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Tuesday, February 10, 1976
8:00 P.M., E.S.T.


Remarks of
Vice Chairman
Board of Governors
of the
Federal Reserve System

at a joint meeting of
The New England Chapter, Robert Morris Associates
The Massachusetts Society of Certified Public Accountants

Newton, Massachusetts
February 10, 1976

The recent and continuing debate in professional, govern­
ment and public circles on appropriate disclosure by banks and bank
holding companies has yielded little net public benefit to date.
Coming at a point in the nation's economic recovery where it is now
important to encourage a revival in investment, it has aroused naive
concern and may induce conservative lending practices on the part of
bank managements which could hold back the availability of business
and real estate credit.

The impact of the new disclosure proposals

also may be to impose significantly different methods of financing
for State and local governments and possibly some types of business
enterprises as well.
The other side of the coin is that an outcome of the debate
may be a more timely and more pertinent disclosure system.

A meaning­

ful improvement in financial reporting by banks and bank holding
companies would, in turn, enable participants in markets for bank
debt and equities more accurately to differentiate among institutions
as to soundness, earning prospects and management capability.


from my point of view, the market reaction to bank performance and
condition is a far more effective cathartic for management than jaw­
boning by bank regulators.
So far as I have been able to observe, the parties involved
in this controversy are not at odds as to the usefulness of disclosure
and the constructive role markets might play in channeling resources

-2to better managed and more profitable institutions.

Markets have made

glaring errors in past evaluation of bank securities, not so much,
I believe through the lack of relevant and refined accounting data
as through misreading economic trends, failing to perceive the signifi­
cance of management changes or the reasons for diversity in earnings
trends— in short, for giving insufficient attention to the data that
were available.

Nonetheless, the case for more timely and meaningful

data is a strong one.
In this context of comments I should add reference to the
fact that it is only with in the past decade or less that many of our
banks have provided anything more than the most rudimentary facts
about their assets, liabilities, earnings and operations.


little may have escaped bank examiners' attention and reports by many
banks to their stockholders are exemplary as to disclosure, the quar­
terly balance sheets mandated by law and intended to inform the public
of the condition of individual banks have remained outmoded as to dis­
closure needs and of limited usefulness to either investors or depos­

Although disclosure inadequacies are mainly those of omission,

there are some of commission too.
For example, as with nonfinancial institutions, window
dressing around statement dates is an "accepted" practice even for

Often, the practice is not so much to put a better light on

financial relationships that the public might interpret as adverse
as it is to tout a ranking in a particular banking market.

How much

-3being number one or number two in some local, regional, national, or
international market means to investors I could not say--the cost of
arranging that status is sometimes high.

Perhaps the practice should

be considered under the heading of advertising license; in any event,
its contribution to meaningful disclosure is negative.
A proper disclosure policy should afford market participants
financial data in a convenient form for evaluating and comparing the
debt or equity securities of various issuers from the standpoint of
safety, yield, and marketability and for bringing to light points of
unusual significance for a participating bank.

Similar benefits would

be realized by depositors or other creditors whose claims are uninsured
because of size or character.

These claimants include banks, govern­

ments, nonfinancial corporations, trust funds and institutional investors.
Many of these interests have views on disclosure peculiar to their
actual or prospective ownership or creditor status.

My own approach

as a bank regulator, not unnaturally, is colored by a background and
experience of looking for information bearing on the viability of a
banking institution.

However, variation in points of view need not,

in my opinion, result in a significant expansion in over-all disclosure

There could hardly be significant differences in vari­

ous users' attitudes toward the need for an evaluation of management
quality and performance, earning performance and potential, asset
quality relative to yield, intermediation and foreign exchange
exposure, or leveraging.

Even if every fact reasonably pertinent to

these factors were available there would still be no necessary unanimity
in judgment.

Nor is that a goal sought by disclosure requirements.

-4Based on my experience there is much more to be gained from
increasing the frequency of disclosure and making greater use of the
income and expense statement, including off-statement supplements,
than there is from restructuring the balance sheet in one way or

And I have in mind proposals to use actual market values

or constructed values based on the current level of interest rates.
The erratic behavior of interest rates over the life of a
medium- or even short-term security and the consequent fluctuations
in capital values that would be incorporated into a revaluation is
far more likely to mislead than inform investors as to the bank's

In banking, the disadvantage or advantage of an interest

rate change will often have been preallocated to depositors or bor­
rowers through the loan or deposit contract.

In any event, such

changes should, because of the nature of banking, impinge primarily
on the bank's customers and not on the bank.
While a choice need not be made among high priority dis­
closure needs, compliance costs and privacy considerations become
factors as additional facts become redundant or only marginally
The case for greater frequency in reporting— and in the
present context this means quarterly instead of annually— rests mainly
on the fact that a bank's eamings-asset-liability.condition can
change significantly in a short period of time as a result of internal
decisions or external forces.

Whenever financial changes occur

-5swiftly or unexpectedly, as they sometimes do, yearly reports make
stale reading and staler analyses.

Prompt recognition of change—

or no change— in a bank’ condition serves two purposes.

It informs

the public and in light of that disclosure bank managements inclined
to be dilatory are motivated to timely consideration and action.


incidental benefit is that frequent reports can also serve multiple
statement needs such as those that arise in connection with proposals
requiring approval of some government agency.
To get down to the core of the controversy over disclosure
one must grapple with the issue of what facts are relevant.


a word of art in some quarters, can be made to encompass so broad a flow
of minutia, conjecture, projection and prejudice as to make a travesty
of the concept of financial analysis.

On the other hand, materiality

can be interpreted so restrictively as to actually conceal strengths
or weaknesses that lie just beneath the superficial appearance a given
institution may present to the public.
Reaching a reasoned middle ground on the substance of dis­
closure is made difficult because of long-established bank reporting
practices which are clearly inadequate by present-day standards.


inheritance has given rise to the judgment that investors, in particu­
lar, have suffered from inadequate disclosure requirements and a fail­
ure on the part of bank regulatory authorities to gitfe sufficient
consideration to investor interests as well as those of bank creditors
other than depositors.

-6The current attempt to reach for confidential data and views
of bank regulators who are presumed to qualify as investment advisors,
or at least be a reliable source of information appropriate to that use,
could, in my opinion, be counter-productive for a number of reasons.
The main one is the conditioning and potentially debilitating impact
of such a role on the examiner and the examination process.

In addi­

tion, the scope of information available to examiners is not needed by
investors and could be damaging to the traditional practices under
which individuals, businesses and governments have long conducted
their financial transactions.

Banks endeavor to safeguard and respect

the privacy of their customers within the limits of the law while
recognizing as they must that, for the public protection, there are,
in the United States, no customer relationships beyond the scrutiny of
regulatory authority.
The disclosure advocated in some quarters would include
categories of depositors, borrowers or others with whom the bank does
business based on race, color, creed, country of origin or residence,
nature of business or occupation and perhaps sex.

The specific nouns

often used for these categories can be recognized for their invidious

Buzz words in banking today, such as "problem bank,

"New York," "OPEC," "REIT," are associated with liquidity exposure, manage­
ment deficiencies, or potential loss.

Because of the crudeness of their

applicability they can do damage to banks and their customers and have
serious consequences for the financial structure of our economy.


-7particular words may have short lives but they will, no doubt, be
followed by others equally damaging.

There is little point in trying

to suppress an idiomatic shorthand for bad, bad, bad, but there are no
grounds and, in my opinion, great potential dangers associated with
incorporating prejudice into analyses of quality of assets or manage­
ment performance.

After all there are good loans in the most distressed

sectors of our economy and bad loans in those that are booming.
To remove prejudice from judgments about the quality of
assets, liabilities, and earnings, objective categories must be used
to measure loan or management performance.

This can be done only if

there is reasonable assurance that books of account reflect what has
happened, that self-dealing does not exist, and that financial entities
have accounting safeguards in place to maintain the integrity of the
financial record.

We should assume too that bankers are not fools

throwing away their depositors' money nor are they possessed of the
prescience to anticipate the events in the economy that may, for a
time, change the quality of their assets or their earnings.

Try to

recall what your investment antenna told you a year ago, or even two
months ago, and check it against today's market.

If you're honest,

you'll be humble; if by some chance you've been right on the button,
take a bow while you can.
A nonbanker looking at the hazards banking appears to face
may well wonder how it can be that bankers and banks have survived
in a world buffeted by war, inflation, depression, floating exchange

-8rates, gyrations in interest rates, regulatory constraints and competi­
tion from a broad range of institutions and financial alternatives.
The explanation is that a bank is suspended in or supported by its
environment. That environment consists of the bank's customers—
depositors and other suppliers of funds on the one hand and loan
customers or issuers of securities on the other.

These suppliers and

users of funds absorb the bulk of gain or loss from economic uncertainty
and they ordinarily bear the initial shocks.

The bank itself is like

a cork floating serenely on the sea riding vith the tides, the swells,
the calms and storms*

Of course, the cork will sink if its power of

levitation is stretched by dead weight.
Without trying to press the analogy too far, think of a
bank as an institution that survives because it avoids dead weight
and maintains a safe spread between what it pays for money and what
it gets for it.

Indeed, the very essence of good banking is the

maintenance of a viable spread between the cost of funds and the return
on them.

No other fact for disclosure is of greater importance.
Before concluding my remarks on the complex and, in some

quarters, emotional issue of what is appropriate in disclosure for
banks and bank holding companies, I would like to set forth a few
specific do's and don't's to illustrate the way I perceive the material­
ity issue.



Require frequent reporting - quarterly statements of
condition, income and expense are needed for all deposi­
tory organizations and particularly the larger institu­


Insure the integrity of accounts - by giving more attention
to internal control systems and to policing their operations.


Establish more definitive accounting standards to govern
the timing of income or expense accrual.

Front-end loading

or any other skewed distribution of these flows or
accounting procedures which convert their impact into
asset or liability items should be revealed or avoided.

Require some method of indexing excessive exposure due to
area or industry concentration.

Banking law in the United

States has the effect of encouraging concentration of bank­
ing institutions' investments geographically.

Often as a

derivative consequence, a like concentration in deposits
and loans occurs in a particular industry such as agricul­

Most banks are sensitive to this type of risk ex­

posure but as they are also obliged to meet their local
communities' service needs, concentration of risk may be

Until the banking structure is modified to

provide for greater diversification in loans and deposits,
this risk of concentration should be made clear.


The maturity profile of bank assets should be matched
against the maturity profile of bank liabilities and should
be reported in a manner and frequency which reveals the
gross exposure to disintermediation.

The net exposure

requires taking into account offsetting liquidity resources
as interbank balances, marketable securities, and access to
market, bank and Federal Reserve credit.

The flexibility inherent in loan terms and interest rates
should be summarized in a manner which shows the exposure
of the institution to interest rate changes.

However, such

a requirement should not be interpreted to in any way
inhibit banks from incorporating such flexibility into their
loan contracts or if they have not done so, to modifying
loan terms in a manner mutually agreeable to the bank and
the borrower.

The modification of terms may affect the flow

of income directly but unless the loan is charged off in
whole or in part, the modification of terms should not
affect the book value of the loan or security involved.
The don't list is shorter because the do list by implicatior
covers several don't's.

Of course, neither list is complete.


Don't require banks to forecast or project their earnings or
losses nor such environmental factors as trends in interest
rates nor economic activity in the areas they serve.



-11they choose to do so let it be done at their own responsi­

Any projections would have a tendency to be self-

serving, stimulate puffery and institutional vanity, of
which there is already too much, and, if required by govern­
mental authority, would gain a level of creditability which
can be misleading.

Don't require the report of classified loans other than
for the write-offs that have been taken in whole or in part.
It has yet to be demonstrated that "specially mentioned" or
"substandard" loan classifications provide significant
clues to future loan losses.

These categories have been

used by examiners to direct attention to technical short­
comings that should be remedied but have a lesser bearing
on loan quality.

They often are more of a reflection on

management than on borrowers.
While banks follow different policies with respect to
the charge-off of loans, some move early to keep their loan
portfolio in a prime condition and others await confirming

In either event the examiners' findings are

required to be taken into account by management.
On the "do" side, the use of a half-dozen or so loan
categories for regular reporting of gross losses and recoveries
would likely become over time a source of useful analytical


Don't require banks to reveal the aggregate of non-perform­
ing loans— loans on which interest payments are delinquent.
While it is appropriate to show the effect on income of a
shortfall in expected receipts, reporting the aggregate of
the total principal amount involved has the effect of
exaggerating the severity of the situation, discourages
negotiated workouts involving deferral of payments and may
cause banks to enforce unduly harsh effects on their


Don't bog down the whole process of disclosure in a myriad
of details the effect of which will be to confuse and hide
what is really going on.
Let me conclude by reminding you that disclosure require­

ments deserve serious consideration on all sides.

The issue of what

to disclose is not a simple one because a manageable number of facts
or relationships pertaining to a bank or bank holding company must
be selected from the thousands of bits of information generated by
the detailed record-keeping systems used by such organizations.
That selection process must serve the needs of shareholders, deposi­
tors and other creditors.

It must also be recognized that disclosure

can affect the vital role of banking in our economy in financing
consumers, business and government.


-13These objectives need not be in conflict but that result
may easily come about if disclosure standards cause banks to alter
their community role and be turned into, as at times in the past,
risk-averting investors that put their funds predominantly into
Treasury securities and other Federally guaranteed paper.