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An Address By

L. William Seidman, Chairman
Federal Deposit Insurance Corporation
Washington, D.C.


The 86th Annual Convention of
The Conference of State Bank Supervisors

San Diego, California
April 7, 1987

Good morning.
Once again, it is a great pleasure to be with you and to have this opportunity
to share my thoughts on the bank regulatory environment.
Each year federal bank regulators like myself are invited to appear before
We invariably talk about the changes that are occurring in the financial
services industry, and each year we talk about the industry crossroads we
aDDroach and the imminent crises that demand reasoned, yet swift, decisions.
Well» this year is no different. The rate of change in financial institutions
gives us watershed decisions to make on a regular basis.
Many years ago, the late and esteemed Rep. Wright Patman, as Chairman of the
House Banking and Currency Committee, spoke at the dedication of the FDIC
building in Washington, D.C. During his remarks he said: "We have gone too
far in the direction of bank safety. Last year there were no failures at
all. To me, this is a danger signal." I suspect that Mr. Patman is now happy
in that "great committee room in the sky." Change has increased the risk of
failure by a factor of 20.
This morning, I would like to attempt answers to some sticky questions which
have been put to me by some of your membership. Even if you find my replies
to be wrongheaded, uninformed, or just plain dumb, remember we are dealing
with complexity and answers aren't easy, and that we all seek a common goal
a sound, stable and prosperous financial system.
Question one — What about our turf problems and our divided exam program?
Effective supervision in a multi-state environment raises "turf" problems on
all levels, and it requires an increased reliance on the supervision conducted
by others. This is true for both federal and state authorities.
Organizations like the CSBS will play a vital role in this environment by
promoting effective supervision and in ameliorating minor problems when they
arise. Our focus must be on developing adequate and appropriate supervision.
During 1986, over half of FDIC examiner hours were spent in 3, 4, and 5-rated
banks. Further, our records show that, on average, banks with satisfactory
ratings are examined only about every 2 1/2 years — and of These banks,
nearly a third have not been examined in over three years. These statistics
account for state as well as FDIC examinations, where there is a divided exam
program. Simply put. the FDIC is not spending a great deal of time in well
rated state banks.
The divided examination program points to even more state reliance. The
number of states currently in the program has declined to only 18 from 32.
These remaining states are pretty much operating on an informal, best
efforts" basis. This decline primarily reflects our inability to examine
satisfactorily-rated banks with agreed upon regularity.
Examination responsibility for state-chartered institutions is increasingly
being administered by state banking departments. We hope to see this grow.
Our bank examiners are diverted to perform their duties in the larger number
of banks with unsatisfactory ratings. We must take notice of this situation
and design a new program. This new program should (1) promote Increased state
responsibility, (2) encourage joint training, and (3) provide clear
responsible assignment between regulators. We welcome your input.




m o t ion two — Mhat about our views on the Bush Task Force Report?
I'm happy you asked me that. In short, we'd like to forget it. First, let me
sav that Vice President Bush and the members of the Task Group performed a
valuable service. Their 1984 Report, titled Blueprint for Reform, provided a
vital first step in focusing the national debate on regulatory reform issues.
Reform of our regulatory and supervisory structure is needed and it will
occur. The Questions we now face are (1) how to best accomplish this reform,
and (2) when it should be implemented.
The reform proposals were submitted to the Congress a few weeks ago as part of
the Administration's omnibus trade legislation package. While the specific
bank legislation has not received a great deal of publicity, let me assure you
that, if enacted, the Impact would be revolutionary.
Some of the more noteworthy changes include:

The three existing federal bank regulators would be reduced to two. The
FDIC would cease to have a superivsory role for state nonmember banks.
This responsibility would go to the Federal .Reserve. For national banks a
new "Federal Banking Agency" ("FBA") would be created within the Treasury
Department, incorporating the OCC.
The FDIC would be refocused exclusively on administering the deposit
insurance system. Responsibilities for environmental, consumer, antitrust
and other laws not directly related to the solvency of Insured banks also
would be transferred to other agencies.


The regulation of bank holding companies would be changed substantially.
In almost all cases, the agency that regulates a bank would also supervise
its parent holding company. Thus, most banking organizations would have a
single federal regulator.


Authority to establish the permissible activities of bank holding
companies would go to the new FBA, although the Federal Reserve would
maintain a limited veto right over new activities.


The Federal Reserve would continue to supervise the holding companies of
the very largest domestic banks, as well as those with significant
international activities and foreign-owned institutions.


A new program would transfer current federal supervision of many
state-chartered banks and their holding companies to state regulatory
agencies, creating new incentives for states to assume a stronger role in


The special regulatory system for thrifts would be maintained, but
eligibility would be based on whether an institution is actually competing
as a thrift, rather than on the nature of its charter. Also, the FDIC and
FSLIC would be required to establish common minimum capital requirements
and accounting standards for insurance purposes.

- 3 The FDIC strongly endorses the goals, objectives and basic thrust of the Task
Group's 1984 recommendations. Removing unnecessary federal regulatory
overlap, functionalizing federal oversight, and returning primary bank
regulatory responsibility to the respective state or federal chartering
authority are commendable objectives.
However, I think we need to consider the fragile state of our financial system
today. It is undergoing a time of serious downturn in several key economic
sectors. The number of problems and bank failures are at record levels. In
my view, this is simply the wrong time to embark on a major, untried and
unproven, change in the federal bank supervisory structure.
It also seems inappropriate to seek radical reform of the federal and state
oversight and risk control mechanisms before bank powers and future structure
of the banking industry, which is now being so hotly debated, is decided.
When we decide where we are going, we can decide how to supervise. "If you
don't know where you are going, any road will do." We also note serious flaws
in the legislation to implement the Bush Task Group proposals. One primary
area of concern is the limited flexibility the legislation would give the FDIC
to identify and control risk in insured institutions. The Vice President's
Task Group concluded:
"Current FDIC authority to examine banks for insurance purposes should remain
unchanged," and then went further to grant additional authority which would be
necessary under the proposed new federal regulatory structure. This included
authority to revoke insurance, assess risk insurance premiums, and take
enforcement actions against any insured institution or its management.
The legislative proposal, however, has been constructed quite differently.
For one thing, the Federal Reserve's role seems to go noticeably beyond the
original intent of the Task Group members. But, most importantly, it
effectively emasculates the FDIC's ability to identify, limit and control its.
risk. No insurance company in the private sector could function under such
constraints. If the FDIC is to function as the Nation's deposit insurer,
greater authority — not less — is needed.
Another area of concern is the proposed "Certification-Program" for state
banking authorities. We question both the need to legislate a complex state
certification process and the rationale for designating the Federal Reserve as
administrator over such a program.
The FDIC believes that reform efforts in this area should focus on expanding
the role of the respective state banking authorities and making more efficient
use of your existing programs and strengths. The benefits to be derived by
creating a potentially massive new bureaucratic hurdle are not evident.
Question three — What's our position on outside auditors?
Actually, this is two questions, but I'm trying to save time. One concerns
our pilot program to use CPAs in the examination process; the other concerns a
possible regulation requiring outside audits for state nonmember banks.

- 4 Let me take the pilot program first. As you may know, accountants from two
national accounting firms will join FDIC examiners in bank examinations in our
Dallas and Kansas City Regions. If the pilot program is successful, we plan
to move to a competitive bid program. He hope to do that during the summer
months, which tend to be slow for most accounting firms. Let me emphasize
that the goal is to help us to catch up. It is a stopgap measure — not a
long term solution. It, by no means, reflects a lessening commitment to a
strong supervisory force — federal or state.
What about requiring outside audits? I don't want to overplay this because
it's not far enough along. Proposals haven't totally crystalized, and no
decisions have been made. However, there is considerable sentiment that once
a bank reaches a certain size, it ought to have the benefit of a good,
independent opinion audit. We have noted the tendency to have such audits
drops off quickly as problems intensify.
At present, we are thinking of a size threshold of around $50 million.
Currently, about 2700 state nonmember banks are this big, and available data
indicate somewhere between 45 and 65 percent already get annual opinion
audits. We also may adopt some minimal requirements for smaller banks —
perhaps an independent review of internal controls and insider lending.
Again, no decisions have been made. One reason is the other federal
regulators are also studying the issue. Ideally, we would have uniform
treatment for state and national charter banks.
I hope you don't think we believe the outside auditor holds all the answers.
The FDIC, the undertaker of failed banks, has seen too many clean audits to
believe that. Consider that 70 percent of the 1986 failures that -had outside
audits during the preceding two years had clean opinions. Compare this to the
examination process. Of those banks getting clean opinions, about 80 percent
were considered problem banks at the time of their audit. This is not
unusual. Our records show that all but a relative handful of banks escape
problem status when examined within two years of failure.
Of course the fact that a bank has serious problems does not preclude a clean
opinion. But, I would have expected a few more going concern exceptions.
Nevertheless, we still see opinion audits as a valuable safety precaution. It
is noteworthy that most <2/3s> of the 1986 failures did not have recent
audits. And, I would also add, the accounting profession has been taking a
number of initiatives to ensure quality audits.
Question Four — What is our position on an FDIC/FSLIC merger?
We do not favor a merger for a number of reasons. It would be unfair to place
the burden of thrift problems on the shoulders of the banking industry. Banks
are no more to blame for a broke FS1IC than any other participant in the
financial services industry. Or any other taxpayer group for that matter.
Another reason for not wanting a merger is the FDIC already has enough
problems to deal with. I certainly do not have to tell this group of our
recordbreaking failures (53 as of last Friday, not counting two assistance
transactions) and our 1500+ problem banks. These problems are manageable and
I'd like to keep it that way.

- 5 Of course we cannot Ignore the thrift problem, and it is in all our best
interests to find a solution. We support the Treasury recapitalization
proposal, and we were disappointed to see the size of the program reduced in
On the other hand, I can understand the view of many thrifts. The depth of
the hole is unknown and it was dug by a relatively few thrifts. There are a
lot of good, well-managed thrifts who do not see why they should fill that
hole. An increasing number of those thrifts are considering becoming
FDIC-insured institutions. If they qualify, we have to take them. And,
FSLIC's problems will become that much harder to solve.
While it's hard to find anything positive to say, I think the thrift situation
holds some compelling lessons. First, thè losses have been caused by a
relatively small number of high risk takers. It doesn't take many to break an
insurance fund, which means an insurance fund will not survive without sound
safety supervision programs and resources. Second, the losses were caused to
a large degree by poor practices in granting traditional credits. Too often I
hear concerns about banks getting new powers because of all the risks
involved. I'm strongly inclined to believe the powers banks are seeking, by
and large, pose much less potential risk than commercial lending.
Question Five (and I'll make this my last one)— How do we feel about loan
loss amortization?
I recognize a number of parties find appeal in this approach. Moreover, the
Senate recently passed a provision which, if enacted, would permit
agricultural banks to amortize loan losses over ten years.
The FDIC does not favor the concept of loan loss deferral and also believes it
is not desirable to legislate accounting practices. Accounting should reflect
the facts. What to do about those facts is another matter. As you may have
heard, the FDIC plans to expand its capital forbearance. Capital forbearance
will be available to all banks whose problems stem from external economic
events — not just agricultural and energy banks. We will place less emphasis
on specific capital ratio levels and more on viability in determining
eligibility requirements. In other words, the 4% capital requirement will be
waived if the bank has a viable plan for the future. We also are reevaluating
the feasibility of a net worth certificate program for commercial banks.
Rather than legislating accounting, a better approach is to target forbearance
to keep well-run, viable institutions in business.
Well that concludes my prepared question and answer session. And, now I will
follow it up with a speech - only kidding. But, I'd be happy to answer any
other questions you may have.
Thank You