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■ V*


Federal deposit insurance corporation
W A S H IN G T O N 2 5



It is an honor to have been invited once again to address

the Independent Bankers Association meeting in its annual convention.
We of the Federal Deposit Insurance Corporation feel a special kind
of kinship to the Association for, like you, we are sometimes regarded
as the champions of the smaller banks of this country.

To a very

large extent this reputation derives from the fact that the Federal
Deposit Insurance Corporation has through its examinations experienced
its closest contacts with the smaller banks.

It has been a happy

relationship, and helps us to understand the pride which your Associ­
ation feels in its membership.


The objectives of bank supervision have undergone consider­

able change in emphasis over the years in accommodating themselves
to the different stages of banking development.

Bank supervision

may be said, in a general way, to make contact with individual banks
at three distinct points in their history— their chartering, their
examination, and when necessary, their liquidation.
In the beginning the chartering of banks almost alone
received attention.

Gradually examinations were authorized by more



and more States and their purposes tentatively defined.

Having their

inception in the policing of compliance with chartering terms and
followed by a phase of rather aimless fact-finding, examinations
have finally developed into an instrument dedicated to the health
and longevity of banks.
At one time, well within our memories, examinations were
simply stethoscopic soundings of a bank’s condition.

Any symptoms

of illness were duly recorded, along with any infractions of statutory
provisions, but further than that the examiner did not ordinarily go.
If a bank had inadequate surety coverage or an inactive board of
directors or any other potential hazard, it was proper for the examiner
to record these facts; but to prescribe any remedies was beyond his

A frequent result of this practice of taking no

position on matters for which the responsibility of decision rested
with bank management was to delay corrective action until the patient
was in a dying condition.
Within our life-time the scope of bank examinations has
been extended to include prescription as well as diagnosis.

When a

management is found to be indulging in practices considered to be
unsafe or unsound, even though such practices may not be technical
violations of law, it is the duty of the supervising authority to
take steps to see that these practices are discontinued.

The wisest

and strictest banking legislation gives no assurance of sound bank
operation; and complete observance of legal requirements is no
guarantee against bank insolvency.

Since many of the canons of sound


banking are so intangible that they cannot be embodied into law, it
is up to the supervising agency to supplement legal requirements
with suggestions tailored to individual situations.

Indeed, the

supervising agency has a sober responsibility to urge whatever measures
a situation demands, for to do otherwise is to let down not only the
depositors but also the bank itself.
The development of examinations into a tool for the education
of bankers and the correction of poor managerial practices has been
accompanied with some suspicion that the supervising agencies would
by design or inadvertence invade the area of bank management.
suspicion, I hardly need say, is completely unfounded*


None of the

supervisory agencies has any inclination, right, or ability to assume
the functions of bank management, and all are determined to avoid
any encroachment upon this citadel of free enterprise.

Where sug­

gestions have been made, they have been made with scrupulous regard
to what are recognized as the prerogatives and responsibilities of

Any bank which has received these suggestions, if it

will conscientiously ponder the condition which called them forth,
will recognize that the supervisory agency does not ask for anything
which would weaken bank management.

Instead, the purpose always is

to strengthen management, to the end that our banks will be able to
withstand the impact of adverse economic conditions, should they develop.
What have been the techniques and the fruits of this positive
approach to bank examinations?

I propose to distinguish, first, three

areas in which examining agencies have made what appears at this point


to be appreciable progress; and, second, three other areas in which
banks have made substantial advances in response largely to the per­
suasive pressures of’ examinations.

In no area, of course, have we

reached perfection, so the list Is one of challenge as veil as of



Ability of Examiners. The execution of a positive

examining program which seeks to supplement but not supplant manage­
ment requires a high order of ability on the part of the examining

Acting as both friendly counselor and missionary, eager to

persuade but loathe to criticize, the examiner needs a rare combination
of tact and firmness.

Professional competence is, of course, a pre­

requisite, and includes among other things a knowledge of banking
theory and practices, accounting methods, and banking laws.


this knowledge to bear upon individual situations requires, finally,
intelligence and sometimes intuition#

For the examiner is oft-times

expected to smell out embezzlers, and to recognize unsound trends in
managerial policies long before they eventuate in serious difficulties.
In recognition of the need for able examiners, the Federal
Deposit Insurance Corporation instituted in 19^6 an educational program
for its examiners.

This program consists primarily of correspondence

courses given by the American Institute of Banking, but also includes
evening courses offered by its. local chapters and by colleges or
universities, together with special graduate courses at several


Enrollment in all educational projects totaled 39^

at the end of last year, well over half of our examining staff.


graduate courses, which comprise three years of intensive resident
and correspondence study, have "been completed by 52 of our examiners,
and ^3 others are presently enrolled in such courses.
Except for the graduate students who forego annual leave
to attend summer school, the Corporation pays the costs of this
educational program, and considers it an excellent investment.


in those cases where the Corporation loses an examiner who only recently
completed a course we regard it as a net gain, for the examiner typi­
cally takes a position in a bank where he is able to use his knowledge
to the advantage of the bank#

Improvement of banking operations,

however they occur, is a boon to the Corporation.
Important as our educational program is, we must nevertheless
admit that the main part of an examiner’s education takes place on the

There is no substitute for experience, and it is a unique and

invaluable background which the experienced examiner brings to his

This reservoir of ability has naturally increased during the
It is a pool upon which the officers of banks, particularly

of small banks, should feel free to draw.
Very few officers of small banks have had experience in
more than two or three banks, and frequently their whole career has
been confined within one bank.

In contrast to their limited range of

experience, the average examiner, even a relatively inexperienced one,
is familiar with the internal operating procedures of many banks of



different sizes and differing asset composition.

He may also bring

to his job varied experiences in banks in other States where the
differing laws or economic conditions have some unique applicability
to an immediate problem.

Bank management is missing a real opportunity

when it neglects to avail itself of the examiners’ rich experience.
Like all knowledge, it is the kind of capital whose increase to the
receiver involves no loss to the giver.

Evaluation of Assets. A second field in which bank

examinations have improved is in the philosophy and factual basis of
asset evaluation.

Of all the supervisory activities which contributed

to the banking crisis of the early 1930<s> perhaps the most pervasive
was the adherence by both supervisory and central banking authorities
to the theory of self-liquidating loans and marketable investments.
Whatever historical justification this theory may have once had, it
did not apply to our banking system as it actually functioned in
the 1920’s and 1930's.

Prior to the banking crisis, examiners

appraised assets on the basis of concepts revolving around selfliquidating commercial and agricultural loans, liquid open-market
paper, and marketable securities.

When these, along with other

assets, proved to be uncollectible, and banks experienced a dire
need for funds to meet deposit withdrawals, the financial pyramid
erected upon this concept collapsed.
Development of new and realistic standards of asset appraisal
was consequently a necessary and early step in the rehabilitation of


banks following the crisis of 1933*

Recognition that assets should

he appraised on the basis of their intrinsic value superseded the
old basis of market valuation.

This meant in practice that examiners

would not exert pressure on banks to liquidate assets, but instead
would work for the longer pull, conditioning banks and thereby assist­
ing borrowers to meet their obligations over a normal period, without
reference to fluctuations in market values.

Banks were thus absolved

from the necessity of liquidating sound assets on a depressed market
and thereby accentuating the deflation.
Continued adherence to the new standard was a bulwark of
banking stability as the deflation of the early
the wartime and postwar inflation.


gave way to

It is the adherence to this policy

which has brought occasional criticism to the effect that bank exami­
nations are restrictive--that they, indeed, sometimes impede progress
by making it difficult for banks to finance sound projects.

It may

be true that certain worth-while projects have had to be postponed
or abandoned because of this policy.

But it is my firm conviction

that such minor restrictions have made a positive contribution to
the stability of our economic system.

That banks themselves have

come to appreciate this view is shown by their adoption of a program
of voluntary credit restraint in the inflationary situation of 1950,
a program heartily endorsed by the supervisory agencies, and dis­
continued only after it had successfully fulfilled its purpose.
Asset appraisal on the basis of intrinsic value has been
strengthened greatly during recent years, not only because of the



cumulating experience with this more realistic basis of appraisal,
but also through the development of better credit information.


before did examiners have at their finger-tips so many facts on which
to base their appraisal.

The Federal Deposit Insurance Corporation

has been particularly instrumental In developing and distributing
information concerning municipal bonds, previously a blank page in
the examiner's manual.

The banks themselves have cooperated by secur­

ing progressively more complete financial statements from borrowers.
The combination of these sources of information has given examiners
a basis for appraisals which now reflect more judgment and less guess­
work than characterized earlier classifications of assets.

Supervisory Cooperation.

With some banks subject to

examination by more than one supervisory authority, it is a matter of
great significance that the purposes of examinations are not perverted
by conflicting regulations.

That the agencies have been able to work

out arrangements which take care of their individual responsibilities
and still avoid unnecessary duplication of work is an achievement
which gives all of us considerable satisfaction.
As you know, the Federal Deposit Insurance Corporation has
authority under certain conditions to examine any national bank or
Federal Reserve member bank and regularly examines all insured non­
member banks.

Information concerning insured banks which it does

not examine the Corporation obtains through review and analysis of
the reports of examination made by the other two Federal agencies.
The State banks examined by the Federal Deposit Insurance Corporation


are, of course, subject also to examination by their respective
State authorities as required by State lav.

Here again much dupli­

cation of vork is avoided through concurrent examinations, and
corrective programs are carried out through the cooperative efforts
of the Corporation and the State authorities.
The harmonious relationships among the supervisory agencies
are knitted together by substantial agreement on examination pro­

The three Federal agencies and more than half the States

use what is practically a uniform report of examination, and other
States use it in only slightly modified form.

A landmark was recorded

in 1938 when agreement was reached on uniform methods of appraisal
and uniform definitions for the classification of assets.


this framework the Corporation is able to maintain alertness to
matters of particular concern to it as insurer of deposits, and
still analyze reports of examination in such a manner as to make
uniform statistics available.

The information thus secured has

guided the supervising agencies along paths which, while not parallel,
lead to the same goal of banking soundness and stability.

So far we have directed attention to the tools which an
examiner brings to his job.

let us now consider what he does with

those tools, to which part of the bank he applies them, and how
effectively he uses them as measured by the results which might
reasonably be attributed to his efforts.


(a )


Financial Position of Banks«

It has become trite to

point out the unparalleled stature of our banks in terms of volume
of assets, amount of earnings, the almost negligible number of
failures and other indicators of financial strength.

And it would

be foolish to claim, in view of the economic changes of the past
decade, that these results have come from bank examinations.


who have been concerned with examinations like to think, however,
that examinations have been a positive factor in this overall picture
of banking progress,

A few elements of that belief are so strong

that we are moved to cite chapter and verse.
Our first exhibit is bank capital.

In the general concern

over our historically declining capital ratio, sight Is frequently
lost of the fact that the ratio has climbed Intermittently from its
low of 5«5 percent In 19^-5 to its recent level of 6.7 percent, and
that the aggregate volume of capital has grown steadily to successively
higher levels.

Had it not been for the constant persuasion of examiners

it is possible that the declining trend might have continued.


banks have come to retain a larger proportion of their profits, their
major source of capital, may be attributed at least in part to the
urging of examiners.
A second element of strength to which examiners have con­
tributed is the growing bank practice of absorbing losses currently
without letting them drag on and drag down the bank.

More and more

banks abide by the examiners' classification of assets in their
current operating practices.

Long before the promulgation of the



19^-7 ruling by the Commissioner of Internal Revenue permitting banks
to accumulate limited amounts of tax-free reserves for bad-debt losses
on loans, examiners had been encouraging the setting-up of reserves
for losses.

With the stimulus of the ruling, the practice has become

more wisespread, and valuation reserves against loans now total over
$1 billion, a substantial cushion against the time when loan losses
may again become serious.

Internal Security,

In recent years banks or their

insurer have experienced greater losses from defalcations and similar
weaknesses in their administrative structure than they have from
losses on assets, and attention has consequently been focused on that

Although many bank defalcations have been uncovered as a

result of examinations, the responsibility and the facilities of
examiners for the internal security of banks are sharply limited.
That unuttered question which follows the discovery of
yet another defalcation which has been going on for years needs to
be answered once and for all.

"Where," indeed, "were the examiners?"

Certainly they were there; but they were not looking for crooks, nor
would bank management appreciate visits attended by that bias.


expand examinations into audits would require time and personnel
many times greater than that now allotted for examinations.


more important is the fact that an effective audit is a continuing
project not suited to periodic checks.

The methods which would be

required for examiners to carry on an auditing program would in­
evitably involve them in conflict with management, and thereby impair

12and possibly destroy the spirit of teamwork which derives from the
present division of responsibility.
Knowing, however, the great importance of internal audits
and controls, and recognizing their maintenance to be the responsibility
of bank management and bank directors, examiners have urged that banks
establish an effective program of their own, or alternatively employ a
reputable accounting firm for that purpose.

Some progress has been

made, for about 1,000 banks now have full-time auditors and many
others have arrangements for adequate audits by public accountants.
However, there is much missionary work to be done, as many of our banks
still lack a satisfactory auditing program.
Too many banks regard adequate surety coverage as a substitute
for an audit program.

Actually these two methods of protection, as

examiners are fond of repeating, should go hand in hand, supplementing
each other.

Schedules of fidelity coverage as recommended by the

American Bankers Association are part of each examiner’s manual.


Federal Deposit Insurance Corporation is empowered by law to require
all insured banks to maintain adequate fidelity coverage; and should
some banks demur, the Corporation is authorized to purchase this
insurance and add its cost to the bank's deposit insurance assessments.
So far we have preferred to use the persuasive course of convincing
banks of the wisdom of full insurance protection against all types
of losses.

Results have been gratifying, but too many banks still

carry inadequate surety coverage, even at the reasonable rates
prevailing today.

- 13 -


Bank Management.

Our last point is possibly our most

important, for it encompasses the one factor fundamental to all the

Practically all of the problems encountered by examiners and

the degree of response by banks may be subsumed under one word—

Whether the problem be that of bad loans or infractions

of law or inadequate insurance, it is the fault of poor management,
broadly construed.

The board of directors, which makes policy, has

been either incompetent or negligent; or their agents, the bank's
active management, has not been carrying out the prudent and proper
policies of the board.
Long years of neglect have so obscured the responsibility
of directors that examiners have assumed a major educational project
in their efforts to impress upon directors the seriousness of their

Too often directors, especially of small banks, have

accepted a directorship as the capstone to a career in some unrelated
field, having little interest in and less knowledge of banking
operations, and subjecting themselves, unknowingly,

to grave liabilities.

While the duties of directors vary widely among the different juris­
dictions, and court interpretations provide no sure guide, in no
jurisdiction do the relevant regulations justify the off-hand acceptance
of a bank directorship.
The duties of directors are both comprehensive and minute.
Many of the banking statutes require that directors examine their banks
at regular intervals.

The director is ordinarily charged with the

responsibility for regular attendance at directors 1 meetings, for



the institution and maintenance of adequate safeguards, and for the
development of managerial policies.

He is the appointed guardian

for both the depositors and the stockholders.

If, through failure

to exercise ordinary prudence and diligence in the control of the
bank’s affairs, a loss occurs to the bank, a director may be held
liable personally and jointly with the other directors.

Exactly what

constitutes neglect in such cases is somewhat obscure, but it may in­
clude acquiescence

in such things as making illegal loans or loans

with inadequate security, permitting improper overdrafts or "kites",
and failure to act with respect to slow or past-due paper.
That examiners have made some headway in educating directors
to the magnitude of their responsibility is indicated by the increas­
ingly attentive ear with which their suggestions are heard.


tion reports are no longer simply filed away for "future" reference,
but increasingly provide the stimulus and the know-how for improvement
in managerial policies and operating techniques.

This change in

attitude toward examinations is symptomatic of the growing realization
that bank management and bank supervisors share the same objective— a
sound banking system, safe for depositors, fair to employees and
stockholders, and responsive to the nation’s needs.

By working together

we can build upon the progress of the past a richer and more satisfying