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BANK
AND THRIFT
SUPERVISION
IN TODAY'S
FNVTRONMF.NT.

AN ADDRESS BY

?

L. WILLIAM SEIDMAN, CHAIRMAN
FEDERAL DEPOSIT INSURANCE CORPORATION
WASHINGTON, D.C.

BEFOr‘in m77^

UNITED STATES LEAGUE OF
SAVINGS INSTITUTIONS}

WASHINGTON* -©r6-r*
JUNE 12, 1986v
J

I.

Introduction

I
am delighted to be here this morning. You are
strong supporters of constructive legislative reform,
as evidenced by your recent letter to the House Banking
Committee endorsing expanded emergency interstate bank
acquisitions authority. We look forward to continued
cooperation with the U.S. League in a wide variety
of areas.
II.

Discussion

It's nearing mid year and it's time to take stock
of the likely results for 1986 for the Federal Deposit
Insurance fund. I'm pleased to report that despite
a likely record number and size of failures and assistance
transactions, the fund is operating at a surplus of
a predicted 1 billion plus dollars for this year.
To this date, we have handled 55 failures and
assistance transactions with an average asset size
of $43 million. Our problem bank list has grown from
1150 at the beginning of the year to over 1300 on this
date. Last year we experienced 120 failures.
We estimate that failures and assistance transactions
for the year will be at a new high, between 140 and
160. Our costs on this number of transactions are estimated
to approach 1 billion dollars, and we will acquire
three billion dollars of'*loans and other assets from
failed banks which will require liquidation.
While we will continue to add to our insurance
fund, the increase will come from interest earned on
our investments. Unfortunately, there was no rebate
on insurance premiums for 1986. Because of carryovers
of previous years' losses, a 1987 rebate is unlikely
as well.
These predicted results could be improved if we
have an unusual gain on the sale of our interest in
Continental Illinois Corporation. They could be, of
course, much less favorable were we to have a major
bank failure. Thirty-eight of the failures for the
year to date were purchase and assumption transactions,
16 were payoffs, and one was an assisted transaction.
Our costs increase when we are unable to find bidders
for failed banks, so all of our insured banks should
be interested in helping us achieve changes in the
law which will improve the possibility of our finding
buyers for failed institutions.




2
I thought it was important that all involved in
the financial depository institutions business be familiar
with the status of the FDIC-insured fund, even if many
of you are insured by FSLIC. The public confidence
in banks and thrifts certainly is based on insurance.
Members of the public do not distinguish between the
funds to any great extent.
I meet on a regular basis -- and have conversations
even more frequently -- with Ed Gray and his staff
and with people in the Treasury and elsewhere who have
a thorough working knowledge of the situation at the
FSLIC.
The Federal Home Loan Bank Board has been handling
its problem institutions appropriately and with due
dispatch, given the limits imposed by circumstances
beyond its control. The Bank Board has been handicapped
-- not so much by a lack of money, which gets so much
attention in the press -- but by the handcuffs under
which it has to operate, with OMB restrictions, manpower
and salary constraints, and all the rest. But the
Board has made great strides in the past year in solving
these problems and I believe Chairman Ed Gray and his
people have done a fine job.
A consensus is developing on the need for the
proposed recapitalization program developed by the
Board and the Treasury, so the funding situation also
appears very close to being resolved. We at the FDIC
are fully supportive of the new plan for refinancing
FSLIC andwe will assist it in every way that we can.
The FSLIC-insured savings industry, meanwhile,
has been outperforming most others in the stock market.
The institutions have been experiencing their best
portfolio spreads in 30 years or more, and the industry
has just about locked up a record year for net earnings.
So, the outlook for the savings industry and, by extension,
for its primary deposit insurance fund, is outstanding.
There is another matter I want to address on this
general subject of the two insurance funds. It has
been suggested that the considerable cost of recapitalizing
the FSLIC will result in an exodus from FSLIC to FDIC
insurance, especially on the part of the strongest
institutions. You might expect that we would throw
open the doors and say walk right in. But that is
not the case.




3
I happen to believe very strongly in the need
to maintain two funds and doing what is required to
keep both of them viable. I support the position of
the Treasury that a link should be drawn between current
membership in the FSLIC and all the rights and advantages
available to savings institutions. I also believe
that if an institution is FDIC-insured it should be
FDIC-supervised. In other words, we would not oppose
legislation which would automatically deny Federal
Home Loan Bank membership and status as a savings and
loan holding company to any institution which moves
from FSLIC to FDIC insurance. Those who chose to switch
would in effect become commercial banks and bank holding
companies.
Our guiding principle in our relations with our
fellow financial institutions and insurers is our version
of the 11th Commandment, "Thou shall not speak evil
about our friendly competitors or their insurance fund."
We'd welcome all of you adding that Commandment to
your list, as Chairman Ed Gray has certainly done.
It will serve all of us well in the long run.
I have referred to the Bank Board problems with
OMB. As you know, we too are now involved. Given
the disastrous effect of that agency's involvement
with the Bank Board, one would think that the record
would be clear that bank supervisory agencies are best
run by independent bipartisan boards. This would seem
to be especially true today, at a time when, as I've
described, problem financial institutions are at record
levels. Yet at this time OMB decides to apply a 36
year-old statute to the bank regulators (outside of
the Fed, which at the moment apparently looks too tough
to take on) .
OMB's basic argument is that it must supervise
these agencies because they could affect the unitary
budget. Now we all know in fact that the budget is
affected only because in government it's the practice
to add apples and oranges when it helps make things
look better. Thus some years ago it was decided to
add the surpluses of the Fed and the FDIC to the budget
numbers. But in the FDIC's case no funds are available
to meet the deficits of the government since they are
committed by law to be returned as rebates of premium
or added to this reserve for future losses. No tax
dollars are involved, and no deficits have been incurred.
Based on this record, achieved while I was elsewhere,
it's hard to believe that OMB doesn't have other more




4
important deficit reduction initiatives to which it
should direct its attention. OMB's guiding tenet seems
to b e : "Bless them when they operate at a surplus
-- we'll let them join us."
The FDIC also faces an immediate threat from proposed
Gramm-Rudman Act budget cuts. In keeping with the
spirit of Gramm-Rudman, we have voluntarily reduced
our 1986 budget by 4.3% or $8.5 million. This required
making cutbacks in a number of important areas. We
curtailed hiring and training of personnel, reduced
travel, postponed building improvements, and deferred
a number of important projects. These projects included
developing better management information systems and
other computer programs that would facilitate bank
supervisory activities and other insurance-related
functions.
We are most concerned about the potential impact
of Gramm-Rudman on our capabilities to carry out our
supervisory role, which includes the examination and
oversight of troubled and failing banks. To appreciate
the extent of our concerns, let me explain where our
examination and supervisory program stands now.
Currently, the FDIC has a force of about 1,670
field examiners, a third of whom have less than one
and one-half year's experience. These are the individuals
who actually go out to examine banks, and they account
for 85% of the professional staff of our Division of
Bank Supervision. The size of the field force is almost
exactly where it was five years ago, but a lot has
happened since then. In 1981, commercial banks earned
a return on assets of 81 basis points, 27 percent more
than they earned in 1985. Three times more banks lost
money in 1985 than in 1981. Today we have about 1,300
problem banks -- six times what we had back then.
In 1981, ten banks failed; we average that many in
a month now.
This increase in problem and failing banks has
put a major strain on our field examiners, a force
which, because of self-imposed restrictions, was allowed
to shrink. By the end of 1984, our field force was
down to 1389, 16% lower than its 1981 level. We began
to fall behind as the banking problems grew. No longer
were we able to meet our policy guidelines, which call
for examinations of marginal and problem banks (CAMEL
3, 4, and 5 ratings) at least once a year with visitations




5
in between. In some of our regions, we're averaging
20 months between exams. As for satisfactory banks
(CAMEL 1 and 2 ratings), our policy is to go up to
three years between exams, and we're not always able
to do even that. Experience has shown us that examinations
two to three years old quickly lose their value. Too
often, we go into strong banks to find they've become
weak.
Beginning in 1985, the FDIC started to rebuild
its examination force. Our tentative target is to
reach a well-trained force of 1,800 full performance
examiners by the end of this year. We hope to reach
this level by cutting back hiring in other areas.
We are studying whether additional examiners might
be needed to fulfill our supervisory responsibilities
in these turbulent times.
Our field examiner turnover rate has been running
about 11-12% and we have had to hire about 450 examiners
over the last year to get where we are now. Currently,
one-third of our field force has less than one and
one-half years in experience. This imbalance impacts
our productivity. Training these people, most of which
is done on the job, takes a substantial amount of time
away from our seasoned examiners -- time needed to
examine. It's taking longer to complete examinations,
particularly in marginal and problem institutions where
we've had to start many of these people.
In 1985,
for example, the examinations of such banks averaged
247o longer than in 1984.
We must continue our efforts to strengthen our
examiner force if we are able to stay on top of our
supervisory problems. We do not see how this could
be done under the more drastic cutbacks anticipated
under Gramm-Rudman for 1987 and beyond. As we have
done this year, we would attempt to minimize the impact
on our field force. But assuming Gramm-Rudman cuts
on the order of 10-20%, major examiner reductions would
be unavoidable. For every 100 examiner reduction,
we would lose the capability to conduct about 225 examinations
a year. Examiner cutbacks of 15% would eliminate over
600 examinations in 1987.
We firmly believe stretching out examination intervals
any further in this banking environment would be counterproductive
and not cost-effective. The net effect of the "savings"
will be higher insurance costs and less stability in
the financial system.




6
Vital automated services supporting bank supervision
would suffer as well. Even extremely modest cuts in
the order of 107o would indefinitely delay integrating
bank performance data sources into our offsite surveillance
system. This would also prevent the maintenance and
upgrading of data bank software relied on by the FDIC,
the Comptroller of the Currency, and the Federal Reserve.
Such cutbacks would seriously undermine our ability
to perform cost-effective off-site monitoring.
In short, the Antideficiency Act and Gramm-Rudman
threaten the ability to monitor the safety and soundness
of depository institutions.
I believe it is in the
interest of your industry and the country to support
legislation in the banking committees of both houses
of Congress which will settle this issue of exemptions,
so we can all spend our time on our primary responsibility,
which is in fact a full time job.
Now let me conclude by congratulating you on a
pleasant subject -- the recent thrift industry turnaround.
Bank Board assistance helped forestall some failures.
But it took bold action by the thrifts themselves -combined with a timely drop in interest rates -- to
produce black ink. Many thrifts brought in new management,
analyzed their operations, and charted new courses
for themselves. Restructuring became the name of the
game. Numerous thrifts unloaded old low-yielding mortgages
in 1983 and 1984 and acquired securities, including
mortgage-backed paper. As a result, the median ratio
of residential mortgages to assets fell from nearly
two-thirds in 1982 to just over one-half in 1985.
The ratio of securities to assets climbed from under
15 percent in 1982 to just under 20 percent in the
1984-1985 period.
Thrift industry members are carrying out a strategy
for success. Under Chairman Gray's fine leadership,
the Bank Board also is taking the steps needed to ensure
the sound supervision of the thrift industry. Like
the FDIC, the Bank Board realizes that if the market
is to work efficiently, investors -- and savers -should be able readily to compare thrifts. Adherence
to GAAP accounting provides a good means for comparison.
The Bank Board's recent proposal to move toward GAAP
standards would make it easier to compare FDIC-supervised
thrifts with thrifts regulated by the Board. Besides
facilitating comparisons, GAAP accounting also renders
a good portrayal of a thrift institution's health -one that does not disguise losses.




7
Supervisory policies are also converging in the
area of capital standards. As you know, the FDIC last
year adopted a 6 percent minimum capital requirement,
of which 5.5 percent must be primary capital. That's
basically consistent with the Bank Board's proposed
new approach. The FDIC also recognized the special
need of institutions below the regulatory minimum -mutual savings banks especially -- to increase their
capital over time. To that end, we provided a transition
rule that also meshed with the Bank Board's policy.
Overall, I think you will find that there is no disharmony
between the two agencies on the issue of capital adequacy.
We both agree that thrifts and banks need to maintain
a sound capital base -- both for their good and for
ours.
In short, we at the FDIC and the Bank Board will
do our best to coordinate our supervisory approaches,
in order to minimize uncertainty on the part of thrifts,
their customers, and their investors.
III.

Conclusion

I've very much enjoyed speaking to you. I could
go on. But, apropos of thrift, I think I'd better
heed an old Danish proverb.
It warns, "He who really
wants to save should begin with his mouth."