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Statement
of
Chairman K, A. Randall
Federal Deposit Insurance Corporation
before the
Subcommittee on Domestic Finance of the
House Committee on Banking and Currency
on August 3? 1965

Introduction

Mr, Chairman, as you know, the Federal Deposit Insurance
Corporation was established by the Congress in the depths of the Great
Depression of the 1930’s as part of a program to rehabilitate the
financial structure of this nation.

It has been successful in its

efforts to protect bank depositors and thereby to provide a new and
important element of stability to the entire banking system.

The

copies of the Statement of Operations of the Federal Deposit Insurance
Corporation for 1964 which have been furnished to you will provide
additional background information on deposit insurance, and I direct
your attention to Chart A of page

5.

When the Corporation was established, the Congress was
chiefly concerned with the problem of protecting people with money in
banks that they could not afford to lose.
worked out in fact?

How has this protection

All told, 992 out of every 1,000 depositors in

the insured banks that have failed since this Corporation was established
have been fully protected against the loss of their funds.

Notwithstanding

limited insurance -- $2,500 at the beginning and now $10,000 —




the

2

Corporation has also been quite successful in helping depositors with
larger balances to minimize their losses.
One of the powers possessed by the Corporation is the right
regularly to examine insured state banks which are not members of the
Federal Reserve System.

FDIC's power to examine state member banks and

national banks is restricted to special examinations.

Our examinations,

which are coordinated with the various state banking authorities, cover
approximately one-half of the insured banks.

Bank examinations made by

the FDIC, and by other supervisory authorities, are conducted in the
public interest for the protection of depositors.

This important super­

visory tool is the principal contact the supervisor has with the banks,
and examinations are his primary source of information about the condition
of banks.
bank.

It should be emphasized that FDIC has no power to close a

The power to close a state bank resides with the state.

The power

to close a national bank resides with the Comptroller of the Currency.
It is my belief that the Corporation's examination program, which supple­
ments the supervisory efforts of the states, has been a most effective
contribution to the success and strength of our nation's banking system.




~

3

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Crown Savings Bank
Crown Savings Bank, Newport News, Virginia, chartered in 1905
and first insured by FDIC on January 1, 193^-5 reported approximately

$8 million in assets when it was closed on September

l$)6b.

The closing

was pursuant to a petition of the Commissioner of Banking for the Common­
wealth of Virginia, to the Corporation Court of the City of Newport News,
Virginia, which appointed the FDIC receiver.
Over a good part of its insured life, Crown was a matter of
special concern to the FDIC and was accorded continuing special attention
designed to assist the bank’s management in correcting problems and in
strengthening its loan administration.
of June

It wasn't until the examination

8, 196^, when new problems of serious magnitude were disclosed in

Crown's condition, that the extent of management's dereliction came into
full focus.
The adverse developments in the affairs and condition revealed
at this examination were significantly different in their nature from the
criticized conditions in this bank during the preceding nine years.

At

the forefront of these troubles was a very substantial increase in large
lines and concentrations of credit to out-of-trade area borrowers, with
sizeable portions of these lines exceeding state loan limit statutes.
Another adverse development disclosed at the June,

196U examination was

the fact that outstanding certificates of deposit had almost doubled the
total found at the January 21,

1963 examination.

The certificates of

deposit volume expansion and widespread geographic beyond-trade-territory
locations of the certificate of deposit holders aroused suspicion that




-

4

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these funds were obtained by the bank through brokers or other forms of
solicitation not consistent with accepted bank-depositor relationships.
However, no payment of premiums by the bank for the certificate of deposit
funds was reflected by the bank records.

A further development disclosed

at the June, 1964 examination was the nearly 30$ increase in outstanding
loans between examinations.
Facts uncovered after the June

8 , 1964 examination increased the

aggregate of the large lines and concentrations actually outstanding to
several times the total reflected in the report of examination, and the
creditworthiness of the involved borrowers was found to be substantially
less than revealed by the bank’s files during the examination.

Although

not known or disclosed by management at the time, many separate guaranty
agreements of larger borrowers covering other loans were existent and were
withheld from examiners by Crown's management.

The concealment of the

guaranty agreements prevented the examiners from ascertaining the true
volume of the large lines and concentrations of credit.




- 5 Crown Management
The Crown Savings Bank had been completely dominated-in both
policy matters and day-to-day operations for more than twenty years by
Mr. LeRoy F. Ridley, now
controlled bank.

58 years of age, who in 1926 joined this family-

After 13 years of service as Cashier, Mr. Ridley was

elected President in 19^-9*

The Ridley family controlled approximately

50*¡0 of the common capital stock, with the largest block (42tfo) in the
name of former President Ridley.
Mr. Ridley was a well known citizen of Newport News, a leader
in his local community and the surrounding area, and enjoyed the confidence
and respect of local bankers.

Active in bank organizations, he has been

President of the National Bankers Association and served as Chairman of
its Executive Committee for several terms.
Possessing a pleasing personality and displaying a very
cooperative attitude during examinations of the bank, Mr. Ridley, in the
past, was responsive to the recommendations of examiners and for the most
part was willing to effect needed improvements and corrections in the bank.
With the benefit of hindsight, we are now aware that for some time preceding
the closing of the bank Mr. Ridley adopted deceptive practices in his
relations with our examiners in the concealment of dealings with borrowers
whose loans, overdrafts and kiting operations caused the bank's insolvency.




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6

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Failure
In early August, 1964, the Corporation learned that Crown was
having check clearing difficulties.

A Corporation examiner sent to the

bank investigated and prepared a letter report to the United States
Attorney advising of possible check kiting activities.

This was followed

by a special investigation of the bank’s condition on August 21, 1964,
by our examiners and the state examiners.
The situation reached a point at which it was determined on
or about September 1, 1964, that the bank’s estimated losses had wiped
out its capital and created a deposit exposure in excess of $400,000.
As a result, the Banking Department of the Commonwealth of Virginia
petitioned the Court to close the bank and to create the receivership
on the 4th of September, 1964.

The court action creating the receivership

followed on the 4th of September, 1964.
The payment of insured deposits began two banking days after
the date of suspension.




- 7 -

Brokered Funds
Let us turn now from the somewhat detailed consideration of
the Crown Savings Bank failure to certain other aspects of this hearing.
The financial condition of the Crown Savings Bank and six more of the
recently failed banks was brought about primarily through the acquisition
of bad assets with funds obtained with the aid of money brokers rather
than from the growth of deposits in the normal course of business.

These

funds were brought in with compensation in excess of the maximum permissible
rate of interest which insured banks may pay on deposits under regulations
of the Corporation and the Board of Governors of the Federal Reserve
System.
In the case of each of the seven banks with brokered funds
represented as deposits, there was an arrangement made either directly
or indirectly to have a bonus over and above the permissible rate of
interest on deposits paid to obtain the money.

There were about 388

certificates of deposit of this kind issued by these closed insured banks.
These certificates aggregate about $18.3 million and there was one
certificate of $3 million.

Insurance coverage of these deposits would

amount to about $ 3.8 million.
Because time certificates of deposit have been involved in
so many of the recent bank failures, it may be well to say just a few
words in an effort correctly to describe, and identify them.

A time

certificate of deposit is evidence, in written form, that a specified
amount of money is, and will be, left on deposit for a definite period
of time at the bank.




The certificate also is evidence that the depositor

-

8

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will be compensated at a stated rate of interest.

This kind of deposit

itself is time proven and in some areas of the country it is used as a
substitute for a savings account passbook.
Because of an interesting money market development in the
early

1960*s, certificates of deposit attracted much attention and

attained a new importance in the banking system.

At that time, a number

of large banks in the principal financial centers began to issue
negotiable time certificates of deposit on terms that provided corporate
treasurers with an attractive investment for short term funds.

Thus, a

bank could compete effectively for deposits it otherwise might lose when
funds were withdrawn to buy short-term securities - for example, Treasury
bills.

A necessary related development to maintain the attractiveness

of these CD's was the establishment of a market by security houses to
trade them over-the-counter before the maturity date.

So, if the holder

wanted to get his money out of the certificate of deposit, he could do so
readily.

Typically, these marketable CD's were issued in large units

ranging in size from $100,000 to $1 million.

These transactions are not a

part of the failed banks' story.
This new and imaginative adaptation of a traditional banking
instrument to provide American industry with a modernized financial tool
emphasizes that our banking system is alert to business opportunities.
This is essential for a growing economy.

From a very small beginning in

1961, negotiable certificates of deposit have built to a current level of
about $15 billion.

In other words, this specialized investment practice

accounts for nearly half of the CD's in the system of insured banks.




- 9 -

To repeat, in seven of our recent bank failures certificates
of deposit were misused to gain control of liquid resources that would
not be available to the bank within its normal sphere of operations.
Certificates of deposit do not cause banks to fail.

But the

trouble comes when the CD's or other deposits are misused to swell the
bank's liquid resources, which in turn are diverted or invested in bad
assets.

Sooner or later funds must be repaid.

The bank fails if its

assets are so wanting in quality that they cannot be converted into the
cash necessary to meet its obligations.
Under the Federal Deposit Insurance Act, in any case where the
Corporation is not satisfied as to the validity of a claim for an insured
deposit, it may require the final determination of a court of competent
jurisdiction before paying the claim.

A long line of court decisions in

relation to state deposit guaranty plans, years before the formation of
Federal Deposit Insurance Corporation, had established that money placed
in banks under an arrangement for payment of a bonus or premium in excess
of the statutory or regulatory interest rate limit was not a "deposit"
insured or guaranteed by such guaranty plans.
Under the circumstances surrounding the brokered funds involved
in the seven closed banks, the Corporation decided to submit the matter
to the courts for a determination as to whether the funds placed in these
banks under these facts constituted deposits entitled to insurance.

Con­

sequently, the Board of Directors of the Corporation authorized declaratory
judgment actions in California and Texas for a determination by the courts
of whether these certificates qualify as insured deposits and to what
extent Federal deposit insurance may apply.

Holders of certificates of

deposit of Crown Savings Bank whose insurance was questioned have in many
instances agreed to abide by the results of such actions.




-

10

Remedies
After these actions were filed it became apparent that these
lawsuits would not end the practice by some banks of bringing funds into
the bank at excessive interest rates in exchange for certificates of
deposit or other evidences of deposits.

This is borne out by the large

amount of money involved in some of the transactions, which suggests that
certain lenders of funds to banks are not concerned with Federal deposit
insurance protection.
At the time of the Corporation's original suit on the question
of the insured status of certain certificates of deposit, only two banks
with an aggregate of $U.5 million in assets were involved.

Our reports of

examination had also indicated to us that the practice of brokering
deposits at rates in excess of the maximum permissible rates under Federal
banking regulations was becoming more widespread.

Last year we thought

that this problem involved in the closing of two small banks did not merit
an approach to Congress for legislative action, but we did decide that it
was our duty to request the courts for a determination of this matter.

The

failure of twelve banks in the last eighteen months with assets of about
$8U million, in which the pattern of brokered funds at excessive rates
of interest was important in seven of these failures, has brought me to
the conclusion that this subject requires legislation.
Subsequent appraisal of this matter after the institution
of our lawsuits has convinced us that litigation will not solve the
problem.

Denial by the courts of insurance coverage to these transactions

would not restrict the circumvention of the interest regulations.




On the

11
other hand, it might well have a serious detrimental effect on the status
of an insured deposit in the minds of depositors.

Weighing the desira­

bility of preserving the confidence of the public that their deposits of
funds in banks are entitled to Federal deposit insurance coverage against
the fact that a favorable decision in our lawsuits would not curtail this
objectionable practice of brokered funds, it has been concluded that the
public interest will best be served by preserving the deposit status of
these transactions and by providing by legislation a means for enforcing
the interest regulations of the Corporation and the Board of Governors.
We have sent forward today a draft of proposed legislation which
would accomplish this objective.

A copy thereof is attached with a summary

of the proposal.
I have been advised by the Bureau of the Budget that enactment
of this legislation would be consistent with the Administration’s
objectives.
In addition to the proposal for enforcement of the interest
regulations, the Corporation has under consideration a number of other
remedial measures pertinent to the matters which I have discussed.

These

may be summarized as follows:
(l) Authority for the Corporation and the other Federal




banking agencies to order banks under their super­
vision to cease and desist from unsafe and unsound
practices and violations of law or regulations, and
to suspend or remove officers and directors who
are found to be engaged in such practices or violations;

12
(2 ) Additional authority for the Corporation to extend
financial assistance to insured banks in financial
difficulties;
(3) Authority for the Federal banking agencies to require
banks to obtain independent private audits of their
books and affairs; and

(k) The

imposition of criminal penalties upon persons

who knowingly make false statements to insured banks
in applications for loans or extensions of credit by
such banks.
When legislation is drafted to accomplish these proposals, such
draft bills will be submitted to the Bureau of the Budget for usual
review and clearance.
Another matter in which you have indicated an interest is
the recent change in control of bank management legislation.

The Corpora­

tion sponsored this legislation, which was enacted on September 12, 196*+,
relating to notice of changes in control of management of insured banks.
Under the law, the chief executive officer of any insured bank is required
to report promptly to the appropriate Federal banking agency the facts
about changes occurring in the outstanding voting stock of the bank which
will result in a change in the control of the bank.
A report is also required in cases where a loan or loans are
made by any insured bank which are secured by

25$ or more of the shares

of the voting stock of any other insured bank.

The underlying purpose

of the law is to alert the banking agencies to changes in control of
management of insured banks.




Our experience with the statute as enacted

- 13 -

in

l$6k has,

of course, been brief but has already produced some good

results.
Mr. Chairman, we welcome an opportunity to review with you the
problems brought to focus by the failure of the Crown Savings Bank.

It

is important that we maintain perspective as we view the recent bank
failure record.

The failure of seven banks in

196 k is indeed a small

number by comparison to the 13,820 insured banks in the United States.
Notwithstanding the impact upon any community when a bank fails, it
must be borne in mind that the incidence of failure is small.

The

Corporation has through its entire history endeavored to learn from
these failures and to grow in its ability to solve new problems as they
arise.

Beyond question, the banking system is viable and sound, and the

infiltration of undesirable elements appears to be held at a low level.




SUMMARY OF PROPOSED LEGISLATION
FOR ENFORCEMENT OF
INTEREST REGULATIONS

The attached legislation would amend section 18 of the Federal
Deposit Insurance Act and section 19 of the Federal Reserve Act so as to
provide effective penalties for violations of Federal regulations pre­
scribing the maximum rate of interest which insured banks may pay on
deposits.

Under the proposed legislation no insured bank or officer,

director, agent, or substantial stockholder thereof would be permitted
to pay or agree to pay a broker, finder, or other person compensation
for obtaining a deposit for the bank, except as the Board of Directors
of the Corporation or the Board of Governors of the Federal Reserve
System may by regulation prescribe.

Any payment made by any other person

to induce the placing of a deposit in an insured bank would be deemed to
be a payment of compensation by the bank if the bank has or reasonably
should have knowledge of the payment by such person when it accepts the
deposit.

Any violation by an insured bank of the prohibitions in the

law or regulations issued pursuant thereto would subject the bank to a
penalty of not more than

10 percent of the amount of the deposit to

which the violation relates.

The Corporation and the Board of Governors

of the Federal Reserve System would be empowered to recover these penaltie
by suit or otherwise, together with the costs and expenses of recovery.
The Board of Directors and the Board of Governors would be
authorized by regulation to prescribe what would be deemed to be a pay­
ment of interest.

This term would include an agreement to pay interest

by an insured bank and include payments to the depositor or any other




person made by an officer, director, agent, or substantial stockholder of
the bank or by any other person if the bank has or reasonably should have
knowledge of the payment by such other person when it accepts the deposit.
The Board of Directors and the Board of Governors would also be authorized
to define payment of compensation and substantial stockholder, and to
prescribe such rules and regulations as they may deem necessary to effec­
tuate the purposes of the law and prevent evasions thereof.




D R A F T

L E G I S L A T I O N

A BILL

To amend the Federal Deposit Insurance Act and the Federal Reserve Act with
respect to the payment of deposits and interest thereon, to limit the payment
of compensation for obtaining deposits, and for other purposes.
1

.-*-1 enacted by the Senate and House of Representatives of the United

2

otates of America in Congress assembled, That subsection (g) of section 18

3

of the Federal Deposit Insurance Act (12 U.S.C. 1828(g)) is amended by strik-

^

ing out the next to last sentence thereof, relating to penalties for violations

5

of such subsection, by inserting "(l)" at the beginning thereof, and by adding

6

thereto the following paragraphs:

7
|L ^
9

”(2) No insured nonmember bank or officer, director, agent, or substantial
stockholder thereof shall pay or agree to pay a broker, finder, or other
person compensation for obtaining a deposit for

I 10 Board of Directors may by regulation prescribe.

such bank, except as the
For the purposes of this

1 11

paragraph, any payment made by any other person to induce the placing of a

■ 12

deposit in such bank shall be deemed to be a payment of such compensation by

1 13

the bank if the bank had or reasonably should have had knowledge of such

■ 1^

payment by such person when it accepted the deposit.

■ 15
■ 16
■ 17
■18

"(3) Any violation by an insured nonmember bank of the provisions of this
subsection or of regulations issued hereunder shall subject such bank to a
penalty of not more than 10 percent of the amount of the deposit to which such
violation relates. The Corporation may recover

such penalty, by suit or

■ 19 otherwise, for its own use, together with the costs and expenses of such
■ 20
IBP"
■22

recovery.
Board of Directors is authorized by regulation to prescribe what
shall be deemed to be a payment of interest by a nonmember insured bank




J*

-

2

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1 (which shall include an agreement to pay interest and may include payments to
2 the depositor or any other person made by an officer, director, agent, or
3 substantial stockholder thereof or by any other person if the bank had or
^

reasonably should have had knowledge of such payment by such other person

5 when it accepted the deposit), a payment of compensation, and a substantial
6 stockholder for the purposes of this subsection and regulations issued pursuant
7 thereto and to prescribe such rules and regulations as it may deem necessary
8 to effectuate the purposes of this subsection and prevent evasions thereof."
9

SEC. 2.

Section 19 of the Federal Reserve Act is amended by inserting

10 the following paragraphs after the thirteenth paragraph thereof (12 U.S.C.
11
^ H2

371b):
"No member bank or officer, director, agent, or substantial stockholder

d.3 thereof shall pay or agree to pay a broker, finder, or other person compen|l| sation for obtaining a deposit for such bank, except as the Board of Governors
[15

of the Federal Reserve System may by regulation prescribe.

For the purposes

|l6

of this paragraph, any payment made by any other person to induce the placing

117 of a deposit in such bank shall be deemed to be a payment of such compensation
|l8 by the bank if the bank had or reasonably should have had knowledge of such
1 19 payment by such person when it accepted the deposit.
120

"Any violation by a member bank of the provisions of this section or the

■21

regulations issued hereunder relating to payment of deposits and interest

■22

thereon and payment of compensation for obtaining deposits shall subject

■ 23 such bank to a penalty of not more than 10 percent of the amount of such
deposit to which such violation relates.

Such penalty may, by direction

of the Board of Governors of the Federal Reserve System, be recovered by
|26

suit or otherwise by the Federal Reserve bank of the district in which the




- 3 -

1 offending member bank is located, for its own use, together with the costs
2 and expenses of such recovery.
3
4

"The Board of Governors of the Federal Reserve System is authorized by
regulation to prescribe what shall be deemed to be a payment of interest by

5 a member bank (which shall include an agreement to pay interest and may
6 include payments to the depositor or any other person made by an officer,
7

director, agent, or substantial stockholder thereof or by any other person

8 if the bank had or reasonably should have had knowledge of such payment by
9 such other person when it accepted the deposit), a payment of compensation,
10 and a substantial stockholder for the purposes of this section and regula11 tions issued pursuant thereto and to prescribe such rules and regulations
12 as it may deem necessary to effectuate the purposes of this section and
13 prevent evasions thereof."
1^15

SEC. 3*

The provisions of this Act shall be applicable to funds

received by the bank after the date of its enactment and to any subsequent

16 renewals of a deposit.