View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

DIRECTOR AND ACTING CHAIRMAN JOHN REICH
FEDERAL DEPOSIT INSURANCE CORPORATION
OHIO/WEST VIRGINIA BANKERS ASSOCIATION MEETINGS
JULY 24, 2001

Let me begin by offering my sincere thanks for the opportunity to speak here today. It is
always good to visit with bankers — to listen to your concerns — and tuck away your
insights about our industry, about the FDIC, and how we can do our job better. One of
my goals upon taking this job was to ensure the FDIC was communicating frequently
and effectively with bankers and I believe that must include people in my position as
well as the staff of the Corporation.
We've hosted just under forty delegations of state banking associations — including you
all — for breakfast or lunch at the FDIC's offices in Washington. It has been very
rewarding to get direct feedback — some would say a 'reality check' — from you during
my first few months on the Board. And I appreciate very much hearing your concerns as
you work to meet the financial needs of your communities, make a profit for your
shareholders, and struggle to comply with the regulations sent from Washington.
It is also a special pleasure for me to be here because of my own background in the
banking business. I spent more than twenty years in shoes similar to yours — originally
in Illinois and then, for 20 years, in Florida — and I feel like I have great appreciation for
the decisions you face every day. I've tried to bring this perspective to the Board of the
FDIC — and conferences like this will help keep me focused on the issues and
concerns that are important to you.
I'd like to talk a little today about some of the issues we're following at the FDIC and
give you some sense of what we're seeing in the economy and the supervisory arena.
And finally, I'd like to discuss a few of my own goals for the FDIC itself as we position
the Corporation for the years ahead.
It is very likely most of you have been following — in some fashion — the discussion in
Washington on the issue of Deposit Insurance Reform. And — if you're at all like your
banking colleagues from around the country — you probably have several different
opinions about the subject. But I would like to briefly outline our reasons for bringing this
issue to the table and briefly discuss the recommendations we made to Congress
earlier this year.
As the federal agency responsible for consumer confidence in a safe and sound
banking industry, the FDIC, I think, has an obligation to provide deposit insurance in the
most efficient and cost-effective manner. We must also ensure that our policies do not
make things worse for the industry during hard economic times and we must ensure the
system is administered fairly. Our goal in developing our recommendations was to give
Congress a framework for adapting our current system to the changing financial
landscape.

The current Deposit Insurance system, as most of you know, was modified in crisis and
was designed to help the industry emerge from that crisis. At the time, funding was
badly needed to recapitalize the deposit insurance funds following record bank and thrift
failures. The Congress pegged our fund to a hard target of 1.25 percent of estimated
insured deposits, and allowed the FDIC to charge the industry steep premiums until that
level was reached. This system has worked, and worked well. You all remember this
because you helped foot the bill. But we're in a different era now, and we at the FDIC
believe it's time for a re-evaluation of the system.
In summary, we identified four broad areas we think were in need of reform. First, the
BIF and the SAIF funds need to be merged. This seems to be one area where there is
little controversy. Second, we think we should eliminate the 'hard target' of 1.25 percent
and allow the fund to grow and recede with the economic cycle — to float within a range
— we've suggested between 1.15 and 1.35, but the exact size of the range is subject to
fine tuning. By eliminating the hard target, we remove the specter of a 23 basis point
insurance premium on banks. To provide an element of stability to the structure of the
fund, we've recommended a steady flow of premium revenue to the Fund — not for the
purpose of building a Fund of unlimited size, but to support a fund which has a revenue
stream and which is intended to be revenue neutral over the long haul. This is a
structure which would provide rebates to you when the Fund reached whatever ceiling
is established. These rebates would be based upon your past contributions to the Fund,
and would provide no immediate or near-term rebates to the brokerage firms and other
free riders who have received the benefits of Deposit Insurance in recent years, but
have paid nothing into the Fund. Third, we recommend improving our system of riskbased pricing to ensure that banks pay premiums based more accurately on the risk
they pose to the fund. Finally, we recommend indexing the coverage level — whatever
that level may be — to inflation to ensure it does not erode over time.
We obviously believe these are sensible and reasonable recommendations. In
developing them, we conducted rigorous internal analysis including modeling the
performance of our fund under various reform scenarios. Further, we engaged in
outreach to hundreds of individual bankers and trade groups, soliciting advice and input
to ensure that what we proposed was feasible and would work. And since we released
our recommendations, we've been working with the Congress to determine whether a
consensus reform bill can be written and passed during this Congress.
Now, that doesn't mean there is currently any overarching consensus within the industry
about how to proceed. Indeed, I doubt there's consensus in this room about how to
proceed. But most of us seem to agree that the current system is in need of an update
and I do sense some movement in Washington toward common ground on deposit
insurance reform. I encourage you all to join the debate. Make your views heard both
within your trade organizations and to your representatives in Congress. And help us
design a deposit insurance structure which protects the interests of the banking public,
preserves confidence in our banking system and retains the support of your industry.
This is our goal as we continue our discussion and we welcome your input.

In addition to providing deposit insurance, another thing we do at the FDIC is pay very
close attention to the current state of the economy, with an eye toward understanding
the impact of larger trends on the safety and soundness of the banking industry. I'd like
to review with you — our sense of where we stand and what we can expect from our
economy and our industry down the road.
After 10-plus years of record expansion, we've abruptly slowed to about one percent
GDP growth over the last two quarters. To some extent we're seeing a rapid and
significant change in the perception or reality of economic fundamentals, and that raises
a degree of concern for all of us involved in the financial services industry — whether
we're bankers or regulators.
Let me cover the bad news first. There are trends underway that nobody wants to see
continue. In the first quarter, net income for the S&P 500 was down 27 percent from a
year ago. There have been more than 900,000 job cuts announced since December —
more than triple the number during the same period last year. Nationwide, office
vacancies increased at the fastest pace on record in the first quarter, then surpassed
that record increase in the second quarter. The office vacancy rate in downtown
Columbus, for example, has risen from 11 percent to 17 percent — just since the
beginning of this year, with one million square feet of new space scheduled to be
completed this year. Business bankruptcies and bond defaults are up sharply and
consumer bankruptcies have spiked as well. The global economy is weak. We've all
heard frequent announcements recently of more layoffs and cutbacks planned for
business investment by many of the very firms which once led the New Economy
revolution.
Manufacturing has been especially hard-hit. Capacity utilization in the manufacturing
sector is at its lowest level since 1983. As you know, this has been difficult for Ohio and
West Virginia since manufacturing plays such a prominent role in both of your states'
economies. The steel, chemicals and glass industries — so prominent in West Virginia
— have been hit by the recent slowdown and by longer-term structural factors such as
foreign competition and industry consolidation. Ohio has seen widespread declines in
manufacturing payrolls as well.
Ohio and West Virginia have seen a sharp increase in consumer bankruptcies in recent
quarters. While the number of personal bankruptcy filings for the U.S. grew by 17
percent in the first quarter compared to a year ago….the growth rates for West Virginia
and Ohio were 27 and 28 percent, respectively. To some extent this probably reflects an
anticipation of more stringent bankruptcy laws, but the relatively higher dependence of
your states' economies on traditional manufacturing industries has doubtless played a
role as well.
The way we see it at the FDIC, the near term outlook nationwide is that loan quality may
get a little worse before it gets better. How much worse depends on the depth and
duration of the current slowdown.

So much for the bad news.
It's not all doom and gloom. While we must heed these trends and do our part to deal
with these challenges, it is also important to remember that the U.S. economy and
banking system are in a strong position to weather this slowdown. The nationwide
unemployment rate, while rising, was still at a relatively low 4.4 percent in May 2001.
The U.S. workforce, our technological expertise, and our financial wealth lend our
economy a degree of resilience that is extraordinary. Consumers experienced a $2.2
trillion loss in the market value of their equity portfolios last year, along with another $1
trillion in losses in the first quarter of 2001. Yet they remain fairly upbeat, and consumer
spending continues to support our economic growth.





Insured institutions also continue to exhibit strength. At the end of 2000 there
were only 45 institutions with equity ratios less than 6 percent of assets,
compared to over 1200 such institutions ten years ago.
Quarterly net income for the industry returned to near-record levels in the first
quarter of 2001.
Bank loan portfolios remain relatively unencumbered with non-performing assets.
Again, at the end of 1991 there were 1,000 banks with non-current loans greater
than six percent of total loans. At the end of 2000 there were only 100 such
institutions.

In your states, the overwhelming majority of insured institutions continue to report solid
financial condition. Returns-on-assets have drifted downward in line with weakening
economic conditions. Insured-institution ROA was 0.89 percent in Ohio, down from 0.98
percent a year earlier. The ROA for West Virginia was 0.84 percent in March, down
from 1.0 percent a year earlier. About six and a half percent of banks in each state are
unprofitable, slightly less than the 6.9 percent figure for the nation as a whole.
These financial numbers are scorecards which reflect past events. As I've indicated, the
outlook going forward looks somewhat testing. What is the appropriate response of
banks and regulators to the current economic situation? I think, in part, you simply need
to be aware of the trends taking place and do the analysis needed to develop lending
strategies that you think can succeed under less-than-ideal economic conditions.
As regulators, we need to focus attention on the banks which are farthest out on the risk
curve. This could be any bank whose capital, management or internal control systems
are not adequate to the level of risk selected. Lending concentrations in banking have
been on the increase since the mid-1990s, especially in the area of construction
lending, commercial lending and commercial real estate lending. Banks with significant
exposures in these areas need to consider the possibility that the economic
environment going forward could be less forgiving than it was during the 1990s.

The 1990s ushered in what looks like a new era for consumer lending; an era of
enhanced availability of consumer credit and higher levels of personal bankruptcy filings
and consumer loan charge-offs. Changes in the structuring and delivery of consumer
credit have altered the credit environment in a way that the industry can serve more
customers, and earn more money. For some banks, this has meant operating with a
business model that features high capital ratios, high volume lending, and high levels of
earnings, in exchange for accepting a higher level of loan losses. This business model,
and the accompanying democratization of credit, are reasons why consumer loan
charge-offs have been higher during this expansion. Products like subprime auto loans
and high loan-to-value mortgages have expanded the reach of lenders and the choices
of borrowers, but remain untested in a recession.
As I mentioned briefly earlier, we've seen some deterioration in credit quality in recent
months. At the end of the second quarter, 2001, 1.2 percent of all loans held by
commercial banks were non-current. This is the highest level since the third quarter of
1995. The non-current rate for commercial and industrial loans was 1.82 percent, a
seven year high. While loan quality is a concern, this trend must be put into perspective.
In relative terms, the current statistics do not approach the experience of banks during
the last economic downturn in the early 1990s. Moreover, strong earnings and capital
provide a significant buffer for banks, allowing them to effectively weather the effects of
this erosion in credit quality.
We have also noticed that many community banks are relying on non-traditional
sources of funding to meet loan demand as the competition for core deposits has
increased. These non-traditional sources include wire services for deposits and Federal
Home Loan Bank advances. Since 1995, Home Loan Bank advances have increased
from $33 billion to $172 billion and more than 2,000 additional banks have joined the
system. There is no question that these advances play an important role in helping you
meet your funding needs and manage your liquidity. Advances provide liquidity to
smaller institutions which don't have access to the broader capital markets.
Typically, the FDIC looks at the use of Federal Home Loan Bank funding or other
wholesale funding in the context of the bank's overall funding strategy and in terms of
management's ability to understand and manage the risks associated with these
sources. Our supervisory concerns have typically revolved around the impact of
advances on your liquidity, your interest rate risk, and earnings and capital.
A final supervisory concern I want to mention is related to the ongoing difficulties in the
agricultural sector. Farm banks remain vulnerable because their profitability is closely
linked to the uncertain economics of farming and the ongoing reliance of farmers on
government support payments. Without these payments, farmers would have far greater
difficulty meeting loan payments, and it's worth noting that about half of net farm income
last year came in the form of payments from the Treasury. We are not predicting serious
near-term problems in the farm bank sector. The performance of these institutions
remains steady, with loan quality and capital positions remaining fairly strong. As

supervisors, however, we are watching these trends and the overall economic situation
in farm country very closely.
The final topic I'd like to cover today concerns the FDIC as an organization and my
goals for the corporation as a new Board member. Those of you in the banking industry
today are the survivors. You capitalized the Bank Insurance Fund after the last crisis
and you continue to pay the bills. I believe you have the right to hear where I come from
with respect to how the organization sets its priorities and how I hope we manage our
obligations going forward.
As you may know, our Board of Directors is in transition. Chairman Tanoue left the
FDIC earlier this month after three years of service. Don Powell, a bank CEO from
Amarillo, TX, has been confirmed as our new Chairman and I expect him to be sworn in
sometime in August. I think he's going to be a great leader, for the FDIC and for the
banking industry. James Gilleran of California has been nominated to head the Office of
Thrift Supervision, and the current director, Ellen Seidman, has indicated she'll step
down upon his confirmation. Once we've passed through this transition period, I believe
the FDIC Board will enter a sustained period of stability. I hope we can use this
opportunity to review our internal operations with an eye toward becoming an even
more effective and relevant voice in the banking arena.
The FDIC has been given the responsibility of managing public confidence in our
banking system. And we've been provided the resources by the banking industry to
perform this function. We at the FDIC must always remember that responsible
stewardship of these resources and maintaining public confidence are of paramount
importance to the continued success of the Corporation.
As we work to accomplish our mission at the FDIC, we must always be vigilant about
how we can improve and how we can better meet our responsibilities to you and to the
public. I believe we demonstrated this in our recommendations for reforming our deposit
insurance system.
We must also remain concerned about the burden we are placing on the industry with
the regulations we issue. In Washington there are a lot of smart people with a lot of
good ideas for fixing this, regulating that, and solving something else. And each of these
policies — taken individually — may make all the sense in the world. But I see my job
as not only evaluating each proposal as it comes, but also ensuring that the collective
impact of our decisions isn't counterproductive, burdensome, and unworkable for the
industry we're supervising.
And finally, I believe we in the regulatory community must not let an over-reliance on
procedure and process substitute for clarity of mission and soundness of work. Just as
process can establish clear responsibilities and ensure accountability, it can also stifle
creativity and become an end unto itself. I've seen it happen elsewhere, and I'm sure
you have too. This is a difficult balance, and those of us in government sometimes miss
the mark on this one. Our processes and procedures must support and add value to our

fundamental mission, and they must be easily understood and implemented by the
industry. They must not become missions unto themselves.
These are some of the principles that will be guiding me as I continue my service at the
FDIC. The sign on your window has always meant confidence, stability, and public trust.
I will do my part to make sure it always does.
So thank you again for your invitation to join you here today. It's truly been a pleasure. I
do appreciate the vital and important work you're doing for your communities every day
and I look forward to a productive relationship with you throughout my term on the
Board of the FDIC.
Thank you.

Last Updated 08/02/2001