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OCTOBER 10, 1960




I am delighted at this opportunity to visit Los Angeles
here at the core of America's Golden West.

And I am especially

pleased to be able to talk to this fine audience representing
the auditors and comptrollers of many of our nation's financial
I am here to discuss a business in which you people
are the specialists.

But what I have to say revolves around

the broad theme of our common supervisory objectives.
In that connection, I have a little bit to say about
attaining these objectives, and about the need for an everimproving standard of bank operation.

Much of what I have in

mind has been gleaned from discussions with bankers and business­
men, from talks with our own examiners and auditors, and from
some years of experience in the practice of law and on the
national scene as a Congressman.
In the main, however, I am going to concentrate on the
need for well thought out internal and external bank controls.
You are an ideal forum for my thoughts because the
National Association of Bank Auditors and Comptrollers has for
its objective sound and safe bank operation.
Since we have, in a manner of speaking, common super­
visory objectives, let me define the fundamental supervisory
objective of the Federal Deposit Insurance Corporation as:


desire for a sound banking system - - a sound banking system which



W- 3-10/10-50

is capable of meeting its liabilities without difficulty, while
serving the legitimate credit demands which are made upon it
and being of service to the public.
Now I would believe that your objective as a supervisor
and an agent of the board of directors of your bank would be the
assurance of a strong bank; that is, one with sound assets and
adequate capital, operated in harmony with sound banking principles
and in accordance with banking laws and regulations.

In other

words, each of you, ideally, would serve under proper and
conscientious management, a bank of strong financial condition.
On the other hand, as a Federal supervisory agency, the
Corporations purpose is to insure the depositors of all banks
which are entitled to the benefits of insurance under the law.
This means that we are eminently concerned with the safe and
sound operation of insured banks.
As I see it, the most dominant similarity of interest
between the Corporation and NABAC lies in a common supervisory

the assurance of safe and sound operation of banks.
To this degree, then, we do have much in common, and

it is on this point of mutual endeavor that I want to pin most
of my remarks.
Deposit insurance, of course, has the responsibility
of reducing the impact of bank failures upon the community,
whatever the cause.

However, banks themselves have a particular



responsibility for the prevention of defalcations and other
internal abuses which may lead to failure; a responsibility
recognized by their capital structures and through the fidelity
bonds they carry.

They also have an obligation, in meeting

demands for credit, to make a prudent selection of assets.


insured banks have not made adequate provision against defalcation,
or when they encounter losses in their operations severe enough
to cause insolvency, the Corporation is obliged to step in to
protect depositors.

The Corporation has the further responsibility

of the impact of failures due to economic developments
beyond the control of individual banks.
If a bank fails, and especially if it is the only bank
in the immediate area, the entire community is affected.

It is

the responsibility of the Corporation quickly to restore the
availability of deposits which have been made temporarily
inaccessible by bank failure, and thus to restore the web of
confidence that sustains our banking system.
We pride ourselves on the assumption that money panics,
such as those experienced in the past, have all but been elimin­
ated by our guarantee of bank deposits.
We all recognize that it is confidence which sustains
our banking system.

In fact, every industry and business has a

large stake in maintaining public confidence, but none so large
a stake as has banking.

For banks deal in promises, not in goods,



and confidence is an essential element of every promise.


dence is the keystone in the arch of financial and economic

Federal deposit insurance has done a great deal to

foster this confidence that is so vital to the American banking
system today.
The requirements which banks must meet in order to
become insured are clearly set forth in the Federal Deposit
Insurance Act.

Once a bank is insured, the Corporation seeks to

reduce its risk by regular examinations, and by review of reports
of examination prepared by other Federal banking agencies.
Although the Corporation has no authority to close a bank, the
Corporation may terminate a bank’s insurance if, after prescribed
corrective procedures have been recommended, it persists in unsafe
and unsound banking practices.

This termination procedure is used

sparingly, since most banks charged with

unsafe and unsound

practices, or violations of law, cooperate by making corrections.
Examinations have come to comprise the bulk of our work, and we
believe through them the Corporation has exerted beneficial
influence on the character of banking.
As I have already stated, bank supervision entails, pri­
marily, examination.

Of course we issue regulations, enforce stat­

utory and administrative requirements, and analyze and publish re­
ports and studies. But bank examination gets us into the operation
of the individual bank for a first-hand look at our insurance risk.


Supervisory authorities conduct bank examinations in the
interest of the individual depositor; the stockholders; the
directors and officers; and the operating personnel* And of
most importance, bank examinations are conducted in the interest
of the public*
In the Corporation we believe the prime objective of
an examination is to evaluate the financial condition of a bank
on a given date and thereby assure that its assets in excess of
its capital requirements are adequate to enable it to meet all
of its liabilities to depositors and other creditors.

In addition,

the examination should ascertain whether or not the management
is conforming to the applicable banking statutes and regulations.
In contrast, the performance of a bank audit is a means
of verifying that transactions are correctly recorded and that
assets and liabilities are correctly reflected by the books of
the bank,
I have checked these two definitions of functions
against the recommended practice of ‘internal control' as agreed
upon by the Committee on Auditing Procedure of The American
Institute of Certified Public Accountants, and find that they
are closely parallel in concept.
From this you can clearly see that the Corporation1s
objectives in examination, including all of banking, do closely
parallel those goals of your own professional .organizations*




Both of us are striving for safe and sound banking
operations, through intelligent management programs.

But before

any program can be successful two basic principles must be
accepted as essential.
First, a bank's control program is vital, and should
rank at the top of managements primary concerns.
Second, control procedures must be designed to fit
the special needs of individual banks.
We can all agree that the primary purpose of internal
audit and control is the protection of the weak from temptation,
and of the innocent from involvement.

There is no guarantee that

fraud losses will not occur, but an adequate system of control
assures a two-fold benefit:

a strong deterrent to malfeasance

and the possibility of early detection.

The responsibility

for maintaining a system of internal control lies with the bank's
board of directors, both by law and administrative regulation.
Ideally, each bank's board of directors should seek out a competent
thoroughly trained, objective auditor and appoint him responsible
for the maintenance of an effective control program.

I realize

that for the very small bank the cost of a full-time auditor is
often prohibitive.

In such cases, other means of control can be

utilized effectively, and I shall refer to this matter again,
further on.




On several occasions I have called attention to the fact
that most bank failures in recent years were primarily caused by
defalcation and embezzlement.

These failures, in great measure,

reflected a lack of internal protections and inadequacy of audit
and control.
There are yet some bankers who feel that an annual examin­
ation by one of the supervisory authorities can somehow serve as an
effective audit and means of control.

This is a delusion that all

supervisory agencies have sought to dispel.
Records show that bank embezzlements are on the increase.
Millions of dollars are taken each year; but it is not possible to
make an accurate estimate of the losses sustained, because many of
the shortages have existed, though concealed, for years.
In the past calendar year, a total of 1,632 irregularities
in banks was reported to the Federal Bureau of Investigation. A total
of at least $13 million was involved.

There were 349 convictions.

Motives for embezzlers' activities are many and varied -as are their methods.

Generally these latter fall into the

categories of (1) misappropriation of money or property before it
is recorded; (2) misappropriation of income; (3) manipulation of
expenses; (4) forgery and false entries; and (5) acting beyond
In one of our recent bank failure cases, where several
bank employees were involved in irregular transactions, we found




that salaries paid to these employees were inadequate; a promotion
and vacation policy was lacking; there *7as no rotation of duties;
and employees of the bank were engaged in extensive outside-busine

Probably the most unorthodox activity engaged in by

the failed bank was the practice of sending an employee by car to
a neighboring town, some ten miles away, for cash for daily oper­
The employee gave his personal check to that bank for
the amount of currency required, which may have been $5,000,
$15,000 or $20,000.

This cash was then returned to the bank and

credited to the account of the individual who drew the check.
When this large check came in it normally would be charged to the
drawer’s account, but here was an item which was made to order to
be charged to someone else’s account, or at least a portion of it
distributed elsewhere, and that is what was done in a number of
I need not sketch further details of this picture for
this audience.
Suffice it to say that even the smallest bank can, and
should, carry out a sensible program of internal checks and
controls by: (1) rotation of employees to the greatest possible
extent; (2) separation of duties; (3) mandatory full and uninter­
rupted vacations away from the bank; (4) clearance of counter or
window differences daily; (5) provision of individual facilities
for each teller's cash.

-9This is a minimum program.

No bank can afford less.


I am sure that there exist a few banks which have not implemented
even this minimum program.
There is talk of high cost, both of the program and of
the manpower needed for good internal control.

This may be true,

but the bank s owners and management must resolve only one

does the result justify the cost?
Of the 13,400 insured commercial banks, there are about

9,400* with deposit totals of $5 million or less.


speaking, most authorities on audit have taci^JLyi' agreed that
these banks are too small for a full-time auditor.

This does not

mean that an auditor is completely out of the question —

but rather

that an auditor with other duties might well be put on the staff
of some of these small banks.
As the only supervisory agency with actual dollars at
stake in 96 percent of the nation’s banks, the Corporation has great
self-interest in the conduct of internal audit and control programs.
As a result we hold two additional common objectives with
your organization: (1) improved appreciation by bankers and bank
directors of the need for adequate control systems; (2) and a fuller
recognition of the functions and importance of the auditor and an
understanding that he should be granted broad authority and should be
accountable only to the board of directors of the bank.




But even under the most ideal conditions of control,
losses do occur.

A bank which has taken upon itself a full-scale

program of control still needs the protection offered through
fidelity bond coverage.
The maximum amount of fidelity insurance may not be
necessary for all banks--but this decision should be based solely
upon the bank's efficiency in controlling risk.
We like to follow the old adage here, ’Better safe than
Then finally we have the larger question:
the auditor?”

”Who audits

I will not discuss this question in detail, except

to say that An independent, outside audit is always in order for
any business institution —

a practice which all banks should

Then there is the further question:
How quickly can we assimilate and prepare for the
electronic data processing equipment and coming developments in
business record automation?
Now I will admit that when I started in the law business
some years back, I used a very hesitant typewriter, a roll-top
desk and a few other things that were thought to be right up to
date and modern for the times.

But today, when I read the

publications in the banking field and stop in to visit with ray




banker friends, I find that they are talking a strange new
electronic age language.

It consists of EDP, MICR, off line

systems, Monte Carlo methods, and a raft of other expressions
that leave me blinking.
I will readily admit to a great appreciation for the
historical development of the business machine, from the abacus
to the processing of data by programed digital computers -- but
I can also envision some worrisome areas for both NABAC and the
FDIC as the electronic age rushes toward us.
These new machines surely have their benefits:


will undoubtedly be an improvement in the quality of customer

This will be matched by the simplification of routine

and the easing of drudgery-type work, increasing employee morale.
There will be more timely information for management with an
improved opportunity for more accurate decision making by
operating management.

And coupled with all of these benefits

will come completely new staff and operating level opportunities
for bank personnel.
As these new developments begin to forge their way into
the world of banking, we must be alert to their many and varied
uses, we must be alert to the problems of internal control, to
the costs of the equipment, to the obsolescence factors and to
our own developing needs.

We take heart in the good work being

done by the National Association of Mutual Savings banks,




the American Bankers Association, the American Management Associ­
ation, and by your own NABAC Research Institute
new age of data processing into focus.

in bringing this

The authorities are

striving to keep in step with these developments and we always
hope at least to keep abreast of current developments.
But the problems loom large before us.

I cite the case

of the New York brokerage house which only some months back found
it had been victimized $170,000 by an auditor’s manipulation of
IBM cards.

This new era of the electronic swindler could pose a

knotty problem.

When books were changed with pen and ink, it was

easy to trace the handwriting -- but electronic data processing
cards are purely impersonal —

there’s really no way of knowing

who changed what.

But aside from the problems I have outlined, I like to

think that banking is a dynamic business, and I am convinced of
it because of the innovations and ideas that have been developed
within the past 15 to 20 years.
More people than ever, know more about banking today,
than ever before.
Bank personnel have become aggressive, sales minded,
community active.

These people are constantly on the alert for

new improved ways of doing things and generally have the ability
and knowledge to carry out their ideas.



The machines I have already briefly discussed have
opened up new ways of doing things«.

They have made it possible

for banks to offer services impossible under manual methods a
few years back.
People on the move today —

something like one person

in five changes his residence every year —

make continual new

banking business opportunities.
This rapid evolution and change in bank operation and
service makes the business one of dynamic action and interest.
It is a challenge to our ingenuity.

And to our imaginations.

This is convincing proof of the leadership and dynamic
role being played by our nation*s private financial institutions.
Banking has come into its own.

Today, this segment of business

stands high on the scale of public approval.

This expression of

public approval wasn't acquired with !:Madison Avenue


-- but rather through effective, and continuous service to the

A service that has come to be recognized as safe, sound,

and efficient.
I believe that we must be professionally minded and that
we cannot allow the slightest degree of neglect, of unsound and
unsafe practice, of incompetence, to enter our business.



Public acceptance and approval needs constant sustenance.
It needs informed spokesmen who can state the cause for private
banking and for our free market economy.

And who are also alert

and sensitive to valid criticisms.
Change, in the sense of the self-challenge and selfimprovement of our business and society, is the essence.

We are

all aware that there will always be better ways of doing tomorrow
tasks which confront us today,

Toward this end your association

will continue to show the way, and your association, I hope,
will continue in the forefront,
In conclusion, I want to express the appreciation of
our Board and staff for the continuance of a fine spirit of
cooperation and helpfulness, shown over the years.

It has been truly pleasant and beneficial.