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A d d ress

G e o rg e A . L e M a is t r e
. D ir e c to r \
F e d e r a l D e p o sit In s u r a n c e C o rp o ra tio n

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C A P IT A L A D E Q U A C Y 1

B e fo r e the
B an k Study C o n fe re n ce
A la b a m a B a n k e r s A s s o c ia t io n
T u s c a lo o s a , A la b a m a

S e p te m b e r 25, 1974

I,

FEDERAL DEPOSIT INSURANCE CORPORATION, 550 Seventeenth St. N.W., Washington, D. C. 20429



•

202-389-4221

The q u e stio n , "W hat c o n stitu te s a d e q u a te c a p it a l fo r a g iv en ban k , a holding
company s y s t e m , o r the ban k in g s y s t e m a s a w h o le? " i s one of the m o s t
enduring and l e a s t u n d e rsto o d o f the i s s u e s th at co n fro n t b a n k e r s and bank
r e g u la to r s. In a M a rc h 1952 m on th ly r e p o r t of the G u ara n ty T r u s t C om pany
of New Y o rk , the b a n k ’ s e c o n o m ists p o s e d the p r o b le m in s im p lis t ic but
e sse n tia lly a c c u r a t e t e r m s , sta tin g :
"T h e p r o b le m of m a in ta in in g an a d e q u a te le v e l of ban k c a p it a l i s one
that h a s b een g iv in g c o n c e rn to b a n k e r s and ban k s u p e r v is o r s fo r
so m e t i m e . . .
" . . . (I)n so m e w ay the q u e stio n i s one o f the m o s t in d e fin ite in the
w hole fie ld o f b u s i n e s s . T r u e , the b r o a d p r in c ip le s a r e e a s y to la y
down. The p u r p o s e of bank c a p it a l i s to a b s o r b l o s s e s th at o c c u r
in the r e g u la r c o u r s e o f b u s i n e s s , en ab lin g b an k s to in cu r n o rm a l
c r e d it r i s k s w ith out e n d an g e rin g th e ir d e p o s it o r s ' fu n d s. C a p ita l
sh ou ld be la r g e enough fo r th is p u r p o s e w ithout b e c o m in g so la r g e
that it i s im p o s s ib le to e a r n a r e a s o n a b le r e tu r n on s t o c k h o ld e r s ’
in v e stm e n t.
"T h e d iffic u lty l i e s in t r a n s la t in g th e s e b r o a d p r in c ip le s into c o n c r e te
te rm s. "
That w e a r e to d ay litt le fu rth e r alo n g in th is e ffo r t i s sy m b o liz e d by C a r t e r
G olem be’ s r e c e n t a s s e r t i o n th at " . . . th e re a r e no e a s y so lu tio n s to the q u e stio n
of c a p ita l a d e q u a c y - - a n d p e r h a p s none a t a ll. " A c c o rd in g ly , I h av e no
intention o f hinting a t d e fin itiv e a n s w e r s and f r e e ly ac k n o w led g e that I find
m y se lf in the p o sitio n o f the S a lo m o n B r o t h e r s a n a ly s t s who m o d e s tly
ackn ow ledged in a r e c e n t i s s u e of th e ir B an k W eekly :
"W h ile w e h av e d ev o ted s e v e r a l p r e v io u s i s s u e s of the W eekly to v a r io u s
a s p e c t s o f th is s u b je c t , w e c la im no s p e c i a l in s ig h ts w ith r e s p e c t to
c a p it a l a d e q u a c y . "
H is to r ic a lly , ban k c a p it a l r a t i o s h av e b een d e c lin in g s in c e e a r ly in the n in eteen th
cen tury, w hen c a p it a l am o u n ted to b etw een 60 and 70 p e r c e n t o f to ta l a s s e t s . A s
the n in eteen th c e n tu ry p r o g r e s s e d , the b u s in e s s o f ban k in g ev o lv ed a s the
"in d u s tr ia l re v o lu tio n " and the u s e o f the c o r p o r a tio n fu n d am e n tally a lt e r e d
our eco n o m y. B y 1900 r a t i o s h ad m o v e d to 20 p e r c e n t o r l e s s . E x p a n sio n
of a s s e t s to fin a n c e the F i r s t W orld W ar and the su c c e e d in g bo o m of the
tw enties b ro u g h t the r a tio s t i l l lo w er to a p p r o x im a te ly 13 p e r c e n t by the
onset of the D e p r e s s io n . A g ain the fin an cin g d e m an d s of w a r b ro u g h t ab ou t
a d e clin e in the r a t i o s . In 1945, the r a tio of to ta l c a p it a l and r e s e r v e s to
a s s e t s w a s l e s s than 6 p e r c e n t. R is in g to 9. 0 p e r c e n t by I9 6 0 , the r a tio
again d e c lin e d in the s i x t i e s and e a r ly s e v e n tie s so th at by 1973, it sto o d a t
7. 4 p e r c e n t.




-

2

-

S u p e r v is o r s h av e t y p ic a lly e x p r e s s e d c o n c e rn w ith th is phen om en on . B a n k e rs,
on the o th e r hand, h av e tr a d it io n a lly tak e n the p o s itio n o f WAs Lin dow who
argu es:
" B a n k c a p it a l r a t i o s h av e been d e c lin in g fo r a lo n g tim e and p ro b a b ly
w ill d e c lin e fu r t h e r . H o w e v e r, im p ro v e m e n ts in bank m a n a g e m e n ts
and in the en v iro n m en t in w hich b an k s o p e r a te h ave re d u c e d the n eed
fo r bank c a p it a l o v e r the y e a r s . "
B e fo r e d i s c u s s i n g so m e f a c t o r s w hich , in m y ju d g m e n t, m a y r a i s e s e r io u s
d o u b ts ab o u t th is a s s e r t i o n , it i s p ro b a b ly u s e fu l to o u tlin e b r ie f ly the v a r io u s
fu n c tio n s w hich a r e a s c r ib e d to c a p it a l. T h at they a r e m u ltip le and not g e n e ra lly
a g r e e d upon o f f e r s a hint a s to one c a u s e fo r the a n a ly tic a l co n fu sio n w hich
p e r v a d e s the a r e a . ^M oreover, su ch a d is c u s s io n p u ts in so m e p e r s p e c t iv e
the p e r p e tu a l tug o f w a r b etw een b a n k e r and bank s u p e r v is o r .
F i r s t o f a ll, the fu n ctio n m o s t g e n e r a lly a g r e e d upon i s th at c a p it a l e n a b le s
a bank to a b s o r b u n fo r e se e n l o s s e s o r re d u c tio n in a s s e t v a lu e s in e x c e s s of
e a r n in g s in o r d e r to co n tin u e a s an ongoin g c o n c e rn u n til e a r n in g s r e c o v e r .
W hile th e r e i s g e n e r a l a g r e e m e n t th at th is is an a p p r o p r ia t e fu n ctio n , th e re
i s s ig n ific a n t d is a g r e e m e n t a s to the le v e l o f r i s k th at sh ou ld b e p ro v id e d fo r .
S u p e r v is o r s a r e a c c u s e d o f ad o p tin g a " w o r s t c a s e " a p p ro a c h o r o f s t i l l being
m e s m e r iz e d by the t r a u m a o f the D e p r e s s io n . F o r e x a m p le , C a r t e r G olem be
b e g a n h is v e r y h elp fu l m e m o ra n d u m , " C a p it a l A d e q u acy : The S e a r c h F o r
C e r ta in ty , " w ith the fo llo w in g :
" T h e r e f o r e , sin c e the w o rld h a s s t il l
M uch good, but m uch l e s s good than ill
And w h ile the su n and m oon en d u re
L u c k 's a ch a n c e , but t r o u b le 's s u r e
I'd f a c e it a s a w is e m an w ould
And tr a in fo r ill and not fo r good. "

H

O f th is v e r s e , G o lem b e opin ed " th a t r a r e l y h a s th e r e b een a b e tte r d e s c r ip tio n
o f the r e g u la t o r y a ttitu d e to w ard c a p it a l a d e q u a c y . "
The a g g r e s s i v e b a n k e r 's p o sitio n w a s s ta te d by G e o rg e V o jta in h is stu d y fo r
C itib an k e n title d "B a n k C a p ita l A d e q u acy . " He a r g u e d th at "th e r a n g e o f
co n d itio n s w hich i s o p e r a tiv e fo r the p r o p o s e d t e s t s o f c a p ita l a d e q u a c y exten d s
fr o m c o n d itio n s o f e x te r n a l s t a b ilit y o r 'n o r m a lc y ' to co n d itio n al s e v e r it y sh o rt
o f the p e a k p r e s s u r e s e x p e r ie n c e d in the c r e d it cru n ch o f 1 9 6 9 /7 0 , " and that
" in s e v e r e c y c lic a l sw in g s c a u se d by e co n o m ic p o l ic i e s , the a u th o r itie s m u st
a s s u m e r e s p o n s ib ilit y fo r p u b lic co n fid e n ce in the fin a n c ia l s y s t e m . " (At th is
poin t I sh ou ld note th at M r. V o jt a 's w o rk r e p r e s e n t s a g en u in e co n trib u tio n to
the l i t e r a t u r e in an a r e a in w hich m o s t o f the sou n d a r g u m e n ts w e r e m ad e
lo n g ag o . )




- 3 W hile not se e k in g c a p it a l s u ffic ie n t to w e a th e r a r e p e a t o f the D e p r e s s io n o r
even co n d itio n s c lo s e to e c o n o m ic c o lla p s e , m o s t s u p e r v is o r s w ould fe e l that
bank c a p it a l sh ou ld be a d e q u a te to c o v e r the s o r t of l o s s e s th at w e r e e x p e rie n c e d
d u rin g the " c r e d i t c ru n c h " o f 1 9 6 9 /7 0 and a r e lik e ly to r e s u l t d u rin g the p r e s e n t
tro u b le d p e r io d . One m ig h t w on d er w h eth er M r. V o jta w ould now w rite w ith a s
m uch c o n fid e n ce in the a b ility o f f i s c a l and m o n e ta ry a u th o r itie s to m a n a g e the
eco n o m y q u ic k ly out o f d iffic u ltie s a s he did so m e m on th s ag o .
S e co n d , it h a s b een n oted th at in itia l c a p ita l r e q u ir e m e n ts s a t i s f y o r g a n iz a tio n a l
and p h y s ic a l c o s t s and a s a s o r t of e n try fe e . We a t the F D IC tak e th is p o sitio n
and it d o e s not s e e m to be a c o n t r o v e r s ia l one.
T h ird , a s B ren to n L e a v it t o b s e r v e d r e c e n tly , c a p it a l r e q u ir e m e n ts m a y s e r v e
a s a r e s t r a i n t on a s s e t e x p a n sio n . Though not tr a d itio n a lly thought o f in th e s e
t e r m s , it i s c e r t a in ly tr u e th at the e ffe c tiv e im p o sitio n of c a p ita l r e q u ir e m e n ts
w ill s e r v e to r e s t r a i n a s s e t e x p a n sio n in the p r e s e n t e co n o m ic c lim a te . And,
a s w e sh a ll s e e , th is m a y b e a h ig h ly d e s i r a b l e r e s u l t .
F o u rth , so m e h av e p o in ted out th a t c a p it a l s e r v e s to p r o te c t d e p o s it o r s in the
even t o f liq u id a tio n . T h is i s not a p r im a r y g o a l of s u p e r v is io n , s in c e d e p o s it
in s u r a n c e i s the to o l o f p u b lic p o lic y d ir e c te d to th is end. H o w ev er, it i s tru e
th at l a r g e r c a p it a l a c c o u n ts m a y f a c ilit a t e the C o r p o r a tio n 's fin din g th at a s s i s t ­
an ce to the m e r g e r o f a fa ilin g bank w ith a h e alth y in stitu tio n w ill " r e d u c e the
r i s k o r a v e r t a th re a te n e d l o s s to the C o rp o ra tio n , " th e re b y m e e tin g the
sta tu to r y t e s t fo r p r o v is io n o f su ch a s s i s t a n c e . In su ch a c a s e the le v e l o f
c a p it a l w ill h av e s e r v e d to p r o te c t u n in su re d d e p o s it o r s and o th er c r e d it o r s
a s w e ll.
F ifth , b e c a u s e o f the e x is t e n c e o f the in s u r a n c e fund, it h a s been thought that
the F D IC h a s a s p e c i a l i n t e r e s t in the le v e l o f c a p it a l in a g iv e n bank and the
s y s t e m a s a w h o le. T h is v iew r e s u l t s fr o m the fa c t th at b a n k s' c a p it a l a c c o u n ts
p r o v id e the cu sh io n a g a in s t bank f a ilu r e and b e c a u s e in the even t o f in so lv e n c y
the c a p it a l a c c o u n ts w o rk fo r the b e n e fit o f the C o rp o ra tio n m u ch a s they do
fo r the u n in su re d d e p o s it o r s o r o th e r c r e d i t o r s . It sh ou ld be p o in ted out in
th is r e g a r d , h o w e v e r, th at n u m e ro u s stu d ie s o f the s u b je c t h ave f a ile d to
e s t a b lis h an y d ir e c t c o r r e la t io n betw een bank f a ilu r e and the s i z e o f the b a n k 's
c a p it a l a c c o u n ts. M o r e o v e r , in m y ju d g m e n t, w h ile the C o r p o r a t io n 's in t e r e s t
a s i n s u r e r can n ot b e a v o id e d , g r e a t c a r e sh ou ld be tak en to m in im iz e the exten t
to w hich th a t i n t e r e s t in tru d e s upon the C o r p o r a t io n 's fu n ctio n a s s u p e r v is o r .
T r a d itio n a lly , th e F D IC h a s tak en the " h a r d lin e " in i t s c a p it a l r e q u ir e m e n t s ,
e a rn in g the a s s e r t i o n th at it s in it ia ls m u s t stan d fo r " F o r e v e r D em an din g
I n c r e a s e d C a p ita l. " T h is h a s p ro b a b ly r e s u lt e d , a s the C o rp o ra tio n M an u al
o f E x a m in a tio n s t a t e s , fr o m " . . . the c l o s e r e la tio n s h ip b etw een th e s e r a t i o s
and the C o r p o r a t io n 's r i s k , " and fr o m the f a c t th at s m a l l e r b an k s h av e




- 4 h is t o r i c a l l y b een thought to be m o r e v u ln e r a b le to u n e x p e c te d l o s s e s than
th e ir l a r g e r N a tio n a l and S ta te m e m b e r bank c o u s in s . H o w e v e r, the F e d e r a l
R e s e r v e B o a r d i s p r e s e n t ly the c e n te r o f a c tio n and fo c u s o f c o n t r o v e r s y with
r e s p e c t to c a p it a l a d e q u a c y . The B o a r d h a s e v id e n c e d both its c o n c e rn with
th e m a t te r and it s in ten tion to r e s i s t fu r th e r e x p a n sio n o f d e p o s it s o r a s s e t s
w ith out p a r a l l e l e x p a n sio n o f eq u ity c a p it a l in r e c e n t s p e e c h s by G o v e rn o rs
Sh eeh an and H o llan d , and B o a r d s t a f f m e m b e r B re n to n L e a v it t ; in d e c is io n s
o f the B o a rd r e g a r d in g h old in g co m p a n y a c q u is it io n s ; and in the q u ie t
e x e r c i s e o f m o r a l s u a s io n .
The s o u r c e o f the F e d ’ s c o n c e rn i s , in m y ju d g m e n t, b a s e d on c ir c u m s ta n c e s
m o r e c o m p le x and t r o u b le s o m e than the h is t o r i c a l d e c lin e in r a t i o s fo r the
ban kin g s y s t e m a s a w h o le. The F e b r u a r y 16 i s s u e o f B u s in e s s W eek noted
th at "(in ) 1972, the n a tio n 's e le v e n l a r g e s t b a n k s had an a v e r a g e c a p it a l ra tio
o f on ly 4. 5 p e r c e n t, and th at m a y h av e d e c lin e d d u rin g 1973 in the w ak e of
r e c o r d - h ig h ban k len d in g . " The d r a m a tic d e c lin e in the c a p it a l p o s it io n s of
o u r l a r g e s t b an k s h a s b een p a r a l l e l e d by th r e e o th e r p h en o m en a: the holding
co m p an y m o v e m e n t, the e x p lo sio n o f m u ltin a tio n a l o p e r a t io n s , and the advent
o f lia b ilit y m a n a g e m e n t. W hile m o s t p ro n o u n ce d in in stitu tio n s w ith a s s e t s of
a b illio n d o lla r s o r m o r e , the im p a c t o f th e s e p h en o m en a is by no m e a n s
lim ite d to the r e la t iv e ly few v e r y l a r g e b a n k s.
W hile b rin g in g sig n ific a n t b e n e fits , e ac h o f th e s e f a c t o r s h a s in tro d u c e d new risksj
and c o m p le x ity into the b u s in e s s o f b an k in g. W hile m an y b a n k e r s s p e a k with
c o n fid e n c e o f new s k i l l s and i n c r e a s e d c o m p e te n c e , I a m n ot a t a l l c e r ta in the
im p lic a tio n s and r i s k fo r ban k in g in h e re n t in e a c h o f th e s e p h en o m en a h ave
b een fu lly e x p lo r e d . C e r ta in ly o u r e x p e r ie n c e th is p a s t y e a r in d e a lin g w ith
tro u b le d b a n k s w ould in d ic a te th at c o n s id e r a b ly m o r e c a r e sh o u ld be tak en in
e a c h o f th e s e a r e a
e s p e c i a lly in lig h t o f the p r e s e n t e c o n o m ic e n v iro n m en t
in w h ich b a n k s m u s t fu n ctio n .
B e fo r e lo o k in g a t th e se th r e e b a s e s o f c o n c e r n , it is w e ll to n ote p are n th e tic ally
th at t o ta lly a p a r t fr o m su ch c o n s id e r a t io n s , a s s e t s in the ban k in g s y s t e m a s a
w h ole h av e b e c o m e m o r e r is k y . S in c e I9 6 0 , h o ld in g s o f c a s h and U. S.
G o v ern m en t s e c u r i t i e s a s a p e r c e n ta g e of a s s e t s h av e d e c lin e d f r o m 43. 8 percent
to 24. 1 p e r c e n t. A t the s a m e tim e , the r a t io o f lo a n s to d e p o s it s h a s in c r e a se d
fr o m 52. 3 p e r c e n t to 72. 6 p e r c e n t. T h e se c h a n g e s h av e ten d ed to be s ig n if ­
ic a n tly m o r e p ro n o u n ced am o n g l a r g e r b a n k s.
W hile the to ta l eq u ity of so m e h oldin g co m p an y s y s t e m s i s s ig n ific a n tly g re a te r
than th at o f its b an k in g s u b s id ia r y , th at i s not a lw a y s the c a s e . In so m e c a s e s
eq u ity c a p it a l m a y a c tu a lly be l e s s w hen co m p u te d on a c o n s o lid a te d b a s i s than
fo r the bank a lo n e . A s a r e s u l t , the am o u n t of eq u ity w hich on ce su p p o rte d
the r i s k s o f a s in g le ban kin g s y s t e m now s u p p o r ts the bank p lu s a v a r ie t y of
b u s in e s s e n t e r p r i s e s . T h is i s a l l the m o r e d is c o n c e r t in g in lig h t o f s t a t is t i c s




- 5 pu blish ed by S alo m o n B r o t h e r s in M a rc h w hich sh ow ed that the c o m p o sit r a tio
of to ta l c a p it a l fu n d s to to ta l a s s e t s , l e s s c a sh and due fr o m b a n k s, of the
tw en ty-five l a r g e s t bank h oldin g c o m p a n ie s d e c lin e d fr o m 8. 8 p e rc e n t in 1972
to 7. 7 p e r c e n t in 1973. F u r t h e r m o r e , a t the s a m e tim e the r a tio of equity
c a p ital to n o n - c a sh a s s e t s d e c lin e d fr o m 7. 2 p e r c e n t in 1972 to 6. 2 p e rc e n t.
M ore tro u b lin g than the r i s k s in h e re n t in su ch le v e r a g in g i s the f a c t that w e
do not know w h at e ffe c t s the fa ilu r e o r tro u b le o f an a f filia t e in the holdin g
com pany s y s t e m w ill h av e on the bank i t s e l f . The d a n g e r i s tw ofold. F i r s t
of a ll, th e r e w ill be g r e a t te m p ta tio n to tap the bank a s an a n sw e r to the
p ro b le m s o r n e e d s o f a f f i l i a t e s . A s I h av e re c o u n te d e ls e w h e r e , the fa ile d
U. S. N atio n al B ank i s an e x tr e m e c a s e in p oin t.
Secondly, even w h e re the bank i s e ffe c tiv e ly in su la te d fr o m d ir e c t fin a n c ia l
drain the h oldin g co m p an y p r o b le m s a r e often r e f le c t e d in ju d g m e n ts abou t
the bank i t s e l f . T h is i s e n c o u r a g e d by the f a c t th at m an y h oldin g com p an y
e x e c u tiv e s w ould a g r e e w ith R o n ald T e r r y , P r e s id e n t o f F i r s t T e n n e s s e e
N ation al C o r p o r a tio n , who sta te d : nI think w e sh ou ld k e e p the b an k ’ s p r e s t ig e
behind the c a p it a l m a r k e t i s s u e s o f a f f i l i a t e s . " T he d a r k s id e o f th is a p p ro a c h
w as g r a p h ic a lly illu s t r a t e d in the B e v e r ly H ills B a n c o rp c a se - -u n d o u b te d ly a
so u rc e o f F e d c o n c e r n in th is a r e a . An a f f ilia t e of the B e v e r ly H ills B a n c o rp ,
the B e v e r ly H ills N a tio n a l B an k, had been s e llin g so m e o f it s p a r e n t c o m p a n y 's
c o m m e r c ia l p a p e r . When the tro u b le d p a r e n t w a s u n ab le to m e e t in t e r e s t
p ay m en ts on the p a p e r , a ru n on the o th e rw ise sound bank w a s t r ig g e r e d . A s
a r e s u lt , the h oldin g co m p an y w a s fo r c e d to liq u id a te the b a n k 's a s s e t s
through s a l e to W ells F a r g o .
Though it i s the in e v ita b le and d e s i r a b l e c o n se q u e n c e of the p a tte r n s o f b u s in e s s
d ev elop m en t, th e g r e a t e x p a n sio n o f in te rn a tio n a l ban k in g o p e r a tio n s is a se co n d
so u rc e o f c o n c e rn . F o r e ig n a s s e t s ra n g e betw een 42. 8 and 3 0 .4 p e r c e n t o f the
total a s s e t s o f our fiv e l a r g e s t b a n k s, and they a r e , in m an y c a s e s , r e s p o n s ib le
for the d r a m a tic d ro p in c a p it a l r a t i o s . F o r e x a m p le , one m on ey c e n te r bank
has a r a tio o f eq u ity p lu s r e s e r v e s to to ta l a s s e t s o f 6. 6 p e r c e n t when co m p u ted
on d o m e stic b a s i s and 2. 9 p e r c e n t w hen in te rn a tio n a l o p e r a tio n s a r e in clu d e d .
In ad d itio n to s p r e a d in g m o r e th inly the s y s t e m 's c a p ita l r e s o u r c e s , su ch
o p e ra tio n s co n tain th e ir own p e r i l, e s p e c ia lly fo r the a g g r e s s i v e u n in itia te .
F ra n k lin N a tio n a l B a n k 's e x p e r ie n c e in the fo r e ig n e x ch an g e m a r k e t i s a c a s e
in p oin t, but th e l o s s e s o f L lo y d 's S w is s b ra n c h in the fo r e ig n c u r r e n c y a r e a
d e m o n stra te that even the m o s t e s t a b lis h e d and p ru d en t o f in stitu tio n s can be
burned. F u r t h e r m o r e , the p r e c a r io u s s t a t e o f the in te rn a tio n a l p a y m e n ts
s y s t e m s , th e d is r u p t iv e e ffe c t s o f the flo o d o f P e t r o d o lla r s and the fin a n c ia l
p ro b le m s o f c o u n tr ie s w hich a r e s u b s ta n tia l d e b to r s to A m e r ic a n b an k s h av e
each s e r v e d to g r e a t ly i n c r e a s e the r i s k o f in te rn a tio n a l o p e r a t io n s .




-

6

-

In r e c e n t y e a r s , b a n k s h av e a p p lie d the co n c e p t o f lia b ilit y m a n a g e m e n t. When
c a r e fu lly and sk illfu lly e x e c u te d , th e s e te c h n iq u e s a r e both p r o fit a b le and
e ffic ie n t. T h e re a r e , h o w ev e r, s e r io u s p it f a lls w hen e x p e n siv e and so m e tim e s
v o la tile m on ey i s in v o lv e d . T he d a n g e r s a r e , o f c o u r s e , e x a c e r b a t e d when
b r o k e r e d d e p o s it s o r o th e rw ise p u r c h a s e d fu nds a r e u s e d in lie u o f a sta b le
d e p o s it b a s e to fin a n c e r a p id e x p a n sio n . We h av e found th at q u ite o ften su ch
p r a c t i c e s go hand in hand w ith the m a k in g o f h ig h -y ie ld h ig h - r is k lo a n s . The
v iew o f so m e b a n k e r s w a s d e s c r ib e d by L e h m an B r o t h e r s e c o n o m ist, L eon ard
San tow :
" T h e p r a g m a t ic v iew o f b an k s i s th at you c a n ’ t lo o k a t the old r a t i o s .
T h ey d o n 't a p p ly a n y m o re w hen p e o p le can buy a ll the liq u id ity they
w an t in the m a r k e t p la c e if th ey a r e w illin g to p a y the p r ic e . You
j u s t d o n ’ t n eed c a p it a l a n y m o re . "
B a n k s tak in g th is too m u ch to h e a r t and a b u sin g the te c h n iq u e s o f lia b ilit y
m a n a g e m e n t a r e v u ln e r a b le in a n u m b er o f o th e r r e s p e c t s . "H o t" fu nds a r e
e a s i l y lo s t in an eco n o m y in w hich th e r e a r e m an y in stitu tio n s co m p e tin g fo r
fu n d s, and a s e tb a c k w hich w ould not o th e r w ise be d i s a s t r o u s m a y le a d to a
l o s s o f c o n fid e n ce and the outflow o f su ch fu n d s.
In deed, th e s e p r a c t i c e s h av e g iv e n r i s e to the p o s s ib ilit y o f a m o d e rn kind
o f " r u n " on b a n k s. The F r a n k lin e x p e r ie n c e s u g g e s t s th at d e p o s it in su r a n c e
m a in ta in s the c o n fid e n c e o f m o s t s m a l l e r d e p o s it o r s in the f a c e o f even the
w o r s t s o r t o f a d v e r s e p u b lic ity . On the o th e r hand, the w illin g n e s s o f the
le n d e r o f l a s t r e s o r t and the s t a b iliz in g e f f o r ts of the o th e r a g e n c ie s do not
s e e m to h av e stim u la te d the c o n fid e n ce o f l a r g e in d iv id u a l and in stitu tio n a l
d e p o s it o r s su ffic ie n tly to c a u s e the r e tu r n o f su ch fu n d s. T h u s,
the g r e a t e s t d a n g e r to a fin a n c ia l in stitu tio n to d ay s e e m s not to be a l o s s of
co n fid e n ce by the p u b lic a t l a r g e , but r a th e r the m i s t r u s t o f o th e r fin a n c ia l
in stitu tio n s, c o r p o r a t e e n titie s and the v e r y la r g e in d iv id u al d e p o s ito r .
To th e s e th re e f a c t o r s m u s t be ad d ed p r e s e n t e co n o m ic c o n d itio n s. W hile
in t e r e s t r a t e s m a y d e c lin e , it i s c l e a r th at o u r eco n o m y an d, h e n ce , the
ban k in g s y s t e m can lo ok fo r w a r d to an u n c e rta in and p o te n tia lly r o c k y y e a r .
A lr e a d y , fin a n c ia l in stitu tio n s a r e fe e lin g the e f f e c t s o f the " c r e d i t c ru n c h "
on the r e a l e s t a t e m a r k e t s . T he in so lv e n c y of A m e r ic a n B an k and T r u s t in
South C a r o lin a w a s , in no s m a l l p a r t , the r e s u l t o f an undue c o n c e n tra tio n of
lo a n s to r e a l e s t a t e d e v e lo p e r s w hich b e c a m e illiq u id . W h ere r e q u is it e
p ru d e n c e i s not e x e r c is e d , d iff ic u ltie s w ill o c c u r .
W hile I h av e not stu d ie d in d e ta il the r u lin g s o f the B o a r d o f G o v e rn o rs and am,
of c o u r s e , not p r iv y to l e s s p u b lic a r m tw istin g , it s e e m s to m e th at the
F e d ’ s p o lic y o f tak in g a s t r i c t a p p ro a c h to c a p it a l i s a p p r o p r ia t e a t th is
tim e . T h is flo w s both fr o m the s t a t e o f the eco n o m y and fr o m the fa c t th at




- 7 each o f the th r e e a r e a s d i s c u s s e d - - t h e h oldin g co m p an y m o v e m e n t, in te rn a tio n a l
■ operation s, and lia b ilit y m a n a g e m e n t- - e n ta il r i s k s th at m ay not h av e been fu lly
a p p r e c ia te d in b a lm ie r d a y s.
I h ave d e lib e r a t e ly not d ev o ted a g r e a t d e a l of tim e d e ta ilin g the F D IC a p p ro a c h
to c a p it a l a d e q u a c y . B oth C h a irm a n F r a n k W ille and E d R odd y, D ir e c to r of
our D iv isio n o f B an k S u p e r v is io n , h ave r e c e n tly d is c u s s e d the su b je c t in g r e a t
d e ta il and th e ir r e m a r k s h av e been r e p o r te d e x te n siv e ly . But I w ill s u m m a r iz e
our p o lic y b r ie fly .
F i r s t o f a ll, it i s ou r s ta te d p o lic y th at the v a r io u s r a t i o s a r e to be u s e d a s
b e n c h m a rk s and not the fin a l d e te rm in a n ts of c a p ita l ad e q u acy . Our M an u al
of E x a m in a tio n P o li c i e s s t a t e s : " . . . c a p ita l r a t io s (or r i s k a s s e t r a t io s ) a r e
m e r e ly s im p le , o b je c tiv e m e a s u r e s o f the sh rin k a g e in a s s e t v a lu e s a b a n k ’ s
c a p ita l s t r u c t u r e can a b s o r b at a g iv en p oin t in tim e , and, a s su ch , a r e but a
f i r s t a p p r o x im a tio n o f a b a n k ’ s a b ility to w ith stan d a d v e r s it y . " And, fu rth e r :
" R a tio s m a y a ls o h av e lim ite d u s e a s ro u g h b e n c h m a rk s, r e p r e s e n t a t iv e o f
in d u stry p r a c t i c e and c u sto m , and in th at lim ite d s e n s e , m a y be u s e fu l a s a
sta r tin g p o in t in e v a lu a tin g an in d iv id u a l b a n k ’ s c a p ita l p o sitio n . " The M an u al
m a k e s c le a r th at a b a n k ’ s c a p it a l s t r u c t u r e m u s t be e v a lu a te d in lig h t o f s i x
f a c t o r s : m a n a g e m e n t, a s s e t s , e a r n in g s , d e p o s it tr e n d s , fid u c ia r y b u s in e s s
and lo c a l c h a r a c t e r i s t i c s .
In th is r e g a r d , I a m a w a r e o f C a r t e r G o le m b e 's o b s e r v a tio n th at " (b ) a n k e r s ; . .
w ould ru b th e ir e y e s in a m a z e m e n t if w e w e r e to w r ite th at th is to p - le v e l
attitu d e to w a rd r a t i o s by the a g e n c ie s i s r e f le c t e d in a c tu a l p r a c t ic e . F o r
the fa c t i s th at in the fie ld (and fo r that m a tte r o fte n - tim e s in W ashington)
r a t io s a r e a p p lie d w ith a sin g le -m in d e d d e d ic a tio n w hich b r o o k s no q u a lific a tio n . "
T h o se o f you who a r e a s s o c i a t e d w ith S ta te n o n m e m b e r b an k s a r e b e tte r ab le
than I to e v a lu a te the a c c u r a c y o f th is sta te m e n t. H o w ev er, m a n a g e m e n t and
the o th er f a c t o r s h av e been g iv en c a r e f u l c o n s id e r a tio n in the d e lib e r a tio n s in
w hich I h av e p a r t ic ip a t e d . In th is r e g a r d , I h a ste n to e m p h a s iz e that w h e re a
b an k er fin d s th at he i s b e in g t r e a t e d a r b i t r a r i l y o r that r e le v a n t in fo rm a tio n
h as b een ig n o re d in the fie ld , he sh ou ld p u r s u e h is r e m e d ie s th rou gh both the
R e g io n a l and W ash in gton o f f ic e s .
I sh ou ld ad d , h o w e v e r, th at w h ile a low c a p ita l r a tio i s by no m e a n s the
n e c e s s a r y m a r k o f an un soun d b an k , d r a m a tic d e c lin e s in one o r m o r e r a t io s
m ay v e r y w e ll be r e f le c t iv e o f p o te n tia l p r o b le m s an d, a t the v e r y m in im u m ,
in d ica te the n eed fo r fu rth e r sc r u tin y .
Secon d, the C o r p o r a t io n 's p o lic y w ith r e s p e c t to c a p it a l is m o d ifie d in the
c a s e o f a p p lic a tio n s o f new b an k s fo r d e p o s it in s u r a n c e . T h e re the a v e r a g e
c a p i t a l - a s s e t r a t io i s g iv en s p e c ia l w eigh t on the p r e m is e th at a new e n tra n t
sh ould at l e a s t m e e t the c a p it a l sta n d a r d o f the in d u stry in o r d e r to o b tain a
lic e n s e to c o m p e te . G e n e r a lly , new b a n k s a r e e x p e c te d to p ro v id e in itia l



-

8

-

c a p it a liz a t io n su ffic ie n t to p r o s p e c t iv e ly p ro v id e a c a p it a l cu sh io n a t the end
o f the f i r s t th r e e y e a r s o f o p e r a tio n s a t l e a s t ’ e q u a l to 10 p e r c e n t of the
p r o je c t e d to ta l a s s e t s a t the end o f th at p e r io d . T h is i s ro u g h ly c o m p a ra b le
to e x istin g c a p it a l r a t i o s o f s m a l l b a n k s w ith an ad d ed m a r g in of one o r two
p e r c e n t to c o m p e n sa te fo r the in c r e a s e d r i s k s a c c o m p a n y in g the fo rm a tio n
and d e v e lo p m e n t o f a new ban k and the d iffic u lty in e s tim a tin g the d e p o s it
p o te n tia l o f n ew .b an k s.
In a d d itio n to th e s e g u id e lin e s , the C o rp o ra tio n h a s a f i r m p o lic y th at no
a p p lic a tio n fo r d e p o s it in s u r a n c e w ill b e a p p ro v e d when p ro p o n e n ts a r e unable
to r a i s e a t l e a s t $ 2 5 0 , 000 c a p it a l. It i s f e lt th at any new ban k sh ou ld h ave
the c a p a b ility o f g e n e r a tin g a d e p o s it to ta l o f a t l e a s t two and a h a lf m illio n
w ith in th r e e y e a r s in o r d e r to c o m p e te s u c c e s s f u l l y . Only in s p e c i a l c a s e s
su c h a s an is o la t e d co m m u n ity w ith ou t ban k in g s e r v i c e s w ill a p p lic a tio n s
w ith s m a lle r c a p it a liz a t io n be a p p ro v e d .
A nd, fin a lly , the C o rp o ra tio n d o e s not frow n upon the u s e o f su b o rd in a te d debt
a s p a r t o f the p e rm a n e n t s t r u c t u r e o f bank c a p it a l a c c o u n ts. A s C h a irm a n
W ille p o in ted out in a ta lk e a r l i e r th is y e a r :
M o st s u p e r v i s o r s to d ay w ould in te r p o s e no o b je c tio n to d eb t c a p it a l
th at h a s the fo llo w in g c h a r a c t e r i s t i c s :
1.

A p r in c ip a l am oun t w hich i s in r e a s o n a b le p ro p o r tio n to the to ta l
s t r u c t u r e (our g u id e i s ab o u t o n e - th ir d o f to ta l c a p it a l and r e s e r v e s ) ;

2.

An i n t e r e s t r a t e w hich i s c o m m e n s u r a te w ith p r e v a ilin g co n d itio n s;

3.

Sin k in g fund p r o v is io n s (w h ere they e x is t) th at a r e a d e q u a te and a
r e t ir e m e n t sc h e d u le th at is p r a c t i c a l and r e a l i s t i c ;

4.

A p r in c ip a l am o u n t th at p r o v id e s fo r the b a n k 's r e a s o n a b le
f o r e s e e a b le n e e d s ; and

5.

The c ir c u m s t a n c e s o f i s s u e su p p o r t a g e n e r a l c o n c lu sio n th at the
b a n k 's b e s t in t e r e s t w ould be s e r v e d th e r e b y ."

A n u m b er o f a n a ly s t s , a s w e ll a s in d u stry p ro p o n e n ts, h av e s u g g e s t e d that
the p u b lic i n t e r e s t w ould be b e s t s e r v e d if the a g e n c ie s ab an don ed the e ffo rt
to in s u r e a d e q u a te c a p it a l, th u s allo w in g the m a r k e t to d e te rm in e the
a p p r o p r ia t e le v e l of c a p it a l. In th e ir 1966 stu d y , " P o l i c i e s fo r O ptim um
B an k C a p ita l, " R o b in so n and P e ttw ay co n clu d ed :




- 9 nIn e a r l i e r p e r io d s , w hen f a c t s ab ou t ban kin g w e r e c o n c e a le d and
p u b lic so p h is tic a tio n in fin a n c ia l a n a ly s is w a s s lig h t, r e g u la t o r y
s y s t e m s w e r e n eed ed a s a su b stitu te fo r b e tte r p u b lic in fo rm a tio n .
Now, w ith g r e a t e r d i s c l o s u r e o f banking f a c t s and m o r e co m p e te n ce
on the p a r t o f fin a n c ia l m a n a g e r s and in stitu tio n a l i n v e s t o r s , the
a b ility o f th e se g r o u p s to ju d g e fo r th e m s e lv e s h a s im p ro v e d . Is
the n eed fo r ban k in g r e g u la tio n dw in dlin g? "
And in h e r m o r e r e c e n t stu d y , "Im p a c t o f F e d e r a l Bank S u p e r v is o r s on B an k
C a p ita l, " L u c ille M ayn e s u g g e s t e d th at the a g e n c ie s m ig h t "ab an d o n c o m p le te ly
the u s e of c a p it a l a d e q u a c y s ta n d a r d s in the e x a m in a tio n p r o c e s s and c o n c e n tra te
in ste a d on the c o m p e te n c y o f bank m a n a g e m e n t. "
W hile th is s u g g e s tio n i s c e r ta in ly a p p e a lin g to th o se o f u s who b e lie v e in the
e ffic a c y o f a c o m p e titiv e f r e e e n t e r p r is e s y s t e m and who d e p lo re the n e c e s s a r y
v a g u e n e ss o f our a p p r o a c h to the p r o b le m of c a p ita l, th e re a r e a n u m b er o f
c o n s id e r a tio n s th at the p ro p o n e n ts o f the m a r k e t a p p ro a c h h av e not m e t.
F i r s t o f a ll, n otw ith stan d in g R o b in so n and P e ttw a y 's a s s e r t i o n s abou t
in c r e a s e d k n o w led ge and s o p h istic a tio n r e g a r d in g b an k in g, th is su g g e s tio n
w ould r e q u ir e a d d itio n a l and e x te n s iv e d i s c l o s u r e p r o c e d u r e s fo r even th o se
in stitu tio n s a lr e a d y s u b je c t to s e c u r i t i e s re g u la tio n . M o r e o v e r , s m a lle r
banks not now s u b je c t to S E C r e q u ir e m e n ts w ould fo r the f i r s t tim e be s u b je c t
to a new body o f r e g u la tio n w hich i s c o s tly and b u rd e n so m e . F o r e x a m p le ,
in o r d e r to p r o p e r ly a s s e s s the a d e q u a c y o f a b a n k 's c a p ita l a d e p o sito r sh ou ld
have a g r e a t d e a l o f k n o w led ge r e g a r d in g the b a n k 's a s s e t p o rtfo lio .

Seco n d , a s p ro p o n e n ts o f th is a p p ro a c h s e e m w illin g to a c c e p t, r e lia n c e on
the m a r k e t e n ta ils a sig n ific a n tly in c r e a s e d n u m b er o f bank f a i l u r e s . V ojta
sta te d , " T h e m a r k e t w ill v o te su b s ta n d a r d b an k s out o f e x is te n c e r e ly in g on
the F D IC to a s s u r e p ro te c tio n o f the g e n e r a l p u b lic . In the a b s t r a c t one can
im a g in e and even find d e s i r a b le su ch a s y s t e m . R e s p o n s ib le m en h ave
a r g u e d th a t w e n eed m o r e and not fe w e r bank f a i l u r e s . And it is tru e that
to a c e r t a in ex ten t o u r p r e s e n t ban k in g s t r u c t u r e p r o te c t s the in e ffic ie n t
and in c o m p e te n t, and c o n v e r s e ly "th e b e s t and the b r ig h t e s t " o f the banking
s y s t e m a r e r e s t r a i n e d fr o m co m p e tin g a s v ig o r o u s ly a s they m ig h t. B ut it
m u st be r e c o g n iz e d th at s e r io u s im p le m e n ta tio n of su ch a s y s t e m w ould e n ta il
a r a d i c a l r e o r d e r in g o f the e x istin g ban k in g s t r u c t u r e .
C e r ta in ly , the m a r k e t w ould h av e to be d is a b u s e d o f the id e a e x p r e s s e d by
G o lem b e and m an y o th e r s th at the a g e n c ie s w ill not t o le r a t e the f a ilu r e and
p ayout of a l a r g e m o n ey c e n te r in stitu tio n . M o r e o v e r , p r o c e d u r e s w ould h av e
to b e d e v is e d to h an d le m an y bank f a i l u r e s in a giv en y e a r . And, m u ch m o r e
sig n ific a n tly , su ch a p o lic y w ould g r e a t ly a c c e l e r a t e the c o n c e n tra tio n o f




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b an k in g r e s o u r c e s . W hile su ch a ch an ge m ig h t in the lo n g ru n p ro v e
b e n e fic ia l to both the in d u str y and the c o n s u m e r , both the e c o n o m ic and
p o lit ic a l c o n se q u e n c e s o f su ch r e o r d e r in g sh ou ld b e a n a ly s e d in f a r g r e a t e r
d e t a il than h a s b een done to d a te .
In c o n c lu sio n , I sim p ly n ote th at w e a t the F D IC a r e w e ll a w a r e th at the
c o n flic t b etw een e x a m in e r s and b a n k e r s w ith r e s p e c t to c a p it a l a d e q u a c y
i s not m e r e ly a q u e stio n o f d e p o s it o r s a fe ty on the one hand an d the
m a x im iz a tio n o f r e tu r n on equ ity on the o th e r. T h e re i s a l s o a s u b s ta n tia l
p u b lic in t e r e s t in allo w in g b an k s s u ffic ie n t l e v e r a g e in o r d e r to c o m p e te
e ffe c tiv e ly w ith o th er fin a n c ia l in stitu tio n s and am o n g t h e m s e lv e s . H ow ever,
p ru d e n c e d e m a n d s th at le v e r a g in g not go u n r e s tr a in e d , e s p e c ia lly in the
p r e s e n t e c o n o m ic c lim a te . In the co n te x t o f the p r e s e n t ban k in g s y s t e m ,
a s d efin ed by p u b lic p o lic y , it f a l l s to the lo t o f the ban k in g a g e n c ie s to
p ro v id e th at r e s t r a i n t . T h at w e do so d o e s not m e an th at w e a r e u n m indful
o f the c o m p le x and c o n flic tin g i n t e r e s t s th at m u s t b e s e r v e d .




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