banks
are chartered by 50 different state supervisory authorities and the manner
of supervising those banks at the federal level differs as a result from state
to state.
2. It is important to realize that the FDIC is the sole federal
regulator for the entire mutual savings
_--. industry, a $100 billion industry.
While I appreciate that you:r report is directed only to commercial banks,
I believe it is essential to take into account its activities with respect to
the mutual savings bank industry in order to understand the supervisory
effort of the FDIC.
3. Your report emphasizes the need for flexibility in examination
techniques. We wholeheartedly concur and as a result of a continuing study
going back a number of years, we amended in early November of 1976 our
basic memorandum which governs our examination policy. This amended
General Memorandum No. 1 is quite consistent with the thrust of your report
and I am sorry that you did not include it and a full discussion of it in your
report. We like to think that the philosophy outlined in this memorandum,
which we have tested during the past few years by experimenting in different

APPENDIX

APPENDIX 111

Ill

Honorable Elmer B. Staats
January 17, 1977
Page Two

regions, is the best philosophy for the FDIC to pursue in the examination
of nonmember banks. Since it is so central to our operations, .,nd since
it is a relatively new statement of a flexible examination policy, I would
personally have liked to have seen your in-depth comments about it.
4. We believe, as your report recommends, that more formal
actions should be taken in the supervisory process by federal regulators.
We have attempted to pursue that policy, particularly since late spring and
early summer of 1976, and have requ2ested from the Congress additional
supervisory powers.
5. The report notes the large number of violations of the law during
a typical examination. I was pleased to note that you point out that some of
the laws and regulations are complex and that some of the violations were
of a technical nature that would in no way affect the soundness of a bank.
Rightfully, you also point out that other types of violations, such as a loan
in excess of a bank's legal lending limit, could result in losses to a bank.
In our experience, the major portion of violations of laws set forth in reports
of examination do not affe :t the safety and soundness of a bank. All violations
of laws or regulations are a matter of concern, of course, but it is the particular responsibility of the bank regulator to consider each violation in terms
of whether it was intentional or willful, the consequences flowing therefrom,
the likelihood of continued violations, and other similar matters, and to then
take the appropriate corrective action.
6. Finally, the report implicitly argues that Corporation examiners
should be criticizing loan policies before bad loans are made. I certainly
agree that a closer review of loan policies is important, and criticism of
such policies in advance of tLeir implementation he made where the policies
will obviously lead to an unsafe and unsound condition for the bank or to
violations of law. Most written loan policies will be stated in such a way,
however, that a reasonable examiner will find it extremely difficult to find
something significant in them to criticize. I suspect that the written
policies themselves are not the problem but rather the implementation
of those policies. I certainly see no expertise in our Corporation for
drafting standard written policies that banks we supervise should pursue.
The FDIC was not created to manage banks, nor do I believe that it is your
intention to have your report suggest that. Nevertheless, it does suggest
it, and I do feel obliged to make these conmments about that implication.

III-2

APPENDIX

III

APPENDIX III

Honorable Elr.ner B. Staats
January 17, 1977
Page Three

Finally, the FDIC Division of Bank Supervision has prepared extensive detailed comments concerning recommendations and comments
made
in your report which I enclose for your consideration. Please excuse
the
length and the detail of those commnents; I believe they reflect, however,
the thoughtfulness with which we have reviewed your report.
Thank you for permitting us the opportunity to comment on the
draft of your report.
Very truly yours,

r-e,.4

£:T.Oa3 sa4

Robert E. Barnett
Chairman
Eaclosure

III-3

APPENDIX III

FEDERAL DEPOSIT INSURANCE CORPORATION
DIVISION OF BANK SUPERVISION

Staff General Comments and Agency Recomuendations

Note:

Page references have been changed to conform
to the final report.
111-4

APPENDIX III

APPEJDIX III
CHAPTER 4

The GAO report indicates that the agencies have not established criteria or levels of acceptability with respect to financial ratios and comparisons used in the examination process.
FDIC uses financial ratios as general guidelines for initial
screening purposes.

In banking and in finance, ratios are only

indicators, and as such need to be individually assessed.

The key

element in banking, as in a number of other industries, aside from
management, is

the quality and turnover rate of the inventory.

banking, of course, inventory is principally made up of loans and
securities.

Since no two banks have identical inventories, it

logically follows that where the relevant ratios for two banks
are identical or in the same range, further analysis is required
before a meaningful evaluation of a bank's condition can properly
be made.
The examination is designed to and does enable the FDIC to
ascertain the overall condition of the bank, the quality of its
management, and the extent of compliance with applicable laws and
regulations.

Moreover, the examination report, including the ex-

aminer's recomnendations, is thoroughly reviewed and analyzed at
the appropriate Regional Office.

During these reviews, the re-

viewer also considers the Statements of Condition and Reports of
Income and Dividends filed by the bank; the bank's complete correspondence file, showing its history and the attitudes and abilities of the bank's management; reports of loans to the bank's
III-5

APPENDIX III

officers at other banks, reports of loans against the bank's stock
at other banks, and any supervisory programs which are in effect;
and, comn;

terized monitoring systems which subject the bank to a

number of financial checks.

The major purpose of this review is

to determine the extent and type of supervision which may be
needed, not just "...for arithmetic accuracy, graammar, logic,
support for statements, and internal consistency," as the GAO report states.
After review of the examination report as well as other relevant data at the Regional level, another review process is
ducted at the Washington level for each bank.

con-

Corrective and

follow-up programs are initiated at the conclusion of the examination, and in addition to possible on-sitG visitations or followup examinations, the bank's "vital signs" are monitored via an
automated monitoring system fed by data from call reports, Reports
of Income and Dividends, and examination data.
The GAO Laport also states that examinations have not given
enough emphasis "to the bank's basic management practices, operations, and controls."

Both from a policy standpoint and the prac-

tical application of that policy, the FDIC has been and is in the
forefront of stressing the need to review, analyze and evaluate
the policies and controls of a bank under examination.

Thus, the

following quotations from the Manual of Examination Policies typify our basic approach to this phase of the examination process:

III-6

APPENDIX III

"The Exaniner's evaluation of the loan portfolio involves much more than merely appraising the individual
loans therein. Present management and administration
of the overall loan account, including the establishment
of sound lending and collection policies are of vital
importance if the bank is to be continuously operated in
(Section H, page 3, paragraph
an acceptable manner."
III.)
"Management of a bank's securities portfolio is facilitated by the adoption of a definite investment policy.
*** Details of the investment policy, expressed in
writing, should establish standards for selection that
thoroughly consider: (a) Quality, (b) Maturity, (c)
Diversification, (d) Marketability, and (e) Income."
(Section G, page 1, paragraph I.)
"Sound portfolio management dictates that procedures be
established and adhered to relative to the execution of
purchases and sales, review of portfolio and maintenance
(Section G, page 3, paragraph
of credit information."

III.)
"An important part of the Examiner's duties is the appraisal of the bank's internal controls to determine
their adequacy for assuring both the necessary degrees
of accuracy in recorded information and reasonable pro(Section P, page 7,
tection of the bank's assets."
paragraph III. A.)
In addition, the essential thrust of the examination is premised on the concept that the entire posture of the bank rests on
its management practices, operations and controls and these areas
of concern are carefully reviewed and evaluated in the course of
an examination and at other key points in the supervisory process.
For example, the examination report, which, by necessity, must be
limited to essentials, includes 13 schedules dedicated to the practices, operations and controls of the bank's management out of a
total of approximately 30 schedules in the report.

111-7

APPENDIX III

The GAO report states, in part:
"While the agencies reported some violations of consumer
protection laws and regulations, they acknowledged that
they have not aggressively monitored xonsumer protection
law compliance, and they have begun -evising their approaches.
(See Ch. 7.)"
While we do not argue with the implicat..on of the above statement, the FDIC has expended considerable resources in the area of
consumer protection.

It is estimated that about 10% of our super-

visory effort is taken up with examining for compliance with consumer laws and other matters not related to safety and soundness.
We recognize, however, that additional efforts will be necessary
to enforce the many recently enacted consumer laws and regulations.
Some of the major activities of the Corporation in the area of consumer protection are:

(1) adoption of a separate compliance report

for reporting examinations for compliance with consumer laws, which
has significantly increased the volume of violations cited over
the former method used;

(2) establishment of the Office of Bank

Customer Affairs which serves as a focal point within FDIC for
protecting the legitimate interests of bank customers;

(3) expand-

ed training for examiners and assistant examiners in consumer laws
and regulations, including an orientation in consumer laws for assistant examiners, a week of training for senior assistant examiners, and case problems and additional training for commissioned
examiners; and (4) providing information and education to bankers
and to a lesser extent to consumers (e.g., FDIC has under active
consideration issuance of a series of pamphlets to consumers covering consumer laws and banking and FDIC's role in that area).
III-E

APPENDIX III

In 1972, the FDIC considered issuing regulations and held
hearings on regulatory proposals dealing with the subject of discrimination in granting home loans.

However, for a number of rea-

sons, including that there was a paucity of data needed to write
effective regulations, final regulations were not issued.

However,

a major undertaking conducted jointly by the FDIC and the OCC has
been undertaken to develop a program to insure that the banks under their jurisdiction are complying with federal laws prohibiting discrimination in the granting of home loans.

During the test

phase, anproximately 300 banks will use a specially designed form
in connection with their home mortgage lending activity.

The FDIC

expects that the new systems of data retention and analysis will
provide a reliable indication of where discriminatory lending is
taking place and serve as an adjunct to the examination and complaint mechanisms already used by the Corporation.
The GAO report implies that the FDIC has the authority to examine routinely all insured banks, including member and national
banks.

In point of fact, the legislative history of the Federal

Deposit Insurance Act of 1950 cquite clearly indicates that the intent of Congress was to circumscribe the FDIC's examination of
member and national banks inrthe following manner (H.R. Rep. No.
3049, 81st Cong., 2d Sess. 3 and 4):
"In providing direct authority to the Corporation to
make a special examination of any national bank, District
bank, or State member bank, the conferees were firmly of
the opinion that such author ty is not to be utilized by
the Corporation to embark upon a program of regular
III-9

APPENDIX III

periodic examinations of such banks, which would only
result in a needless duplication of effort. Such
special examination authority is to be utilized by the
Corporation only in a case where, in the judgment of the
Board of Directors, after a review of the Federal Reserve
or Comptroller of the Currency examination reports, there
are indications that the bank may be a problem case, or
that it is in a condition likely to result in loss to the
depositors or to the Corporation."
Unless otherwise directed by Congress, the FDIC feels constrained to exercise its examination authority in accordance with
the above statement of Congressional intent.

In addition, the

further impplicati-i in the GAO report of overlapping examination
authority having to be parceled out through voluntary agreement
bet _en the three agencies is not, at least with respect to the
FDIC, completely accurate.
The GAO report lists four criteria for scheduling examinations.
We simply note in passing that the list of criteria for scheduling
examinations fails to mentionl the primary crit2ria employed by
FDIC, namely the overall condition, compliance posture, and needs
of the bank about to be examined.
The following comments are directed to the statements in the
GAO report relating to Electronic Data Processing (MDP) matters:
The FDIC has recognized the need to devote additional attention to EDP operations and to expand EDP expertise within our examiner and supervisory staffs.

Efforts are continuing to develop

more EDP field examiners and provide an interim career path position for a select cadre of our commercial examiner force.

While

our commercial examination effort addresses all aspects of bank

IlI-10

APPENDIX III

EDP, including the developments in electronic funds transfer, we
also recognize the need for tne development of EDP expertise in
trust operations and will be devoting attention to that area during 1977.

We are planning to provide EDP review examiner positions

for each of the 14 Regional Offices, as appropriate, to accommodate
EDP examination needs.
The Corporation offers an introductory course in EDP for assistant examiners, entitled Course in Examining a Computerized
Bank-I (CECB-I), which is designed to prepare them to evaluate EDP
input/output controls and reconcile the automated applications to
the general ledger control accountn.

Approximately 150 FDIC assis-

tant examiners are processed through this school each year.
dition, a Course in Examining a Computerized Bank II

In ad-

(CECB-II) is

offered for senior assistant and commissioned examiners to train
them in basic automation concepts and computerized examination
techniques.
year.

Approximately 125 examiners complete this course each

Finally, an eight-week advanced course entitled Field Exam-

iner Advanced Automation Training (FEAAT) was commenced in 1974 to
provide in-depth technical training in EDP matters.

Through 1976,

59 examiners have completed this course and two sessions have been
scheduled for 1977 for approximately 28 more examiners.

According-

ly, all of the FDIC's EDP training needs are provided in-house.
The FDIC has developed and implemented an instalment loan
retrieval package for the use of examiners in conducting examinations.

This package not only eliminates menial data-gathering
III-11

APPENDIX III

APPENJDIX III

efforts and saves considerable manhours, but it has improved the
quality of examinations, uncovering some practices which may have
gone undetected heretofore.

Further, during 1976 three other de-

posit EDP capabilities were added to the examiners' software package and a mortgage loan capability will be implemented early in
1977.

Other applications of EDP for use in conducting examina-

tions are in various developmental stages and software will be
considered for trust examinations during 1977.
EDP techniques and capabilities are also being used within
the Washington Office to seek and project solutions to problem
and failing bank situations.
While it is true that many banks do not have enough data
processing activity to justify purchasing an in-house computer and
satisfy their data processing needs through contract servicers, a
number of small banks have acquired so-called mini-computers and
perform their own data processing on-premises.

The evaluation

(examination) of contract servicers presents no unusual problems
for our trained EDP examiners and the evaluation procedures employed parallel those used for bank-operated data centers.

How-

ever, the evaluation of mini-computer operations presents unusual
control considerations and our experience in this area has not
matured.

We are continuing in our efforts to develop a sound ex-

amination approach in this area.
The Division of Bank Supervision Manual of Examination Policies, Appendix C, provides guidance for the preparation of

III-12

D)P

APPENDIX III

checklists, questionnaires, summary comments and report
of examination treatment for banks with their own computers.

Memorandums

to Regional Directors, EDP examiner conferences, and
EDP seminars
provide communication and input for the redesign of examination
practices and training courses.

Each Region adopts its own EDP

examination program and some variance does occur, depending
on the
EDP sophistication found in the banks supervised.

The provisions

for the interim EDP examiner career path and EDP review
examiner
positions for each of the Regions during 1977 should result
in
improved examination efforts at the circumstances and need
dictate.
The average number of man-days per EDP evaluation in 1975
was
3.9 and year-to-date 1976 is 4.1.

Our experience indicates that

Regional Offices with the more sophisticated

banks tend to devote

more manpower to EDP evaluations and to develop more expertise
in
EDP matters than Regional Offices with less sophisticated
banks.
Further, it seems, within certain limits, the more knowledgeable
the EDP examiner, the more time expended in conducting
evaluations.
The FDIC furnishes the results of data center evaluations
to
the bank's management or to the independent data servicer
of a
state nonmember insured bank.

Where a data center evaluation is

conducted as part of a bank examination, the findings of
the
evaluation are incorporated into the report of examination.

Where

the data center evaluation is conducted independently of
a bank
examination, the findings are transmitted under separate
cover.
These evaluations findings may consist of the EDP examiner's

III-13

APPENDIX III

APPENDIX III
summary comments with or without the questionnaire.

Where the

questionnaire is included, appropriate explanation is provided to
ensure that the reader understands that a negative response to a
particular question does not necessarily constitute an unsatisfactory finding with respect to that part of the EDP operation
covered by that section of the questionnaire.

Our experience in-

dicates that many data center managements have requested the entire questionnaire for their review and we feel thait it serves as
a useful educational tool for management.

However, the question-

naire is viewed by the FDIC as a formal workpaper.

The results

of an evaluation of servicer data centers are available to serviced state nonmember insured banks on request or at the option
of the Regional Director .;ithcut any request.

They are also

available to any other federally insured serviced institution upon
request.

All data center evaluation reports developed by the FDIC

are considered to be confidential and the property of the FDIC and
appropriate statements to that effect accompany each such report
released.
The creation of EDP review examiner positions at the Regional
Office level should provide the capacity to communicate more effectively with all data centers and help to achieve more uniform
correction of operational deficiencies.

III-14

APPENDIX III
Recommendation
Therefore,

APPENDIX III

(page 4-7)

we recommend that the Board of Directors, FDIC, the Board of

Governors, FRS, and the Comptroller of the Currency establish scheduling
policies and procedures which would avoid setting examination
patterns.

FDIC Response
We believe that our recently adopted General Memorandum #1, which
has
been under consideration and extensively tested for several years
prior
to adoption, largely satisfies this recommendation.

For more extensive

comments on our General Memorandum, please refer to our comments on
the
q

recommendations contained on page 4-2 of the GAO Report.

II1-15

APPENDIX III

APPENDIX III
Recommendations (page 4-X)

We recommend that the Board of Governors, FDIC and the Board of
Governors, FRS adopt flexible policies for examination frequency which
would allow them to concentrate their efforts on banks with known
serious problems.

We recommend that the Congress amend the National Bank Act to allow
the Comptroller of the Currency to examine national banks at his/her
discretion.

We would be glad to assist the committees in drafting

appropriate legislation.

FDIC Response
Although it was FDIC's long-standing policy to ex-mine each bank once
a year, it is inaccurate and misleading to suggest that that time-frame
was the only guideline used by the FDIC in scheduling examinations, or,
to state it another way, that examinations were not scheduled and conducted by the FDIC based upon the "bank's sourdness; and the quality
of its policies, procedures, practices, controls, audit, and management."

During 1975, FDIC conducted 213 follt -up examinations and a number of
on-site visitations at banks presenting either financial or supervisory
problems.

Further, those banks which were not examined in 1975 largely

consisted of banks which would not fall within the one-year time-frame
guideline under General Memorardum #1.

Although General Memorandum #1

was formally adopted in November 1976 and implemented on January 1, 1977,
the concepts and practices embodied in it are not of recent origin.
Those concepts and practices have been under consideration at FDIC since
III-16

APPENDIX II1

APPEIDIX III
early 1974,

?urthermore, the concepts and practices have been experi-

mented with and tested in five of the FDIC's 14 Regional Offices prior
to formal adoption of General Memorandum #1.

We might add parentheti-

cally that FDIC policy is to experiment on a regional basis with major
policy changes before implementation for the entire Corporation.

Accordingly, while *1a recently issued General Memorandum #1 expresses
more definitively

.n;ft scheduling of examinations is not based on time-

frame priorities alone, nevertheless, we feel that the criticism of
past scheduling practices expressed in the GAO recommendation is misplaced.

The FDIC has followed and continues to follow a policy so

aptly stated in the said General Memorandum #1, namely:
"The first priority has been and will continue to be, effective surveillance and supervision of the institutions which
present either supervisory or financial problems."

III-17

APPENDIX III

APPENDIX III
Recommendations

(page 4-1t)

We recommend that the Board of Directors, FDIC, and the Board of Governors, FRS, extend their current efforts to use State examinations and,
if they do, we also recommend that they
--develop minimum standards for acceptable State examiner
training and examination procedures and
--use only reports of State examinations meeting those
standards.

FDIC Response
The FDIC has determined that the Experimental Withdrawal Program conducted in three states during the past three years will not be continued in its present form.

However, agreement to examine nonproblem

banks on an alternate-year basis has already been consummated with one
state and the possibility of entering into similar arrangements with
other states is being explored.

Furthermore, termination of the Experi-

mental Withdrawal Program should not be construed as a decline on the
part of the FDIC to cooperate to the fullest extent possible with the
various states or to place less reliance on the efforts of the state
supervisors.

The guidelines set forth in General Memorandum #1 provide

a workable framework for increased cooperation with the states.

Thus,

almost by definition, if the program expressed in General Memorandum #1
proves workable and if a state banking department performs in an acceptable manner, the frequency and scope of FDIC examinations in that
state will be reduced.

III-18

APPENDIX III
Recommendation

Iq
(page 4-1 -and

APPENDIX III
4--

We recommend that the Board of Directors, FDIC and the Board of Governors, FRS, establish procedures to base the scope of each examination
on the examiners' evaluation of the quality of the bank's controls,
policies, procedures, and audit.

FDIC Response
With respect to FDIC examinations, the findings and conclusions expressed by GAO are not accurate.

The primary factor influencing the

scope of the exam;ination is not size, but the known history of strengths
and weaknesses of the particular institution.

Furthermore, FDIC examiners

do pre-plan the scope of an examination, by studying applicable files and
previous examination reports, and noting any material changes in the management or style of operations since the last examination.

FDIC examiners have in recent years reviewed a bank's internal eontrols,
policies and procedures prior to actual commencement of the examination
in order to establish the scope of the examination within the minimum
standards prescribed.

With respect to smaller banks, however, such a

review tends to be less formal, hence harder for GAO to detect than with
larger banks.

Considerable leeway in this respect is provided for in the

recently adopted Ge, =ral Menmorandum #1, and we reiterate that these procedures were considered and extensively tested in five of the FDIC's 14
Regional Offices for several years prior to formal adoption.

III-19

Recommendation

APPENDIX III

4-d
(page
n

We recommend that the Board of Directors, FDIC, and the Board of Governors, FRS, develop standards for the preparation, maintenance, and
use of examination workpapers.

FDIC Response
The standards for the preparation, maintenance, use and importance of
examination workpapers are included in the course of study at the
various schools operated by the Corporation and in our on-the-job training program.

The examination workpapers do, in fact, cover a number of

items other than the details relating to specific loans and securities
in support of comments contained in a Report of Examination.

We be-

lieve our examination workpapers will permit a determination that appropriate examination procedures have been followed, provide support
for the preparation of the Report of Examination, and are utilized at
the next examination.

11II-20

APPENDIX III

APPENDIX III
RecoMnendation (page 4,-

)

We recommend that the Board of Directors, FDIC and the Board of Governors, FRS develop reports of examination for EDP operations which
present the problems found, corrective action needed and any necessary
explanatory data in a clear and concise manner.

FDIC Response
The summary comments page of the FDIC EDP questionnaire provides clear
and concise descriptions of the results of a data center evaluation.
In our judgment, a new evaluation report is not necessary at this time
and our form, if effectively used, is comparable to the new one recently
adopted by the OCC.

However, we view our questionnaire as a constantly

evolving tool which will be revised frequently in order to stay abreast
of industry developments and to meet the burgeoning needs of our field
personnel.

See also our comments regarding EDP evaluation reports in-

cluded with our general comments.

II111-21

APPENDIX III

APPENDIX III
CHAPTER 5

GAO stated, in relevant part, that:
"The relationship between the frequency with which
were cited for problems with internal routines and
trols and violations of laws and regulations--both
which are related to management effectiveness--and
frequency of criticism of management effectiveness
not what would have bean expected."

banks
conof
the
was

"While the examiners frequently cited banks for having
problems in two areas indicative of management effectiveness--internal controls and violations of laws and
regulations--they did not often criticize management
effectiveness. As shown below, management effectiveness was most often criticized in problem banks with
less than $500 million in deposits even though 30 to
50 percent of larger banks in the general and problem
samples were also criticized for violations of laws and
regulations and poor internal routines and controls."

"Violations of laws and regulations reflect on management's capability."
Generally, the size and character of the operation engaged
in by a bank defines the scope and requirements of sound internal
controls for that par*ecular bank.

Clearly, the internal con-

trols deemed appropriate for a large,

ophisticated operation are,

in most cases, not appropriate for a smaller, less complicated one.
Management is clarged with the responsibility of deciding the internal controls best suited for its bank in order to provide adequate protection for its assets and a meaningful flow of information to senior management.

Recognizing the practicalities of the

situation, FDIC closely monitors the various internal controls

II111-22

APPENDIX III

employed by banks under our direct supervision and our examiner
personnel may comment on apparent weaknesses observed.

However,

if the particular system has worked with reasonable effectiveness
for a given bank, is within the general bounds of prudence, and
does not constitute an unsafe or unsound practice, corrective
measures are not aggressively pursued, notwithstanding the critical comment in the examination report.
Banking is a highly controlled industry and, thus, is subject
to a plethora of laws and regulations on both the federal and state
levels.

It is, therefore, not unexpected that banks will on occa-

sion be found to have violated, intentionally or unintentionally,
a particular statute or regulation.

It is the job of the bank

regulator to consider each violation in terms of whether it was
intentional cr willful, the consequences flowing therefrom, the
likelihood of continued violations, and management's history of
compliance and attitude toward taking appropriate corrective measures.

Accordingly, if the violation is unintentional or merely

technical in nature and not recurring, criticism of management
effectiveness would not seem warranted.

If otherwise, of course,

criticism of management is probably appropriate.

In short, in

this area as well as all areas of its supervisory responsibility,
the PDIC attempts to follow a rule of reason.

Overreaction to

technical, unintentional violations of law or regulations could,
in our judgment

'_pactadversely on the entire enforcement pos-

ture of the Corporation.

'III-23

APPENDIX III

APPENDIX III
GAO stated that:

"The agencies rarely criticized a bank's loan policies
until loan problems developed. For example, if a
bank's managers had not adequately diversified the bank's
risks, examiners did not criticize the inadequate diversification policy until those lines of credit actually
became classified."

"For example, inadequate loan policies were not cited
by examiners until the banks had large amounts of classified loans, as shown by data for banks in our general
and problem samples combined."
The FDIC, of course, encourages banks under our direct supervision to adopt sound written loan policies.

Furthermore, in vir-

tually every formal enforcement action, F'DIC routinely requires
the of'

ding bank to prcvide written armu pcli.cies accepta'ole co

the Corporation and the aT,l.nltRoate Wstes
oversight of a bank's written lowa, poo .cies

ar'ts ittl

cowerett,

does not, and ic n%,t

loan policies Zor the bank or

intended to, extend to -writing thn

specifically prescribing how, when and to w. r. the credit facilities of the bank are to be used.

We view suclh action by the FDIC

as objectionable on two grounds:

(1) as ei-crcaching on man&ge-

ment's prerogatives, and (2) perhaps constituting a ftom of cred-.
it allocation.

Out task is

to review the ;olicies to determine

that they are within the bounds of safe and sound bauaking practices.
However, it may be somewhat naive ·

assume thlat a review of the

written loan policies of a bank will, in most cases, reveal imprudence.

Typically, it is the implementation of such policies

which generates criticism.

III-24

APPENDIX III

APPLNDIX III

It is not accurate to suggest that the failure to diversify
risk is only criticized when "those lines of credit became classified."

It is both FDIC policy and practice to comment on a

failure to diversify (concentration of credit) without regard as
to whether or not the assets involved have been adversely classified.

The Division of Bank Supervision Manual of Examination

Policies states in relevant part:
"...the inclusion of a concentration of credit in a report implies criticism of a banc's policies amenable or
susceptible to management control."
(Section H, page 6,
paragraph IV. C.)

GAO note:

Omitted comments pertain to material
in the draft report but omitted from
the final report.

III-25

APPENDIX III

APFENDIX III
CHAPTER 6

The thrust of Chapter 6 may be summarized as follows:

examiners

seldom meet with bank directors, the examination reports do not convey
the bank's problems in a clear and concise manner to the directors, and
the material in the confidential section should be furnished to the
banks.

The recommendations are that the FDIC and the FRS require

examiners to meet with the directors or audit or examining committee
after each examination and that the FDC

and FRS develop and use

reports of examination "which provide the banks with the results of
the examination and any necessary supporting information."

As we view

it, the implication is that FDIC and the FRS redesign the report of examination along the lines of the OCC's new format.
We believe that the statements and recommendations stem from a
misconception, or perhaps a misunderstanding, of the policies and
practices of the FDIC in the matters covered in Chapter 6.

The

following responses to the GAO recommendations tepresent a brief
summary of the FDlC's policies and practices, and efforts to improve
those policies and practices, regarding the supervisory areas dealt
with in Chapter 6.

III111-26

APPLNDIX III

APPENDIX III

Recommendation (page 6-5)
Therefore, we recommend that the Board of Directors, FDIC, and the
Board of Governors, FRS require their examiners to meet with the bank's
board of directors or audit or examining committee after each examination.

FDIC Response
FDIC cc-ducted approximately 7,900 examinations in 1975.

Senior offi-

cials from the various Regional Offices met with bEnk management on
approximately 1,750 occasions, representing 22% of all examinations.
Throughout 1975, there was an average of 224 banks under our supervision
which were formally designated as financial problems.

FDIC policy is

to meet with bank directors at least where problem situations exist.

FDIC staff has in the past year been reconsidering the question of how
often meetings with bank directors should be held.

In consideration of

this subject, the responsibilities of bank directors, the Corporation's
responsibility to bank directors, and our past and present practices in
holding board meetings were weighed.

In a broad sense, the board of directors of a bank is responsible for
th. formulation of sound policies and objectives of a bank, the effective supervision of its affairs, and promotion of its welfare.

In dis-

charging these responsibilities, a director's duty is to exercise due
care or be exposed to a charge of negligent performance of his duty.

III-27

APPENDIX III

APPLNDIX III

To insure that bank directors are aware of the contents of examination
reports, the Corporation requires that a receipt accompanying each report be signed by the bank's executive officer stating that the report
"...was duly considered by the directors...and a record of the action
taken thereon by the Board has been entered in the minutes."

Moreover,

at each examination, the examiner is charged with the responsibility
of determining that the bank's board minutes reflect a thorough consideration of examination reports and correspondence received from supervisory authorities since the last examination.

To enable bank managements to begin work on problem areas prior to receipt of the completed examination report, a list of adversely classified assets and other major criticisms is provided to the executive officer at the completion of each examination and most of the FDIC Regional Offices have implemented deadlines for receipt of completed examination reports in the Regional Office--usually 1.0 calendar days after
the close of the examination.

The FDIC Manual of Examination Policies states, with respect to examiners holding meetings with directors (Section Q, page 3, paragraph I.E.)
"Except in instances where authority nas been delegated by
the Regional Director, the Examiner should consult with the
Regional Office before calling a board meeting. Ordinarily,
ms.tings with the board of directors should be held at the
conclusion of all examinations of problem banks. A meeting
of the board may also be required when experience and instinct tells the Examiner a likelihood exists that the bank
will be added to the problem list or will be earmarked for
other special supervision. Additionally, where there is a
substantial volume of c:lasified assets, low capital or other
areas of important cri:icism, a board meeting may be desirable. This is particularly true when the trend has been unfavorable and previous admonitions have gone unheeded."

iiJ-28

APPENDIX III

In keeping w: h this policy, it is in fact the practice in most regions
for the exeainer to hold a meeting with bank directors if problems of
consequence Pxe found at the examination, or if significant adverse
trends are noted since the last examination.

In virtually all instances

involving problem banks, a representative from the Regional Office will
meet with the directors, and in most cases an invitation is extended to
the state authority to participate in the meeting.

The FDIC is cognizant of the benefits flowing from more frequent meetings with the boards of directors of banks under our direct supervision
and anticipates holding such meetings with increased frequency in the
future.

We are also actively reviewing the posture of the FDIC in

this regard with a view of improving upon the timeliness and conduct of
such meetings.

III-29

APPENDIX III

Recommendation

(page 6-10)

We recommend that the Board of Directors, FDIC, and the Board of Governors, FRS, develop and use reports of examination which provide the
banks with the results of the examination and any necessary supporting
information.

FDiC Tresponse
FDIC conducted an intensive study in 1965 to assess the impact of its
examination report on banks.

As a result in 19o9, a new examination

report format was put into use.

We believe this report format, and

the guidelines under which it is used, provides a clear, concise picture of problem areas to bank managements.

Various FDIC staff members

have attended familiarization sessions on the (XCC's new examination
report format.

The OCC has tested his new format in only ten banks and

the impression of the FDIC staff members is that the report format is
somewhat cumbersome, especially in problem situa ions.

There appears to be some misunderstanding with respect to the purpose
and thrust of the confidential
examination.

(supervisory) section of the report of

The purpose and thrust of the confidential section are

to allow the examiner to comment on matters uncovered during the course
of the examination which may not lend themselves to complete substantiation, but which may serve to alert his superiors that further investigatory or supervisory efforts may be necessary.

For obvious reasons,

such material is not, and should not, be provided to the management of

II-30

APPENDIX III

APPEN;DIX III
the bank.

However, a thorough study of the role and use of the confi-

dential section was started some months ago and, when completed, will
probably result in significant changes in its thrust, format and content, or in its elimination.

III-31

APPENDIX III

APPENDIX III
CHAPTER 7

As is indicated in the FDIC comments to the recommendations
made by GAO in this chapter, we view the impact of the changes in
the FDIC examination process set forth in General Memorandum #1
as significant and vital to an understanding of the Corporation's
examination philosophy and practices.

We believe the entire

General Memorandum should be included in the GAO report.

However,

in the absence of that we offer the following excerpts from General
Memorandum #1, with emphasis added:
"The first priority has been, and will continue to be,
effective surveillance and supervision of those institutions which present either supervisory or financial
problems."

"Emphasis at these modified examinations should be placed
on management policies and performance; the evaluation
of asset quality, alignment and liquidity; capital adequancy; and, compliance with applicable laws and regulations."
"In those banks with assets of $100 million or more, all
report schedules which are presently in use and are applicable to the given bank will continue to be included in the
examination report. Where the fixed asset investment is
moderate in relation to capital, there are no statutory
viol ,tions widh respect to fixed assets, and absent other
pruvoems of significance, fixed asset schedules may be
omitted from these examination reports. Further, examiners
are instructed to assess the qualit; of management systems
and reports as well as audit and control functions, and
where it is permissible to do so without cnmpromising the
irtegrity of the examinations, utilize the output of those
systems. Cash counts and proof and verification procedures
may be omitted in those banks where it is appropriate to
do so, and branch offices whic do not hawe a s4 enificant
Pt I- examined. nowever,
volume of important assets nt .
in the latter instance, conditions as these offices should
be reviewed with management priir to the conclusion of the
examination."

III-32

APPENDIX III

"If believed desirable in the opinion of the Regional
Director, simultaneous examinations may be arranged of
all closely related banks or subsidiaries of bank holding
companies, requiring coordination with other bank regulatory agencies. The type of examination employed in each
bank at simultaneous examinations will be at the discretion
of the Regional Director unless precluded by the guidelines
for modified examinations."
* **

"It is expected that the Corporation's automated bank
examination programs and monitoring systems will be used
wherever possible in an effort to provide increased efficiency and conserve manpower. This use should include the
scheduling of examinations as well as their conduct. Further,
sampling techniques should be used wherever possible."
"It is expected that visitations will be frequently used as
an investigatory and supervisory tool for those banks which
show adverse trends, either at examinations or through a
monitoring system, and to gauge compliance with provisions
of cease and desist orders. Further, visitations subsequent
to management or ownership changes should be used to assess
the attitudes and abilities of the new management/ownership
if the principals .re not already known to the Regional Office."
"In addition to the required periodic examinations, it w1ll
be the policy to conduct a visitation at each new bank quarterly
during the first two years of operation (visitations need not
be held during the quarter in which an examinat on, either by
the Corporation or the state authority, is conducted). The
purpose of these visitations is to gain some measure of the
performance of management and the direction in which the bank
is headed. At the discretion of the Regional Director, findings
of the visitation may be reported in either memorandum form or
examination report format."
The GAO comments on the status of monitoring systems in th_ Office
of the Comptroller of the Currency and in the Federal Deposit Ins rance
Corporation set forth in chapter 7 of the report have served a usetul
purpose in that thU] focus on an aspect of bank supervision which has
grown in importance in the recent past few years and may be of even greater
importance in the future.

Some clprification is needed of t' e fundamentals
III-33

APPENDIX III

of analysis of bank reports, of the various systems which have been
developed to facilitate such analysis for supervisory purposes, and
For

of a framework for evaluation of the efficiency of the programs.

purposes of illustration, the following comments are based upon a comparison of the National Bank Surveillan:e System (NBSS) and the systems
in use at FDIC.
a) An essential element of any monitoring system is a data
collection system.

The quarterly Reports of Condition and

the quarterly, in the case of large banks, and semi-annual,
irn the case of smaller banks, Reports of Income comprise the
primary data base for both the NBSS and the FDIC systems.
Data from reports of examination are important supplements
to the data base; at the present time FDIC probably relies
more heavily than the NBSS on this source of information.
Obviously, a monitoring system that depends on regular
financial reports submitted by banks is only as good as the
information in the reports.

The information items must be

meaningful; they must be accurate; and they must be available
on a timely basis.

Given that tle OCC and the FDIC use the

same format of the Reports of Condition and Income, their
divergence appeals to be in the areas of accuracy and Limeliness.
The OCC has put into effect an editing system which reiuires
less stringent tests for mathematical accuracy and internal
consistency in the national bank reports than that used by
the FDIC in proceosi.n- reports for all insured banks.
1II-34

FDIC

APPENDIX III

has workcJ from another angle.

The Corporation has

begun to levy fines on banks that get their reports in
late.

All three federal bank regulatory agencies have

cooperated in an effort to upgrade the quality of the bank
reports so that less correction and revision are required;
clearly much more needs to be done.

While this process is

moving forward, both the OCC and the FDIC have had to modify
their analytical systems in order to utilize bank reports
that are sufficiently accurate for mor'toring purposes.
b) Another essential cf a monitoring system is a computer
based
program that compiles individual bank ratios of balance sheet
and income and expense items and compares the ratios of each
bank with the same ratios for comparable banks.

Most moni-

toring systems use a technique known as "outlier analysis,"
flagging banks if its ratios deviate substantially from the
average of ratios for comparable banks.

The presumption is

that such analysis can provide clues as to banks with financial problems, current or prospective.
In a banking system as diverse as that in the U.S., differences
in operations among banks can be expected to be substantial.
A very large money market bank's ratios may appear to be
unusual
or atypical of averages based upon ratios for all the banks,
large and small.

When its ratios are compared with those of

banks of comparable size, doing a comparable business,
i.e.,
ratios of its "peers," such a bank may not be atypical
or, an
outlier.
II-35

APPENDIX III
APPENDIX III
Neither the OCC nor the FDIC could afford to wait for the
completion of definitive studies on how to sort banks into
peer groups.

Such work is continuing on a theoretical level

as well as on an empirical level.

Currently, however, the

3CC has established peer groups on the basis of bank asset
size.
At FDIC, the effort has been made to allow the Regional Director
to specify the banks within his region that are "peers."

For

analytical purposes of the Washington Office staff, peer groups
have been defined primarily on the basis of asset size of bank
within Region or state.
With the large number of items in the Reports of Condition and
Income and the frequency with which such reports are filed, the
number of ratios that can be constructed for a particular period
or as measures of change between periods is extremely large.
Selection of the key indicator or indicators has consumed a
considerable amount of time at FDIC.

One approach, the Early

Warning System (EWS), examined literally hundreds of ratios to
determine which were the best discriminators between known problem
banks and control groups of banks with no known serious problems.
The result was a winnowing down to 7 ratios, 2 based Vapon income
and expense items and 5 based upon balance sheet items.

EWS is

run annually to produce a list of banks whose sAven ratios indicate
the similarity to banks with known problems.

A second approach

(JAWS) selected 6 ratios (plus an additional 2 for large banks)
III-36

APPENDIX II

which have proven to be indicators of basic changes in a bank's
operations.

These indicators have been incorporated into on-

line system available in the Regional Offices which flags banks
with ratios atypical of peer group averages, and displays five
important ratios based upon the latest report of examination
of each of these banks.
The OCC system includes certain ratios which have been designated
is "key indicators," i.e., that provide the best general measures
of unusual or changed circumstances in a bank.

The process is

sequential in that analysis of banks with atypical values for
key indicators is extended to additional financial ratios that
round out the picture of a bank's condition in the critical area.
c)

A third essential element of a monitoring system is the development of a method for evaluating its effectiveness or results.
The crux of the monitoring systems is the review of the output
of the computer based systems by trained financial analysts and the
FDIC has been using experienced examiners in this important function
who have flagged "watch lists" of banks which should be examined
earlier or more often than other banks.

In the final analysis,

however, no monitoring system has yet been developed which is
iOO% efficient in signaling banks with unusual problems.
Thus, some flagged banks turn out, on further analysis, to be
perfectly sound while some banks with serious pzublems are not
flagged.

Presently, the most any system does is suggest that a

bank exam. ation should be scheduled and the aspect or aspects
of a bank's operation which requires special scrutiny.
III-37

APPENDIX III

APPENDIX III
d)

The fourth or final element of a monitoring system is
tation.

implemen-

At the present time, the monitoring exercise leads

up to an examination of banks singled out by the financial
analysts.

Optimally, the examiner receives a profile of the

bank to be examined and a blueprint of the areas to be focused
on with the most care.
The GAO report

states, in essence, that the FDIC has recently

established trust examiner specialist positions.Although the FDIC
historically was the only one of the three federal bank regulatory
agencies that did not designate trust examiner specialists as such,
some FDIC bank examiners devoted a major portion of their examining
time to trust work.

However, it is corrc.t that the FDIC has now

established 14 trust examiner specialist positions and is in the process
of filling these positions.

III-38

APPENDIX III

APPENDIX III
Reconmiendations (page 7-25)

We recommend that the Comptroller of the Currency invite FDIC and FRS
to jointly evaluate its new examination approach.

we further recom-

mend that, in the event of a favorable assessment of the new process,
the Board of Directors, FDIC, and the Board of Governors, FRS revise
their examination processes to incorporate the concepts of OCC's approaches.

FDIC Response
In light of the limited testing that has been conducted (10 banks) of
the OCC's new process, we believe it is premature to consider that
process a success either for large or small banks.

Representatives of

the OCC admitted that, while the new procedures are workable in banks
ith assets between $50 million and $1 billion, they do not appear
feasible for banks with assets of less than $25 million.

We therefore

qu, tion the logic and wisdom of GAO's recommendation that FDIC adopt
such proceas, either for the large or small banks under our direct supervision, especially when it is recalled that 91% of the banks we directly supervise have assets of less than $50 million and 77% leas than
$25 million.

Since the number of large banks directly supervir

1 by

the FDIC has and continues to increase, our examination process is
necessarily designed to handle small, medium and large-sized banks.
However, we shall follow closely OCC's experience with the new examina.tion pro-ess as it undergoes further testing, and we ramain receptive
to further revision in our own examination approach which will b.
ficial to and improve our supervisory capabilities.

III-39

jene-

APPENDIX

III

APPE;NDIX III

In our judgment, the discussion of changes in FDIC's examination approach does not reflect sufficiently the impact and significance of
those changes, especially with respect to our review of the management
policies and internal controls of a bank under examination.

We believe

that the c4anc-es made by the FDIC represent, at the present time, the
most logical, beneficial, and prudent improvements in the examination
process.

We have blended the proven tecckniques and practices with a

new approach which we feel should enable FDIC to focus more directly
on, and devote more time and effort to, problem ane near-problem situations, and concomitantly less on healthy banks.

We refer to excerpts

from our General Memorandum #1, included with our general comments.

III-40

APPENDIX III

APPENDIX III
Recormmendations (page 7-we)

We recommend that the Board of Directors, FDIC, the Board of Governors,
FRS, and the Cmanptroller of the Currency jointly staff a group to analyzet

shared national credits at State and national lead banks under Fed-

eraL supervision and that the three agencies use the uniformc classification of these loans when they examine the participating banks.

We recommend that the Board of Directors, FDIC, the Board of Governors,
FRS, and the Comptroller of the Currency work together to refine their
monitoring systems and their approaches to examining for compliance
with consumer credit laws.

FDIC :Response
AlthouCh--as the GAO report points out--of the 183 participations in
shared national credits traced by GAO only 19 were to state nonmember
insured banks, the FDIC is now a participant in the Shared National
Credits Program.

We are, of course, in favor of the thr-ee federal bank regulatory agencies sharing and working together in the important area of consumer
credit ccmpliance.

However, in many instances healthy competition in

the area of consumer credit compliance as well as in other areas of
banking supervision between the three federal bank regulatory aencies
can lead to a better system of supervision than complete uniformity.
Thus, the development of an independent approach by one or more of the
agencies may lead to a better end result.

III-41

APPL;,DIX

III

APPENDIX III
CHAPTER 8

Our comments here cover the general theme of the chapter,
namely the supervisory and enforcement practices of the three
agencies and their "problem bank" criteria.

We feel discussion

of these vital subjects is desirable in order to place them in
their proper perspective.
The FDIC serves the dual roles of bank supervisor and insurer.
Accordingly, the FDIC "problem bank" definitions are based on those
banks which pose the greatest degree of financial risk to the
Corporation, with fine tuning of the designations into various
gradations of risk.

The three problem bank categories used are

analagots to the three adverse classifications of Substandard,
Doubtful, and Loss which the federal bank regulatory agencies
utilize to designate assets of greater than normal risk.
There are no simple mechanical formulae that can be universally
applied to determine whether or not an operating bank warrants FDIC
problem bank status.

Indeed, we believe a problem bank designation

should only be imposed on a case-by-case basis after a comprehensive,
in-depth analysis of the entire bank.

Among the more important ele-

ments requiring analysis and evaluation are asset quality and liquidity, the margin of capital protection, the degree of stability or
volatility in the bank's liability structure, the character and ability
of its management, the bank's earnings performance, and its adherence
to applicable laws and regulations.

These elements are closely inter-

related and, depending on the circumstances, each element may be

III-42

APPENDIX III
weighted differently.

APPENDIX III
Accordingly, the FDIC disseminates general

criteria--not specific guidelines--for the designation
of problem
banks to our Regional Directors in order to encourage
independent
Judgment and provide some flexibility to meet the
new areas of
regulatory concern as they arise.

The Waeshington Office of the

Division of Bank Supervision then applies more standardized
analysis
and evaluation to the recommendations of our Regional
Directors before
determining whether to add a particular bank to or
delete it from
our list of problem banks.

The listing themselves are not subject

to approval by the Corporation's Board of Directors,
although the
Board regularly receives extensive information about
all problem
banks and may be directly involved in the imposition
and enforcement of a corrective program with respect to particular
banks.
FDIC also reviews examination reports of the FRS
and the OCC,
assesses the risk exposure which the banks examined
by those agencies
pose to the deposit insurance fund, and, where appropriate,
designates
state member and national banks as Other Problem,
Serious Problem or
Serious Problem-Potential Payoff. Although FDIC
does not directly
supervise these banks, we do follow closely the
supervisory efforts
of the other agencies, largely because of our financial
stake in the
outcome.
It should be noted that, with respect to banks under
the direct
supervision of the FDIC, an inferior financial condition
is not the
sole cause for more intense supervisory activity.
Causes for concern

III-43

APPENDIX III

APEINDIX III

iay be reflected ill violations of laws or regulations, marginal
management and policies, or a subpar financial condition which had
not yet reached a level presenting an undue risk to the FDIC fund,
and thus, does not warrant a formal prolbem designation.

For example,

the various Regional Offices maintain informal listings of banks
which pose supervisory--but not financial--problems, and the Washington Office uses a computerized screening device which serves as an
additional test for uncovering financial as well as non-financial
supervisory problems.
The fundamental approach of FDIC to banks exhibiting supervisory pi-

.ems or trends in that direction is to exercise preven-

tive measures, that is to take necessary and appropriate measures
early enough to keep the bank from deteriorating to a level requiring the assignment of a formal problem designation.

As the GAO

report points out, informal methods are generally relied upon, and
experience indicates that these methods have largely been successfulo

One of the more useful methods of informal supervision which

FDIC frequently employs has been effectively overlooked or ignored
in your report.

The method we refer to involves the use of the

so-called "Letter Agreement."

The Letter Agreement is used by our

Regional Directors following an examination to confirm with bank
directors a program which the Regional Director feels will, if adhered
to, correct the situation.

The Letter Agreemert is not intended, and

is not used, as a substitute for a formal written agreement entered

IJI-44

APPLNDIX

ilI

APPLINDIX

III

into under Section 8 of the Federal Deposit Insurance
Act or cease
and desist or termination of insurance proceedings,
although the
letctr agreement may serve as a basis for such subsequent
action.
Its use is generally confined to corrective measures
agreed to by a
bank's board of directors when a bank first shows
problem or near
problem characteristics
In addition to the foregoing, the GAO report discusses
the use
.f termination of insurance proceedings and atates,
in part, that
canceling "a bank's deposit insurance does not solve
its problems."
While this statement is perhaps literally true, it
could be misleading.

Termination of insurance authority has, through the
years,

proven to be an effective and useful remedial enforcement
tool.

The

threat of instituting a,.d the institution of such
a proceeding has,
in the vast majority of cases, been the vehicle for
forcing a recalcitrant and/or poorly managed bank to take effective
corrective
measJures.
The table in the report dealing with the GAO sample
of 54 FDICsupervised problem banks shows that a request for
a formal response
to reported deficiencies was made in 44% of the cases,
that progress
reports were requested in 41%, that a meeting with
the bank's directors
was requested in 30%, that there were written communications
with 54%,
6% of the banks were visited, and that no credit is
given for special
examinations.

We do not believe that the table presents an accurate

picture of FDIC supervisory efforts.

In point of fact, the Regional

Director transmits a letter to each bank, reiterating
the problems
III-45

APPEJDIX III

APPUEDIX II
disclosed, and requesting appropriate corrective efforts.

Frequently,

in the letter to bank management, the Regional Directors request periodic progress reports which often lead to other exchanges of correspondence or meetings with respect to progress, or lack of it, shown in
the reports, a board meeting may be scheduled, or visitations or a
follow-up examination may be held.
We note that the table shows that meetings with directors were
held in only 30% of the banks.

It is the FDIC's policy to have a

board meeting in all problem situations.

As indicated previously,

in i975, conferences were held with the management of banks on approximately 1,745 occasions, and 1,750 in 1976.
The GAO report, among other things, questions whether banks that
remain on the problem list for e period of time are indeed problems.
A': year-end 1974, 76% of the FDIC supervised banks on our problem
list had been on the list for less than two years, and at year-end
1975, 82%.

In addition, at year-end 1975 only 16 banks had been on

the problem list in excess of three years (out of a total of 8,925
FDIC-supervised banks.)

To summarize, some form of formal supervisory

action was taken in seven, or 44%, of the sixteen cases and informal
supervisory actions achieved improvements in another seven, or 44%,
of the sixteen cases.

Correctior

of the problems in the remaining

two banks is to a large degree dependert upon improvement in the
severely depressed economy of the banks' market area.

In calendar

year 1976, two of the sixteen oanks were rehabilitated and, since they

II -46

APPENDIX III

APPEIDIX III

no longer warranted prcLblem designation, were removed from the FDIC
problem list.

In addition, two others were removed from the list--

one through merger into a healthy institution and the other was closed.
We also note in passing that e limited number of banks may present
financial and/or supervisory problems of a continuing nature which,
despite aggressive corrective efforts, do not lend themselves to a
permanent and wholly acceptable solution,

In such cases, the banks

are not in serious enough condition to wt.rrant exther termination of
their insured status or of their charter.

It seems clear, however,

that these banks should be continued as problem banks and receive
special supervisory attention.

III-47

APPENDIX III

Recommendations (page 8-.6)
We recommend that the Board of Directors, FDIC, the Board of Governors,
FRS; and the Comptroller of the Currency establish more aggressive policies for using formal actions.

Written guidelines should be developed

to identify the types and magnitude of pLoblems that formal actions
could appropriately correct.

FDIC Response
Congress granted cease aad desist powers in 1966 w

h the enactment of

Section 8(b) of the Federal Deposit Insurance Act.

For several years

thereafter, there was some reluctance to utilize Section 8(b) powers
due mainly to a general misunderstanding of its purpose and usefulness.
Prior to enactment of Section 8(b), the FDIC's only experience with
formal administrative corrective measures was the termination of insurance proceedings, a severe form of action which could result in the
removal of the deposit insurance coverage of a bank.

Because of its

severity, the Section 8(a) proceeding wa& used judiciously and only
after all other means for accomplishing correction ware exhausted.
Apparently, albeit erroneously, that same rationale was largely applied
to Section 8(b) proceedings.

In addition, there was to a lesser extent

an unwillingness to try something new.

Commencing in 1970, a program

to educate FDIC personnel as to the usefulness of Section 8(b) action
was begun.

The FDIC first used its cease and desist authority in 1971

and between 1971 and 1975 issued 38 cease and desist orders and three
formal written agreements.

In contrast, in a recent renewed effort to

III111-48

APPENJDIX III

APPENIDIX III

foster the use and to test the effectiveness of cease and desist powers,
in calendar year 1976 alone FDIC issued 24 such orders and five emergency orders.

In addition, at year-end 1976, 18 more cease and desist ac-

tions were in various stage- of process.

While cease and '-sist action is in most cases effective as a corrective measure, there are some instances where it may be of little or no
use and could perhaps be counterproductive.

For example, the recently

experienced worst economic period since the great depression caused
severe problems to the banking industry, many of which did not lend
themselves to correction through use of the cease and desist powers.
In short, it is not a panacea for the removal of all problems experienced by the banking community.

The recommendation for adoption of criteria for use in formal actions,
contained in the last sentence of the recommendation, is troublesome.
We would recommend against adopting formal criteria for uise of Section 8, because the statutory criteria are adequate.

The facts and

circumstances of bank problems seem so varied, and the remedial actions
can differ so much eccording to the problem, it would be inhibiting to
have to work within the confines of additional written criteria.

The

adoption of such criteria could give the banks additional bases for
contesting Section 8 actions.

III-49

APPENDIX III

APPENDIX III
Recommendation

(page 8-4Y)

We recommend that the Board of Directors, FDIC, the Board of Governors,
FRS, and the Comptroller of the Currency develop uniform criteria for
identifying problem banks.

FDIC Response
We believe our general comments clarify the posture of the three federal bank regulatory agencies with respect to problem banks, including
those which pose supervisory problems as well as those which present
inordinate financial risk to the FDIC.

Moreover, we do not believe

there is confusion or wide disagreement among the bank regulatory agencies as to which banks should be accorded close surveillance and supervision by the respective agencies and that, except in a failing bank,
and to a limited extent in a bank holding company situation, there is
virtually no overlap of regulatory jurisdiction at the federal level.
Furthermore, the need to develop common criteria for problem banks is
not obvious and indeed may not be appropriate.

It is, we believe, appropriate and useful for the FDIC as an insurer
to view what constitutes a problem bank from a somewhat different perspective than the other two federal bank regulatory agencies.

In ad-

dition, the extent to which the three federal bank regulatory agencies
use somewhat different approaches to the issue of banks in need of increased and intensified supervision could foster a greater degree of
innovation in this area of supervisory endeavor and could serve as a

III-50

APPENDIX III

check and balance in the promotion of the widest coverage of such
banks.

Finally, the objectives and detached review process conducted

by FDIC of all types of examinations, in order to assess the degree of
financial exposure to the insurance fund, provides an overall review
of all banks without imposing across-the-board guidelines which may
not be suitable for the three agencies on an individual basis.

III-51

APPENDIX III

APPENDIX III
CHAPTER 9

The GAO report states:
"A recent FDIC study of 92 banks that failed between
1960 and September 1976 showed that 57.6 percent were
caused by improper loans to officers, directors or owners, or by loans to out-of-territory borrowers...."
The experience noted above led to the issuance by FDIC in
1976 of a regulation entitled "8337.3 Insidex Transactions," as
part of the Corporation's "Unsafe and Unsound Flanking Practices"
regulations.

II111-52

APPENDIX III

APPENDIX III
CHAPTER 10

The following is a blief summary of the operation of the FDIC
Training Facility:
The Division of Bank Supervision (DBS) Training Center located in
Rosslyn, Virginia, was established in February 1970 and presently haspermanent staff complement of seventeen.

The training programs which it

conducts are directed toward achieving professional proficiency and the
maintenance of a highly qualified bank examination staff.
Career training is accomplished, in balance with field examination
experience, primarily thrcugh our bark examination schools which are
comprised of seven diLferent schools or courses
has a duration of two to three weeks.
examination schools:

of study.

Each school

Subject schools include the basic

School for Assistait Examiners, designed for newly

employed examining petsonn.el; the School for Senior Assistant Examiners,
which provides training in accounting, EDP, and consumer protection laws;
the School for Examiners, which is designed for the development of the
commissioned examiner; and the Basic Trust School, which deals with the
basics of trust department examination.

In addition, more senior train-

ing is provided through the Advanced Trust School, the Course in Examining
a Computerized Bank, and the School for Commissioned Examiners.

Subject

matter within the various bank examination schools is well structured
both wfith respect to material to be covered in the daily presentations
as well as the pre-course study expected.

Students ordinarily spend

eight hourd a day Monday through Friday in classroom and related work.

III-53

APPENDIX III

During the six-year period 1970 through 1975, 189 school sessions
were held involving nearly 5,100 students.

For the 1976 school year,

we held 46 school sessions with approximately 1,200 students attending.
Training is directed primarily towards FDIC personnel.
the period 1970 through 1975,
examiners,

However, during

training was provided ior 549 state bank

28 students nominated by foreign government banking authorities,

and 13 FRB examiners.

The related figures for 1976 are 157, 22, and 7,

respectively.
An additional and important operation of the Training Center is the
Progress Evaluation Program for senior assistant examiners who are being
considered for career advancemenr to the status of commissioned examiner.
This

rlrigrarm assesses a candidate's knowledge and proficiency in rules,

regulations, and policies; loan analypis: and development of conclusions
and recommendations after review of a report of examination.
includes both written and oral portions.

The program

Findings of the progress evalu-

ation are weighed as one of several factors in considering a senior
assistant examiner for promotion to commissioned examiner status.
Between 100 and 200 such candidates are evaluated annually.

The eval-

uation utilizes a three-member panel of examiners over a th ee-day period
for each candidate.

III-54

APPENDIX III

Recommendation (page 10-6)
We recommend that where feasible the Comptroller of the Currency; the
Board of Directors, FDIC; and the Board of Governors, FRS, combine
their examiner schools and standardize their curriculums.

FDIC Response
Although we find the comments and recommendations contained in the
report on examinet training provocative, on balance we believe teha
did not afford sufficient treatment or depth to the various examiner
training and educational programs offered by the FDIC.

We are especially dismayed by the fact that the GAO study largely ignores tile operation of the FDIC Division of Bank Supervision
Training Cencer.

(DB.)

The FDIC Training Center is undoubtedly the best

bank examiner training program in the country.

Nevertheless, because

of our burgeoning training needs, the FDIC is considering constructing
its

awn,

larger facil.ty with resident dormitory quarters.

The FDIC

has approached the FRS and the OCC to join with the Corporation in a
cooperative training facility.

Both the FRS and the OCC have evidenced

interest in this project and discussions on a cooperative training effort are going forward.

A brief aurmmary of the operation of the FDIC

DDS Training Center is i.ncluded with our general comments.

III-55

APPENDIX III

APP;NDIX III
Recommendations

(page 10-31)

We recommend that the Board of Governors, FRS, (1) establish a fulltime training office to operate its examiner training program and (2)
carry out the revision of examiner school curriculums which it has
recognized as needed for sometime.

We also recommend that the Comptroller of the Currency; the Board of
Directors, FDIC; and the Board of Go-vernors, FRS; increase their training in EDP, law, and accounting, as desired by their examiners.

FDIC Response
We plan to give further attention to this apparent need.

It is worth

pointing out in passing, however, that, at least with respect to EDP
training, in addition to the regular bas4c EDP courses (Course in
Examining a Computerized Bank (CECB) I and II), an advanced eight-week
technical EDP school, known as Field Examiner Advanced Automation
Training (FEAAT), is presently offered ito examiners who have a desire
to become highly proficient technically in EDP matters.

III-56

APPENDIX iII

APPENDIX I1I
CHAPTER 11

The GAO report indicates that a cooperative effort among the
federal bark regulatory agencies in the development of monitoring
systems may have "speeded development" and mentions the need for
continued coordination.
Each agency is in the process of developing or has developed
monitoring systems and each has learned from its own experiences.
We agree that there should be coordination among the agencies in
these efforts and would point out that a significant amount of
sharing and exchange of concepts and ideas has already been effected.
However, as pointed out previously, there is also merit to the three
agencies developing systems independent of one another.

Innovation

i; fostered and a healthy competition to have the best system available could be beneficial to all the agencies.

In addition, although

the major objectives of the three federal bank regulatory agencies are
similar, there are unique characteristics of each which may render the
development of a system common to all inappropriate.

While we do not

presume to comment on the unique needs of the OCC and FRS, central to
the FDIC's needs is L-e developmant of a system to cope with the substantial number of small and medium sized as well as a significant
number of large sized banks under our direct supervision.

Thus, in

the case of FDIC, a system that is sufficiently flexible to meet the
needb of supervising large sophisticated banks, as well as smaller less
complicated banks, is apparently what is required.
II'-57

APPENDIX III

Of course, adequate staffing and gathering accurate data on a
timely basis are two vital elements in the development, implementation, dnd maintenance of any monitoring system.

The FbIC is moving

forward in its efforts to satisfy these essential elements.

Finally,

FDIC has, in the main, completed the testing phase of our monitoring
systems and is in the process of integrating them into our examination process.
The GAO report states that an OCC official indicated that the
interagency system for processing bank data was inadequate because
banks were not meeting established reporting deadlines and FDIC
took approximately four months to keypunch and computer-edit the
system.
The FDIC does maintain the bank reported financial data for all
insured banks supervised by the OCC, FRS and FDIC.

Data submitted by

the national and state member banks are initially processed by the FRS
and submitted to the FDIC for edit testing and acceptance into the
finalized data base from which all of these agencies draw information.
The OCC is correct in asserting that the FDIC has taken up to four
months to process all of the reports from some 15,000 insured banks
and to produce a final data base.

However, delays in receipt of

correction data from the OCC and FRS where edit tests have failed
on banks under their respective supervision have been a major factor
in the finalization of the data base.

III-58

Efforts are being made to

APPENDIX !II

APPENDIX III

obtain agreement among the agencies on edit-check criteria so the.
corrections can be made on a more timely basis.
In order to meet both the monitoring and other needs dependent
on bank reported financial data, it would, of course, be to the
benefit of all agencies to derive a set of editing criteria which
would produce an acceptable financial data base with greater alacrity.

III->9

APPkLNDIX III

APPENDIX III

Recommendation (page 11-8)
We recommend that either (1) the Board of Directors, FDIC: the Board
of Governors, FRS; and the Comptroller of the Currency jointly establish a more effective mechanism to cambine t'eir forces in undertaking
sigr.ificant initiatives to improve the bank supervisory process or in
attacking and resolving common problems; or (2) the Congress enact
legislation to establish a mechanism for more effective coordination.
We would be glad to assist the committees in drafting appropriate
legislation.

FDIC Response
We recognize the merit of resolving common problems of the three agencies through closer coordination and cooperation.

Indeed, there is at

the present time a substantial exchange of information between the
agencies' headquarters as well as at the field levels.

However, if

there is any merit to the concept of separate federal supervisory agencies, and to a dual banking system with state and federal supervisior
of banks, the benefit would seem to be the opportunity to try different
approaches and to have a diversity of examination and supervisory procedures.

The possibility of useful innovation and improvement in the

bank examination and supervisory processes is greater if there are
several agencies trying different approaches than if every change in
examination methodology required approval of all the agencies.

Neverthe-

less, the possibility of establishing a particular vehicle for the agencies to resolve common problems and take joint efforts in new initiatives
will receive serious consideration.
III-60

APPENDIX III

APPI:NDIX III
FDIC ADDENDUM

We note that the draft GAO report is silent with respect to
the planning and modernization efforts undertaken by FDIC in recent years to keep our supervisory activities abreast of economic,
technical, and social developments.

We have attached a digest of

our planning and implementation of those planning efforts.

III-61

APPLNDIX III

APPENDIX III

In 1965, an exhaustive analysis of the examination and supervision functions of the Corporation, similar in many respects to the Haskins and Sells
study of the OCC, was undertaken by a committee of three experienced field
examiners who were detailed to the Washington Office.

Some of the recom-

mendations flowing from that study were:
- Increased emphasis on examination-by-exception techniques with at
least an annual visitation to each bank under our supervision
- Mutual interchange of (non-confidential) data with state banking
departments
- The establishment of effective guidelines for the volume of loans
which should be analyzed in a given bank
- Development of a program of procedural audits of certain banks and
furnishing audit assistance by the Corporation to some banks upon
request
- Revision of the report of examination to make it more usable to
bank managements and the supervisory functions of the Corporation
- Adoption of recommended policies by the Corporation in regard to
asset reserves, common capital stock, classification of assets, and
utilization of termination of insurance proceedings
- Publication of the Corporation's policies
- Limitation of field investigations of statutory applications to
those which are of significance in respect to competitive and
bank soundness considerations
- Development of more efficient application and investigation forms

III-62

APPECIDIX III

APPENDIX III

Streamlining and expediting of application
processing within the
Corporation
of authority to the Regional Directors for acting
on

-Delegation

certain statutory applications
-Restructuring

of the geographic and managerial composition
of the

Regions
-Internal

revisions designed to follow a specialized,

functional

approach promoting better communications and
training
Utilization of automated systems to aid in
scheduling examinations,
the review of examination reports, and gathering
in; rmation in connection with statutory applications
Expansion of EDP training programs, and the
selection and training
of examiner personnel in the managerial aspects
of computer
operations
Strengthening of requirements

fo: commissioned examiners as well as

revisions of the centralized evaluating process
-Expansion

and intensification of training of examiner
personnel,

including the executive levels
Conducting periodic staff meetings to include
both Regional and
Washington Office senior personnel
-The

interchange of senior examining personnel with
other Federal

agencies for short periods of time
-The

revision and enhancement of expense allowances
for travel and

relocations.

III-63

APPEINDIX III

APPENDIX III

Long range planning programs have been continuous since the 1965 study.
The Projects and Planning Branch of the Division of Bank Supervision was
established in 1971, and the Board of Directors created the Office of
Crporate Planning in 1974.

Developments at the Corporation within the

past five years or se. flowing from planning efforts, and paralleling
recommendations in the Haskins and Sells study, include:
- Implementation of completely revised examination report formats
for commercial banks (late 1969) and mutual savings banks (late
1972)
- Development in 1970 of an extensive training center for our
personnel as well as those of the Federal Reserve, Comptroller,
State Banking Departments, and some foreign students
- Reorganization of the Washington Office of the Division of Bank
Supervision along functional lines and the addition of a legal
counsel to our Regional structure in 1971
- Extensive revision of the Manual of Examination Policies was
begun in 1972
- New forms for filing and investigating statutory applications were
developed and implemented between 1971 and 1973
- Delegation in 19'3 of specifically defined authority to the Regional
Directors for approval of all statutory applications except those
involving mergers and the grat

.;g of deposit insurance

- Limitation on actual field investigations of statutory applications
to those situations where the competitive or overall bank soundness
c3nsideracions made them necessary

III-64

APPENDIX III

APPEPNDIX III

- Dissemination of the Corporation's policy statements and decision
guidelines was begun in 1970
- The development of automated early warning, trend analysis,
consumer loan evaluation, and review-by-exception systems was
initiated in 1971
- Emphasis was substantially increased on training programs and
specialization, particularly in the areas of automation, trust,
and international activities (although FDIC has limited direct
involvement in the international field)
- The development of guidelines and the initiation of experimentation
with an examination-by-exception program which emphasizes the
evaluation of management and systems

- Study, experimentation, and implementation of statistical sampling
as part of the examination process
-More

widespread application of disclosure requirements in

connection with securities offerings by banks
- The development of a new examination report for trust departments
and a complete revision of the Manual of Examination Policies
relating to trust activities, and selection of Trust Specialists
in order to provide more expertise in this complex area of
bank
examination.
Other FDIC planning efforts include reviewing considerations
of overlapping regulatory functions resulting in the development of
a recommendation for regulatory reform, the experimental Selective
Withdrawal

III-65

APPENDIX III
from Examination Program, and an experiment

APPENDIX III
in conducting separate

compi ance examinations, aimed largely at measuring adherence by banks
with consumer-oriented laws, regulations and policies.

A separate Office of Bank Customer Affairs was created in early 1975 to
oversee a variety of depositor and consumer-oriented fun-cions.

addition, a Consumer Affairs Unit within the Division of Bank Supervision
was established in 1971 and continues in operation.

Additionally, our examination staff has been expanded from about 900 in
1960 to approximately 2,000 at year-end 1975, and we expect to add
approximately 150 more examination personnel annually during the next few
years, spaced so as to allow efficient assimilation into our examination
corps.

Considerable effort has been expended on the development of information
systems, and data contained in Call and Income and Dividend Reporta have
been available to the public since 1972.

Along with the development of early warning systems, the Corporation has
increased its emphasis on the potential risks to the insurance fund flowing from larger banks, liquidity, earnings performance as an indicator of
overall bank soundness, and failure to use or untimely use of enforcement
measures.

Early and more detailed review of problem and near-problem

situations at the Board level has led to an expanded review staff, and our
experiences in problem situations prompted issuance of a regulation
governing insider transactions in banks under our direct supervision.
m11-66

APPENDIX IV

APPENDIX IV
SURVEY OF COMMERCIAL BANKERS

We sampled commercial bankers' opinions about Federal
bank supervision and examination. We mailed a questionnaire to a randomly selected sample of commercial banks
operating as of December 31, 1975, Our sample was drawn
from lists of banks supervised by the three Federal agencies.
SAMPLE DESIGN
From our lists of banks we drew two samples. One sample comprised banks which were receiving special supervisory
attention at the end of 1975--the so called "problem banks."
We randomly selected about 50 percent of these banks (203)
regardless of their deposit size.
The other sample comprised banks which were not receiving special supervisory attentior .1,475). They were selected to provide a representative b,smple of banks of different
deposit sizes.
(See ch. 12.)
In all, the questionnaire was
sent to the chief executive officers of 1,678 banks, and
1,501, or nearly 90 percent were returned.
THE QUESTIONNAIRE
Following is a copy of our questionnaire. The percents
associated with each response represent all banks who answered a given question.

IV-1

APPENDIX

APPENDIX IV

U.S. GENERAL ACCOUNTING OFFICE

SURVEY OF COMMERCIAL BANKS
INSTRUCTIONS:
The purpose of the questionnaire is to identify the
perceptions and attitudes of bank management oil the
examination and supervisory processes as they affect
bank operations. Yoa will be asked to consicr the
impact of examining !,"rsonnel on your bank, the
effectiveness of communications between the supervisory
ot pofs.-' I.e
agencies and banks, and your a: -:....
positive and negative aspects of these same superviscry/
regulato:y processes.

3. About how many applications to open new
branches have you made within the last
10 years? (Check one.)
I) C] none (go toquestion6)
2)

57.4

1-5

29.5

6-10

6 6

I
3) 0

The completed questionnaire should represent the
views of senior bank management.
We would like you to respond to each question. Some
questions may appear to require a review of records id
order to respond. Please do not perform any extensive
review but rather provide your most informed estimate.

The questionnaire is numbered only to permit us to
delete your bank's name from our list when we receive
your completed questionnaire and thus. avoid sending
you an inappropriate follow-up request.

11-15

2.8

16-20

0.8

over 20

What is the typical length of time between the
date of application for a new branch and the
date of approval or rejection of that application?
(Check one. I
I)

2 months or less

21.2

3-4 months

46.7

There are numbers printed beside the response boxes
to assist our keypunchers in coding the responset for
computer analysis. Please disregard these numbers.

5-6 months

19.8

7-12 months

8.8

I. BANK CHARTER AND NEW BRANCH
APPLICATIONS

E 13-18 months

2.2

1.3

For how many years has :.our bank held its' present charter? (Check one. I
5.

5 years or less

8.o

6-10years

5.0

0 1l-.15years

6.3

016-20years

2.6

COmore than 20 years

Oyes

4.0

2) O no

96.0

How reasonable does thb length of time between
applicltion and approval/rejection seem to you?
(Check one.)
I)

very reasonable

40.2

somewhat reasonable

36.5

3) [ undecided

77.5

Was your bank previously chartered at another
governmental level, within the last 10 years. i.e..
if currently a national '" nk, did bank previously
hold a state charter; if a,., ently a stats bank. did
bank previously hold a national charter? (Check
one. )
I)

over 18 months

IV-2

[

somewhat unreasonable

very unreasonable

4.9
15.1
3.3

APPENDIX

II. BANK'S PERCEPTIONS CONCERNING THE
EXAMINATION PROCESS
6.

How does your bank usually first learn of the
plans for an impending Federal examination?
(Check one.)

written notice

0.4

personal visit

0.9

3 )

__________

To what extent, if any, do Federal examinations
place a burden on bank operations. personnel
time. customer time and convenience? (Check
oneforeach row)

Customer time
Bandconvenience

7. In general how much advance notice of an ex-.
amination does your bank receive? (Check one.)
1)

no advance notice

_________

10.

98.1

.9
61.0

1.6
11.0

0.5

In a typical examination about how long are at
least some bank examin.7rs present on bank

premises? (Check one.

2) 0

some notice but less than 2 days

.
3.

3) C3 2-5 days
0. 5
7. In general how much advance notice of an
e0.15) 61mo thay0

3) 0
0.111.0

4.1

1.5

3.2

E preparation for production of a minimal

1.8

El from 4 to less than 5 months

0.3

on
11.

2) Cl preparation for a minimal amount of
manual retrieal of datays
0.2
3)
preparation for an extensive amount ofn
manual retrieval of data0.1

from 4 to less than 6 weeks

0.7

no preparation necessary

20.2

6) El from 3 to less than 4 months
7)

one, or more notice

68.6

2) L fronm 2 to less than 4 weeks

8. Which of the following best describes the kind
o preparat on required of your bank prior to
the arrival of the Federal ank examiners? Check
78 9

2
less than 2 weeks

Ct, )

more than 5 months

0.1

In general, how would you rate the Federal
examiners with respect to (I) their knowledge of
banking and (2) their professional demeanor?
6 weeks

5.8

EXAMINER0.1

number of computer printouts the kind
1.9

preparation

production
for
of an extensive
prior t
number of computer printouts

I. Knowledge oft
banking

demeanor

IV-3
IV-3

67.8

29.5

1.4

6.4months

0.2

APPENDIX

12. More specifica'ly, how would you rate the
competence of the Senior Federal examiner in
the following areas? (Check one r;lting lor vcch
row.)

13.

Ili general. hou adequalte or inadequate is the
Senior Federal Exanminers' understanding ('f the
lollo-ing specialized area'? (Clteck one rurine
Ir each r:,w.)

V7
-

of
q68.li
l4
Illille
27.6

5.1

_s
56.0

.,l().1i
NR

42.6

1.3

3. Abilitl to) asess
capital adeillalc

66.3
7.2

0.9

25.3

68.4

4. Ahility to sh.uc,
adequaciy o
itiernal .:outulol
5. Ability to evalualt
the collilvten.e6.4
of Iaagetent

he Abilint.tt) ev;jRMe
tile ningllws a

0.1

11.

I 9.0
67,.5

1.5
.
0.6

9.5
matuagentent
20.8
2.1

67.7

growth itt haink

S. Ability to vcalutate
hleadetquacloit
liquidie!

1.1

65.9
25.5

0.3

7.2
0.7

68.0

to dete).
Ahbility
miane tle iulpact

0.3

11.5

18.4

soulndlpess

ol' seil'-dealllgs

oil solurndiless.

68.1

!0. Ability to eitegrale
deta iled tintrmttapreherlsive pIatulre
of hatik oaltitillsn
I.

20.1

C.3

5.7

25.3

_ 10.0

1.4

0.4

Other (please
des.ribe)
NR- No

1i ii

usnse

IV-4

20.3

datt

pIoI0CNl1g

9.3

lll

llalioal

ollelatios

1.4
1

67.4

7. Ability to evaluate
tlle imipa;t o'

0.3

10.3

20.2

-ect.oui:

2. Kinowledge of
banking laws and
Sregula
iioslla

. I1ao68 .4 1.3

(.7

66.5

I. Ability to deli 03115

APPENDIX

17.8

0.3A
4.2 19.7 - 0.9

19.7

65.9

2.6

70.7
8.6

0.36

APPENDIX

APPENDIX IV

the five items which you consider to be the most important. regardless of the agency's priorities. (Be sure to
mark all vyour selections in column 1. Second, and converselv, again review the list. but this time check the five
items which you considerto be the least impoi,ant in column 2.

_Mc:s

RANK

least

Impotalnt Importalt

RANK

Assurance that external pressures are not leading to unlsound
hanking practices

242

37.7

Evaluation oif internal control. including internal audit

421

139

Presentlation of an integrated picture of bank operations

7.3

6.0

Determnalltlion of existence of conflicts of interest

11.7

Protection of tlle safety of depositors' funds

L-valuatio,i ,,I portfolio halatce/imbalance

10.2

441

Deterillinatiol ol existence of1sell-dcaliigs

17.6

Fs.-cast of trends in the haenkil,~

2.6

Coutpiiance with laws and regulatilons

il.str
3

(10. L),'talion of deposit volatility

II.

Evaluation of capital adequa:

12.

Evaluation of asset quality

13.

Ev'duation ,)t' managemient

14.

Evaluation of' liquidity

15.

Evaluation of'earnings

16.

Other (Please specify)

IV-5
IV-5

5.8
5.021
356

3
101

5.1

2L4

APPLNDIX

15.

APPENDIX

To answrer this next question. we ask you to again consider this list. bhut from a different point of view. From
your experience, which five items do you think the agencY considers to be tie most important? (Indicate ytu,answer hy ckheckin thel upprpriaute hxtrf. isn idatumn 1.1 Conmerselv. which five do you think the agency considers
to be the least important': IC/leck fi've ho,.rxs in co/umn 2.

Assitrna.e Itha e\telllal pI'.lNlll'es
unsititld hanlking placti.ce'

a.e ntt le.adilt

RANK

Most\
Imtp.oll;aml

L-a'st
Importatlt

RANK

12.6

43.7

Rvaaliationl of inirle3al ¢o'tmol. intilliiig 'l' 111l .umdit

42.0

13.6

Presentatioll to all integrated ptcnre ot alink illeart injs

5.2

63.4

De'iermttilalit

20.0

22.3

Prote¢ttll olf the salIetv of dtllotiholr'

48.5

6.2

12.3

39.1

20.5

19.2

1.8
1.8

70.5
70.5

73.7

1.9

o'Xi:tletC.' *1t :imtllict*,
*tt

Fvaluation o1po flil

Determliltionl otf esicttentce

Fore¢:asI of lelid.in

('otmpliantce with laws atind eglaitions

litn
let'

htinlds

halan i t

thalamice

%elf-dealtllg\

the h.Inktlg Indtle

10.

Evaluatiotl ofI dclpsitl vldtilit\

4.3

53.4

II.

Eval. tathlatit, Calaital adetutlac.

55.1

4.5

12.

Evaluatiion of a3'sset qttalilt

.57.5

5.2

13.

Evaluatio, lo,1 Illtat.ltlCllet

32.5

14.7

14. Evallltit ln to iqiutitidi t

35.3

10.7

Evaluation of eartnilng

12.4

37.1

I S.

O1. Other (Please specify)

IV-6

APPENDIX

16.

APPENDIX

Does the examiner spend enough time in examining your bank?

17.

yes

72.2

probably yes

23.2

undecided

0 probably no

2.2

O no

0.9

Loan Assessment
41.4

1"*' 22 3

6.3

7.5
12.7 21.2 52.3
Capital Adequacy

3.9

1.8

34.8

5.8
9.7
19.3
Internal Control
30.4

55.5

6.3

0E0

2.9

3.8
7.8
18.8 47.0 13.7 7.0
Managemer' Assessment
23.2
28.5
]
28.5

0.5

1.9

lOg

3.1
4.9
15.21 48.3 115.Q 10.3
2.3
Compliance with Banking Laws and Regulations 40 0
9
40.0
1
1
9.7

8.7
13.1 18.21 50.3
6) Other iSpecify'
1

0.6

22.5
IP

a1
5)

[.7
[1

d of0 t J2

From the viewpoint of bank management. how
useful is the bank examination process? (Check
one.)
I)

of little or no Jse

1.0

a small degree of use

6.6

a moderate degree of use

33.3

ahigh degreeof use

46.1

L1 a very high degree of use

13.0

1.5

Indicate whether or not you feel the bank examiner pays the appropriate amount of attention
to each area. Do this byv checking one of the
scale positions on the numbered boxes provided
below. For example. if ywin feel the examiner
spends either too little or too much time in a
particular area, you should check an appropriate
box at the end. or near the end of the scale. On
the other hand. ifryou feel the examiner 's time is
appropriately allocated. check *ither a middle
box or one ofthe boxes near the middle.
1)

18.

5.5

3.2

1.0

IV-7

APPENDIX IV

19.

To what extent would you agree or disagree with the following statements about the Federal examination
proeess? (Check onetfireuch rnw./

-1.

3.
4.

43.3

.
4a0iiu.tliatu1.d
he C\t...illiial.till plcss i 1.tiel it hIalk
I:ailure

20.9

th rough

The cxamiaiiation pti):oess is usel'il to hank nlanllgelltl

Othel

(Please specify)

IV-8

21.9
9.7

33.5
33.3

.19.2
379

19.9
19.2
8.3

27.2
4.8

57.4

26.9

5.0

32.6

11.2

itll idenliifyin

0.8
12.6

27.8

7.4

11ille ;atiioll

2.6

20.6

8.0

,I
2.6

6.1

2.1

pteIt:iall problems
7.

40.9

in pli.ve'.'ig hank

It hank mi'nalgelmlel ill tolecaslinlg
wlll'ful

_ is uis llo Ii batik inliagenleni
roe."

ll e
reoMmllliendinlg ai comt

ri
47.2

plovidiu: lectogiiolil anld C11¢ollragepltcess i Ilseltill in ll
The examinalionl
o1 tie qualil1 of eliicel miad emploie.e iktMitaltla.e
miiel tu

.. ioll
The exa inmial

47.2

The examinatiiiion prot:ess is uteful in provwidiug in indeleident appraisal olf
hatnk stundiie,.s

Thle examlination pioces., i,
lultire t relld

9.6

1.3

APPENDIX

IF YOUR BANK IS A NATIONAL BANK, PLEASE
GO TO No. 22.

22.

20. How are State examinations typically conducted?

41.6

1) - Coordinated but not conducted
concurrently with the Federal agency.
2) 0 concurrently with the Federal agency

4D.7

17.7

Some observers have asserted that there are
inconsistencies in communications received by
banks from t:.e Federal supervisory agencies.
Others disagree. They feel that in general communications are basically consistent. To what
extent, if at all, has your bank experienced the
communications problems characterized by the
various situations described below?

0 independently of the Federal agency

are the state examinations than the Federal

examinations from each of the following aspects?

COMMUNICATION
PROBLEMS
'

ca _

2= : .

report and other
c
j=

vwritten guidance
fromOF
I~
same_csuper-

PF.
c,

ASPECTS OF

vising agency

STATE
EXAMINATIONS

_1.

2.
3.

Usefulness .of
state exami.ations
Scope of state
examinations
Competence of
examining
personnel
'-4.(please
(please
Other
Other
specify)

Disparity between
guidance given in
t examinlation
'he

,'~

.,'

62
3.1

13.6
753

66
8

25.2
64.0
-

Disparity betwee
formlal comlouni-

cations from an
L8

80.6

I:v

77.8

agency and informal
contacts with personnel from that
same ageny
Disparity between

69.1

7.3
26.0

Disparity between

260

communications
received from two
or three different

Federal agencies a/

57.4

1L181

We believe that an unknown percentage
of respondents interpreted the phrase
"d:ffezenL Federal agencies" to mean
other Federal agencies such as the

......

Internal Revenue Service, and SecuriLies and Exchange Commission,

and not

merely the three Federal bank supervisory agencies.
This belief is ba!sed
on conversations we held with several

national and state nonmember bankers
who answered this question.

IV-9

APPENDIX IV

m. EXAMINATION REPORTI AND COMMUNICATION

27.

23. a)ln the last 5 years how many times has your
bank been examined? lindicate rour ansiwer by
r- ling a number.)
NO. OF TIMES BANK EXAMINED
3 or less

1) or more

24. a)ln how many examination reports. if any. have
you noticed a situation where major deficiencies.
as noted in the text. were left out of the
"comments andconclusions" page? (Check one.)
NO. OF REPORTS WHERE DEFIC:ENCfIES
WERE LEFT OUT
1

10ororreM2

25.a) Also in how many of these reports. if any. have.
you noticed a situation where deficiencies reported
in"comments and conclusions" page were not
supported by the text? (Circle one.)

26.

59.0

from 2 to less than 3 months

16.4

0] from 3 to less than 4 months

4.3

S),

from 4 to less than S months

1.1

O from 5 to less than 6 months

0.7

0 %ixn-nr.isormcre

0.1

Pate the clarity with which the examination
r'-oFti. t;tally explain .le nature and extent of
the probtlemls, if any. (Check one.!
I)

C) very clear

32.3

3.8

10or more

0 generally unclear

0.3

] very unclear

0.1

7 F

some general discussion of content area

general discussion of content area

from I to less than 2 rr onths

borderline

detailed discussion of content area

little or no discussion

41.7

18.4

63.5

22.6 4)

less than a month

C] generally clear

ro wha. extent if at all do the bankl examiners
discuss their findings with the bank management
before leaving to write their report? (Check one.)

27.0 3)

0.6 1)
8.1

)F REPORTS WHERE DEFICIENCIES
WERE NOT SUPPORTED
1 2

How long after tlhe examination is completed do
you usually have to wait for the report? (Check
one. I

detailed discussion of content area and
findings

DATA NOT AVAILABLE
23, 24. and 25.

FOR QUESTIONS

IV-10

APPENDIX

29.

APPENDIX

In your opinion, how effective or ineffective is the Federal supervisory process, including examinations, in
achieving each of the following objectives? (Check onefor each row.I

RANK
I

Assurance thati external pressures are not leading t,
unsound banking I..lctices

Presentation of an integrated picture of hank operaions

Evaluatio

Determinationl of existence (if conflicts

Protection of the safety of depositors' funds

6.6

of internal controls including internal audit

4.3

of interest

Determination of existence of self-dealings

Forecast of trends in the banking industry

8.3

21.6

42.2

564

10.0
1.7

18.3

10.

Compliance with laws and regulations

.0
33.0

7.5

50.4
61.7

Evaluation of deposit volatility

5.3

12.

Evaluation of capital adequacy

16.0

66.5
70.0

13.

Evaluation of asset quality

18.8

70.0

14.

Evaluation of management

8.3

I5.

Evaluation of liquidity

15.3

69.1

16l.

Evaluation of earnings

8.8

59.7

Other (Please specify)1.3

2.7
14.4
4.9

0.3

6.8

04
04

1.4
0.1

5.2

0.5

25.5

6.0
6.0

1.0

27.7
4.7

28.8
10.9

9.6
0.5

36.3

2.4

28.7

40.3

_.7

28.1
12.0

57.5

Evaluation of international operations

IV~-11

36.7
36.7

64.9
56.9

a) The rank order is based on the sum of the "very effective"
and "effective" responses.

12.3
32.8

59.9

Evaluation of portfolie nalance/imnbalance

>
45.6

21.6

4.8
0.1
1.5

3.1
1.30

0.4

9.6

1.3

0.3

27.4

6.9

1.2

12.

2.5

0.4

6.6

APPENDIX IV

IV. OVERALL OPINION ON BANK SUPERVISION
30.

There are both advantages and disadvantages to
Federal supervision of banking. In the following
three questions. we have listed some of these.
You are asked to consider the advantages and
disadvantages and then to rate
en according
to the amount of advantage
tlisadvantage
brought to the banking industry as a result of
Federal supervision.

(2) Second. consider the disadvantages listed
below. How great or how small do you think
these disadvantages are? Consider each of the
disadvantages separately. (Check one for each
.}

{I) First. consider the advantages. How great
or now small are the advantages that are
reali7ed by the banking industry? fC'heck one
for each row. )33.1

o .,>
e
i
ADVANTA(1ilS

>
-

I . Sii'l-¥Visitit
n
::restricts
.
llexibility
_
28~~it xliniopertiakes
k
rZ 3
2. laminattion takes
_il
limle o h;bik
prtsnoel
Ic>

_
3

' -v

ri ;.- l
s-l30.7 22.7

16.0

Protection of the
industry by an
entranice screening
to reject unsound
applicants

27.9

29.7

27.3

i
'tantion dupliCd!C olher tylles
'fex 1 n revies

1.5
4.0

12.8
230.7
22.4

0.9
3.6

3.2

8.3

33.4
23.2

7.4

9--nt

52.8

1.6
4.1

15.9

2.3

Other specify

5.3
30.5

28.8

17.7

14.4
24.9
.

25.7
(.

Protectionl of the9.4
industry by maintaining a deposit
insurance find
3.8
Other (specify)

55.5

:mued ope raJ ion
inlleicientl
hanks 58.0
5

Conlributioni
toward tihe preIbilurventin
ol hathink
failure

18.1
26.8

aminaultion mtakes

24.3
6.3
___________ ___of
27.2
12.0

of Bank's internall

4
4:n

1.0

6.7

a possible contribut1o0 to tile coll-

I-xternal1 review
audit 1and
conloAl
piocedures

35.4

facilities

> ;i
4

16.9

38.3

xanlllling

-bank

44.6

pe{'rsonnel use

22.7

Reslictionll of th
extlremes nl
cmitpeliti~ot

_
>
,

>
.-

'Availahilit
supe.rvis.ory
agenc
sUlpervisory a
pelsonlnel l'o0
advice alld cntsil at iollt

'i
_

D)ISAI)VAN'TAGL S

24.0
-4.0
77

911.4 11.4

(3) Third. consider both the advantages and
disadvantages to the banking industry. Do you
the advantages outweigh the disadvantages.
or do you think the converse is true? (Check

10.1

48.2

1) 0

Advantages substantially outweigh the
disadvantages

41.0

[

Advantages outweigh the disadvantages

7.8

Advantages and disadvantages balance

10.9
-R

28.3

equally

47.1
2.7

0 Disadvantages outweigh the advantages

0.3

=] Disadvantages substantially outweigh
the advantages

IV-12

APPENDIX IV

31.

APPENDIX IV

The following are four possible alternatives for
organizing bank supervisory agencies, Consider
each, and indicate the degree to which you
oppose or support the particular alternative.
(Check one for each row.)

32. The following are possible changes to the existing Federal examination process. Do you support
or oppose these changes? (Check one for each
row.)

~~ALTERNATIVES
v
;~~z
ORC;^NIZATIO N
ALTERNATIVES

9.4

15.6

16.6
-agencies
49.
13.3
15.6

Restricing examiPOSSIBLE
nations Cr:ANGES
only
.

324
26.0

I.
32.4
'

259.4

16.6

126.0

Federal
o3.sulpy
erviory
Fed4.Ol
n
eeral
svisorynations
Ipenc~iesbut no
supcnvisory
hgnosmaller
Stat
e supervisory.5
visory agencies
3.

Onl

49.2

one
y Federal

1.3
18.6

3.5

14.2

15.9
Only one Federal
supervisory agency
and no State super~~~supervisory
agency
viso~ry agencies

25.2

65.4

4.9

Other (specify)

0.8

2.6

26'~.

3.9

1.4

1.7

3.0

67
.9

26.6
6.8

edium
sing thed bank4.3

Resricting exa

5.8

baks to be
5. Increasing the
frequecy of
examinations tor
all banks19
s~~~~oppeal
rory
r
6. Decreasing the
fheirrequency of
examinations

23.8
2.9
7.9

1i7.4

71.
2934.8
25.1

3.0

6.8
4.3

38.2

18.7

34.8

1.5

48.1

-__7.9

raIVlbank5.7
7.

IV-13

Providing the
opportuolity for
banks to be
examined on
their request, in
addition to the
regular examination
Other (specify)

3.
0.8

0.6

ations to o
r all
banks
requiring.7

18.7

8.0

very
b eq3.5uir
large
anks
Restricting
examispecial
nationssupervisory
a) only

Restriting
cyexaio
nations to only
banks

23.3

State supervisory
agencies

natior.ns to only

wit
Only
three Federal
supervisory
agencie
supervisory
agenciey
and
State
and State supersuper-y
agencies

edium sized ba
Restricting exami-

15.7
44.9

17.0

25.1
7.4

20.5

10.

APPENDIX IV

33.

8) Other (specify)

In the following question. you are asked to evaluate
several possible changes to Government involvement in the banking industry. no this by checking one of the scale positions on the numbered
boxes prov'ided below. For example. if you feel a
possible change would be "Beneficial" or
"Detrimental." you should check an appropriate
box at the end. or near the end of the scale. On
the other hand. if you feel there is little choice.
check either a middle box or one of the boxes
near the middle.

0
1

34.

Elimination of chartering by the Federal
Government
70,4
10.6

123

5.5
2.3
2.8 19.0
6.3
17.2 46.9
2) Elimination of chartering by State Governments
71.6
11.9

010

6.1
2.7
3.1
16.5 4.5
16.8 50.3
3) Elimination of the requirement for government approval for bank branches
13.8
72.8
6.3
3.3
13.4
4
7.0
17.5
48.3

000000

6.3
4)

4.2

13.4

7.0

17.5

48.3

Elimination of the requirement for government approval for bank mergers 77.6
10.2

i~'-

4.2
5)

3.3

23
2.5

1
3.5

01 0
12.2 8.4

-s-

20.0

49.2

Elimination of all governmental bank examinations
87.8
5.4

0o0 1

n00

3.1
1.0
1.3
6.8
2.9
1.7 71.2
6) Elimination of bank regulations entirely
5.4
89.4
1 - 2
1
1 '
6
'

9.5 76.1
3.4
0.6
1.4 15.21 3.8
Elimination of bank supervision entirely
4.3
90.1

O0 n]

3.1

0.8

0.9

5.1

2.7

10.3

V. ADDITIONAL COMMENTS

Indicate the degree to which you feel the
changes are beneficial or detrimental.
1)

77.1

IV-14

If you have additional comments on any of the
items within the questionnaire .or topics not
covered. please express your views below on this
page. Your answers and comments will be
greatly appreciated.

APPENDIX V

APPENDIX V
PRINCIPAL OFFICIALS RESPONSIBLE
FOR ADMINISTERING ACTIVITIES
DISCUSSED IN THIS REPORT
Tenure of office
From
To
DEPARTMENT OF THE TREASURY

SECRETARY OF THE TREASURY:
W. Michael Blumenthal
William E. Simon
George P. Shultz
John B. Connally
David M. Kennedy

Jan.
May
June
Feb.
Jan.

1977
1974
1972
1971
1969

Present
Jan. 1977
May 1974
June 1972
Feb. 1971

OFFICE OF THE COMPTROLLER OF THE CURRENCY
COMPTROLLER OF THE
CURRENCY:
Robert Bloom (acting)
James E. Smith
Justin T. Watson (acting)
William B. Camp

July
July
Mar.
Nov.

1976
1973
1973
1966

Present
July 1976
July 1973
Mar. 1973

FIRST DEPUTY COMPTROLLER
(note a):
Justin T. Watson

Sept. 1962

July 1975

FIRST DEPUTY COMPTROLLER
FOR POLICY (note a):
Robert Bloom

Aug.

L975

Present

FIRST DEPUTY COMPTROLLER
FOR OPERATIONS (note a):
H. Joe Selby

Aug.

1975

Present

APPENDIX V

Tenure of office
From
To
FEDERAL DEPOSIT INSURANCE CORPORATION
Board of Directors
CHAIRMAN:
Robert E. Barnett
Frank Wille

Mar. 1976
April 1970

Present
Mar. 1976

COMPTROLLER OF THE
CURRENCY:
Robert Bloom (acting)
James E. Smith
Justin T. Watson (acting)
William B. Camp

July
July
Mar.
Nov.

1976
1973
1973
19Lt

Present
July 1976
July 1973
Mar. 1973

DIRECTOR:
George A. LeMaistre
Vacant
Irvine H. Sprague

Aug.
Mar.
July

1973
1973
1968

Present
Aug. 1973
Mar. 1973

Aug.
June

1975
1975

Present
Aug. 1975

Sep.
Sep.

1971
1969

June 1975
Sep. 1971

Division of Bank Supervision
DIRECTOR:
John J. Early
John J. McCarthy Jr.
(acting)
Edward J. Roddy
John L. Flannery

FEDERAL RESERVE BOARD
CHAIRMAN, BOARD OF GOVERNORS:
Arthur R. Burns

Feb.

1970

Present

VICE-CHAIRMAN, BOARD OF GOVERNORS:
Stephen S. Gardner
George W. Mitchell
J. L. Robertson

Feb.
May
Mar.

1976
1973
1966

Present
Feb. 1976
Apr. 1973

V-2

APPENDIX V

APPENDIX V
Tenure of office
Fromn
To

Division of Bankin Supervision and Regulation
DIRECTOR:
Brenton C. Leavitt
Frederic Solomon

Aug. 1974
Aug. 1959

Present
Aug. 1974

GOVERNORS:
David M. Lilly
J. Charles Partee
Philip C. Jackson, Jr.
Philip E. Coldwell
Henry C. Wallich
Robert C. Holland
Jeffrey M. Bucher
John E. Sheehan
Andrew F. Brimmer
J. Dewey Danne
George W. Mitchell
Sherman J. Maisel
William W. Sherrill

June
Jan.
July
Oct.
Mar.
June
June
Jan.
Mar.
Nov.
Aug.
Apr.
May

1976
1976
1975
1974
1974
1973
1972
1972
1966
1963
1961
1965
1967

Present
Present
Present
Present
Present
May 1976
Jan. 1976
June 1975
Aug. 1974
Mar. 1974
Apr. 1973
May 1972
Nov. 1971

1968
1975
1956
1970
1971
1970
1973
1973
1968
1968
1970
1976
1976
1966
1971

Present
Present
July 1975
Present
Present
Aug. 1971
Present
Aug. 1973
Jan. 1973
Present
Present
Present
Mar. 1976
Feb. 1976
Present

FEDERAL RESERVE BANKS

PRESIDENTS:
F. E. Morris
P. A. Volcker
A. Hayes
D. P. Eastburn
We J. Winn
Vacant
R. P. Black
Vacant
A. N. Heflin
M. Kimbrel
R. P. Mayo
L. K. Roos
Vacant
D. R. Francis
B. K. MacLaury

District
bank
Boston
New York
New York
Philadelphia
Cleveland
Cleveland
Richmond
Richmond
Richmond
Atlanta
Chicago
St. Louis
St. Louis
St. Louis
Minneapolis

V-3

Aug.
Aug.
Aug.
Mar.
Sep.
Nov.
Aug.
Jan.
Apr.
Feb.
July
Feb.
Mar.
Jan.
July

APPENDIX V

Tenure of office
To
From
Minneapolis
Vacant
Minneapolis
Jr.
Galusaa,
D.
H.
Kansas City
Roger Guffey
Kansas City
G. H. Clay
Dallas
Baughman
E. T.
Dallas
Vacant
Dallas
P. E. Coldwell
San Francisco
J. J. Balles
San Francisco
Vacant
San Francisco
E. J. Swan
VICE PRESIDENTS IN
CHARGE OF BANKING
SUPERVISION AND
REGULATION:
D. Aqu ino,
Senior Vice
President
L. J. Aubrey,
Vice President
F.W. Piderit, Jr.
Senior Vice
President
T. K. Desch,
Vice President
J. R. Campbell,
Senior Vice
President
H. W. Huning;
Vice President
W. S. Farmer,
Senior Vice
President
J. L. Nosker,
Senior Vice
Prestdent
R. Z. Heck,
Vice President
R. M. Stephenson,
Vice President
J. R. Morrison,
Senior Vice
President

Feb.
May
Mar.
Mar.
Dec.
Oct.
Feb.
Sep.
June
Mar.

1971
1965
1976
1961
1974
1974
1968
1972
1972
1961

June 1971
Jan. 1971
Present
Feb. 1976
Present
Dec. 1974
Oct. 1974
Present
Sep. 1972
June 1972

Boston

Oct. 1974

Present

Boston

July 1969

Oct. 1974

New York

July 1965

Present

Philadelphia

Aug. 1972

Present

Philadelphia

Jan. 1969

July 1972

Cleveland

Oct. 1964

Present

Richmond

June 1976

Present

Richmond

Jan. 1961

May

Atlanta

Nov. 1972

Present

Atlanta

July 1964

Oct. 1972

Chicago

Jan. 1970

Present

V-4

1976

APPENDIX V

APPENDIX V
Tenture of office
From
To

H. E. Uthoff,
Senior Vice
President
L. G. Gable,
Vice President
W. T. Bilington,
Senior Vice
President
R. E. Scott,
Senior Vice
President (acting)
T. R. Sullivan,
Vice President
H. B. Jamison,
Vice President
I. L. Jennings,
Senior Vice
President

St. Louis

Oct. 1970

Present

Minneapolis

July 1967

Present

Kansas City

July 1971

Present

Kansas City

July 1970

July 1971

Dallas

June 1962

Present

San Francisco Nov. 1971

Present

San Francisco Jan. 1969

Oct. 1971

V-5

Full text of GAO Reports & Testimonies : Federal Supervision of State and National Banks : A Study, [Vol. II: Main Body of Report]

FRASER