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>or RELEASE ON DELIVERY Bxptcfd AT 9:30 A.M. (1ST) Statement by 3. Charles Partee Member, Board of Governors of the Federal Reserve System before the Committee on Banking, Housing and Urban Affairs United States Senate December 10, 1982 I am happy to appear before this Committee today to discuss the Federal Reserve's involvement with the Penn Square Bank. Let me state at the outset that the Federal Reserve's involvement was limited to its role as a lender of last resort, regulator of Penn Square Bank's parent bank holding company and to a general concern over the impact of bank failures on the orderly operation of the nation's financial system. As a lender of last resort, the Federal Reserve provides essential credit to depository institutions for the purpose o f providing temporary liquidity in times of need. The lending function o f the Federal Reserve is conducted through the District Federal Reserve Banks, which operate under broad guidelines established by the Board in Washington. In the case of Penn Square Bank, the Federal Reserve Bank of Kansas City was the lending bank. The President of the Kansas City Reserve Bank has appeared before a Congressional Committee to explain the Reserve Bank's loans to Perm Square Bank in detail, and his testimony is a matter o f public record. Briefly, the relevant facts are as follows. On dune 30, Penn Square Bank requested, and was granted, a $20 million loan from the Federal Reserve Bank of Kansas City. This loan was supported by a pledge o f $26.3 million o f Penn Square Bank's customer notes. The loan was repaid the next day. Friday, July 2, the bank again borrowed, this time in the amount of $5.7 million, which was collateralized by $39.4 million of Penn Square Bank's customer notes. Over the July 4th weekend, the Federal Reserve Bank was notified by the Comptroller of the Currency that the Penn Square Bank's current loan losses and potential loan losses arising from irregularities in loan documentation and other business practices would extinguish the bank's capital funds. The Comptroller also -2 - informed the Federal Reserve that the Penn Square Bank would be unable to meet the demands of its depositors and creditors from private funding sources. In response to the Comptroller's evaluation of the bank's asset portfolio, its capital position, and the dissipation of its private funding sources, the Federal Reserve Bank notified the Comptroller o f the Currency of its intention not to extend credit to the bank under these circumstances. Subsequently, the Comptroller declared the bank insolvent, and it was closed on July 6. The Federal Deposit Insurance Corporation, as receivor, paid the $5.7 million loan owing to the Federal Reserve Bank of Kansas City, which released the collateral to the receivor. The Federal Reserve also functioned as the regulator of the bank's parent company, First Penn Corporation. The condition o f First Penn Corporation was essentially reflective of the condition of the bank, since the parent company was a "shell" principally serving as a vehicle to hold the stock of the bank. As is the case when the holding company owns a national bank, the Reserve Bank relied on the findings of the Comptroller with respect to the bank's condition. The Federal Reserve Bank of Kansas City inspected the First Penn Corporation on two occasions between the beginning of 1981 and the time the bank failed in July of 1982. There was no evidence that any of the activities of the holding company contributed to or were in any way responsible for the Penn Square Bank's difficulties. Indeed, virtually all of the parent company's assets were represented by deposits with, investments in, or loans purchased from the Penn Square Bank. In the context of the Board's concern over the effect of the failure of Penn Square Bank in the markets generally, the Federal Reserve explored possible alternatives to liquidation of the bank. Given the circumstance and the short period of time available to arrange an alternative solution, however, it became clear on Monday, 3uly 5, that the bank was destined for liquidation. -3Prior to the dosing, the Federal Reserve was notified that the Penn Square Bank had a substantial amount of uninsured deposits from financial institutions. Under the receivorship, the uninsured depositors were to be given "Receiver's Certificates” amounts equal to the uninsured portion of their respective deposits. In response to the potential liquidity needs of these financial institutions, the Federal Reserve announced that the "Receiver's Certificates" would be acceptable as collateral for advances at the Federal Reserve discount window. Since the failure of the Penn Square Sank, the Federal Reserve has received only a limited number of discount window borrowing requests from these institutions. As of today, there are no loans outstanding secured by "Receiver's Certificates." The Federal Reserve has also reviewed the Penn Square episode to determine the capacity of existing bank laws and regulations to handle a similar situation should it occur in the future. It is our judgment that current banking statutes and regulations, and the supervisory tools available to federal bank regulators are adequate at present to oversee the safety and soundness of our nation's banking system. We would point out, once again, that the failure of Penn Square resulted from an extreme emphasis on growth at the expense of sound lending and funding practices, and in the absence of proper management oversight and controls. The extremely unsound banking practices that caused the failure of the Penn Square Sank represent an isolated instance, not characteristic or typical of most commercial banks or depository institutions generally. Indeed, the evidence we have continues strongly to indicate the overwhelming majority of banks being operated in a sound and prudent manner.
@FedFRASER