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FOR RELEASE UPON DELIVERY "BANK CAPITAL AND THE SUPERVISORY AUTHORITIES" Address Of Federal H. EARL COOK Former Chairman Deposit Insurance Corporation Before The NATIONAL ASSOCIATION OF SUPERVISORS OF STATE BANKS Hotel Commodore New York City Wednesday September 18, 1957 " m m CAPITAL AND THE SUPERVISORY AUTHORITIES" When I was asked to participate in this program my expected remarks commanded the respect and the prestige that go with the office of chairman of the Federal Deposit Insurance Corporation. Since my acceptance of your gracious invitation, however, I have regained my old title of "private citizen", and any authority that my words might have today must rest upon the prestige of experience rather than that of office. To hold your attention in these changed circumstances is a real challenge, and I am grateful for this opportunity to talk with you once again about hanking ~ a subject of interest to all of us. In my 50 years in the banking profession -- and I think we are entitled to call it a profession — I have never known a group more deeply devoted to the well-being, the progress, and the public responsibility of banking than your Association. Thirteen years ago I attended my first conference as Superintendent of Banks in Ohio, and I have been coming ever since. During the past ten years, while I was on the Board of Directors of the Federal Deposit Insurance Corporation, you have extended to me every courtesy and have been an unfailing ally in the promotion of a sound banking system. As one comes to make his valedictory talk he feels especially called upon to address his remarks to important and enduring problems. Every problem, of course, has its own particular complications and significance, and I would not belittle the many problems which now confront both the banking business and the supervisory agencies. There is one problem, however, which holds a kind of record for persistence and insolubility. It has been with us from the very beginning and is still today a matter of vital import. I refer to the question of bank capital. Something of the timeless character of the bank capital problem is apparent in the emphasis I placed upon it in my remarks to this association at our meeting in Washington ten years ago. Then, as now, there was concern over the adequacy of the bank capital margin. The major post-war trends were becoming evident; loans and other risk assets were growing at a rate greatly exceeding the shrinkage in the volume of cash and Federal obligations. As these trends continued, banks added steadily to their capital, even managing to improve slightly the relationship between total capital accounts and total assets, but slipping steadily behind in the relationship of capital to "risk" assets. BANK CAPITAL AND THE SUPERVISORY AUTHORITIES” ~ 2 In some quarters there is a disposition to view the present capital margin as an inevitable and tolerable result of historic trends, and to accept it as a new norm of adequacy. In that attitude there lies a great threat to our present banking system, failing as it does to recognize the vital link between bank capital and the functioning of our economic system. Banks have a primary responsibility in allocating credit among different economic demands. They have performed this responsibility in an efficient way. This is indicated by the development of our economy to its unparalleled position of strength. The key to their efficiency in doing this rests upon the decentralization of decision-making, a decentralization that goes hand in hand with our dual banking system and our thousands of independent banks. What has the adequacy of bank capital to do with this mechanism? Simply this: Serious questions are bound to be raised if and when the owners of a bank permit their equity in the enterprise to shrink so drastically that they have little at stake in sound banking. They may well be accused of exercising authority and reaping rewards all out of proportion to the risk they assume. Our present system of decentralized decisions, with its inherent wisdom and efficiency, may be threatened. To assure the vitality of the present system, banks need to maintain a reasonable relationship be tween capital and assets, and bankers need to awaken from the complacency of believing that "whatever is, is right". Most discussion of capital adequacy is based upon less philosophical considerations than I have just indicated. Instead, concern is focused more upon the capital accounts as a margin or reservoir for absorbing losses. Looked at in this light, how do banks measure up today? Capital accounts of all banks total almost $20 billion. We should not be misled or unduly encouraged by that large figure, however, despite its very considerable size. For one thing, it is only a small fraction of total bank assets or deposits. For another, it is an aggregate very unevenly distributed among banks. Furthermore, any substantial inroads upon these capital funds, even falling far short of exhausting them, would do irrepar able harm to our banking system. Though bank losses have been extremely low for several years, the present situation is not entirely reassuring. Many latent losses have no doubt been avoided through the price rises and general prosperity character istic of the last few years. Lately, the fluctuating market values for fixed-income-bearing securities have introduced a new complication. This latter circumstance is, of course, no cause for concern to bankers whose asset structure features high quality credits scheduled to mature so as to avoid any need to sell depreciated securities. But not every bank can be expected to anticipate its needs accurate3.y, and depreciation in the securities portfolio can be the source of substantial losses. Sour loans and sales of depreciated securities can quickly impair capital margins. What can banks do to improve their capital position? For many years they have relied principally upon retention of earnings. While this is a “BANK CAPITAL AMD THE SUPERVISORY AUTHORITIES'1 -- 3 prudent thing to do, it has not resulted in as rapid or substantial growth in capital as I feel to be necessary, Some of you may be familiar with my recent talk before the Illinois Bankers Association, where I suggested that the sale of new bank shares is the only remedy today that measures up to the urgent need. Seldom has the situation been as conducive as it is today for the successful flotation of new bank shares. Banks can improve the attractiveness of such investments by paying out a larger proportion of their earnings, I feel that any given increment of earnings paid out to share-holders in the form of dividends would attract more in new capital than it would itself add by being retained in capital accounts. By lending their encouragement to this course, as well as by other effective measures, the bank supervisory authorities can do much to facilitate the availability of capital to banks. We must not expect, however, that we have or shall soon find a permanent solution to the complex problem of bank capital. The problem itself is eternal; we learn this over and over as our solutions of old problems become out-moded by new situations. All we can expect is an intelligent attention to the day's developments, flexibility in our approach to this vital problem and firmness in our resolve to equate bank capital with banking integrity, I trust that you will not take lightly my plea for more adequate bank capital as merely the swan song of a departing friend. For you may not so easily get rid of me. It is not easy to push aside the interest of a lifetime or to break off the friendships that I have found among you. Providence willing, I hope to attend many more of your meetings, and thus renew at least once a year the inspiration I have always received from being with you. ***
