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rary S, v cEDERA! deposit corpora-, T m * AflCE g L. WILLIAM SEIDMAN CHAIRMAN FEDERAL DEPOSIT INSURANCE CORPORATION WASHINGTON, D.C. ON V o / THE FINANCIAL CONDITION[OF FDIC-INSURED INSTITUTIONS , ' X. BEFORE THE •, COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS UNITED STATES— SENATE ^ 10:00 a.m. May 25, 1988. Room SD-538, D1rk$en Senate Office Building Good morning, Mr. Chairman and members of the Committee. I am pleased to present the Federal Deposit Insurance Corporation's views on the condition of the banking industry and its insurance fund. At your request, the regulators already have submitted, through the Federal Reserve Board, a variety of statistics. My testimony today will provide an overview of the financial condition of FDIC-insured banks and respond to the specific questions raised in your letter. First let me suggest a perspective for my remarks. ordinarily focus on banking problems — today. The business media as does, in fact, my own testimony That is only natural as most of our time is spent dealing with those problems. However, the real news is that, despite increased competition from all sectors of the financial community, severe economic problems in parts of our country, and an unprecedented pace of change in the industry, the banking system as a whole is sound and is getting sounder. Given a reasonable ability for the system to evolve and adapt through a prudent restructuring of the financial services industry, that assessment should continue to be true over the long run. GENERAL ECONOMIC CONDITIONS I would like to preface my discussion of the financial condition of the banking system with some general observations on the economy. In last year's testimony we suggested that agricultural problems had bottomed out and that slow gradual improvement could be anticipated for 1987. That - 2 - turned out to be the case and improvement 1n that sector is expected to continue in 1988. Despite this improvement, the problems of agriculture and agricultural banks are not over. The upturn is slow and banks' performance normally lag the economy both on the way up and on the way down. However, even though problems are still there, the trend is in the right direction. We also indicated last year that the energy economy had apparently reached bottom, but the ripple effect had not yet run its course through the rest of the local economy. Therefore, banks could expect more problems. It is perhaps arguable whether or not the energy sector had indeed bottomed out. It does not appear any worse than last year, but certainly no one would describe it as in a robust recovery. There is no doubt that the ripple effect, particularly in the real estate markets, continues to cause serious problems for banks. Office vacancy rates in energy-centered areas are among the highest in the nation. A large volume of property is being withheld from the market, though not by the FDIC, to prevent oversupply. value declines are nearing an end. Hopefully, property Even in that event, the adverse effect on the economy and on banks in these areas will continue for some time. Last year we also expressed some concern over the aggregate levels of debt outstanding, especially consumer debt, with much of it owed to commercial banks. While we are still concerned, the rate of increase in this debt has been reduced, thus decreasing the probability that it will become a major banking problem. Another area of concern is interest rates, particularly the effect a rise in rates would have upon the thrift industry. Many of these institutions already - 3 - are having problems with asset quality. If interest rates increase, the resulting impact on thrift earnings may well exacerbate the financial difficulties of that industry. Fortunately, Interest rate risk in the banking industry is not large at this time. FINANCIAL CONDITION OF THE INDUSTRY Capital — Aggregate primary capital of all insured commercial banks grew from $214 billion at year-end 1986 to $234 billion at year-end 1987, a 9.4 percent increase. However, nearly all the growth in primary capital occurred in the reserve for losses component which resulted from the loss provisions made by the large money center banks for troubled loans to developing countries. This new reserving provided adequate, if not comfortable, reserves against developing country loan risk. Smaller banks continue to have higher capital to asset ratios than larger banks. The Southwest Region, dominated by the energy industry and once comprised of banks with some of the strongest capital ratios, experienced sizable declines in capital during 1987, and now exhibits some of the weakest capital ratios. The growth in capital outpaced the less than two percent growth in assets during 1987. capital. The industry as a whole currently has an adequate level of However, a continued growth 1n capital is necessary to maintain that position, especially if asset growth returns to higher levels. Current minimum capital rules set substantially similar capital requirements for all banks, regardless of asset size or the identity of the bank's primary Federal supervisory authority. These capital-to-asset, or leverage, ratios - 4 - continue to serve as useful tools in assessing capital adequacy, especially for banks that are not particularly active in off-balance sheet activity. However, the FDIC believes there is a need for a capital measure that is more explicitly and systematically sensitive to the risk profiles of individual banking organizations. While a risk-based system may require certain individual institutions to increase capital, these increases will help to further stabilize and strengthen the banking system. The FDIC recently joined the OCC and Federal Reserve in issuing for comment a risk-based capital proposal based on an Internationally agreed outline. This proposal is part of an ongoing effort by the bank regulatory authorities, both in the United States and in foreign countries, to encourage the establishment and convergence of international capital standards that would apply to all international banking organizations. The FDIC proposal would apply to all State nonmember banks, regardless of size. However, we are considering ways to minimize the impact on smaller banks by exempting them from unnecessary and cumbersome reporting requirements. Our present estimate is that few smaller banks would be required to increase capital as a result of applying the proposed risk-based standards. At this time, the proposal would not replace or eliminate our existing capital maintenance regulations, which require minimum levels of primary capital and total capital as a percent of total assets. However, once the risk-based capital framework is fully implemented, the FDIC, 1n conjunction with the other Federal banking agencies, will consider whether the existing regulatory leverage ratios should be left in place. If the agencies decide to retain a - 5 - leverage requirement, the FDIC also will consider whether the definition of capital for leverage purposes should be revised to conform to the definition of capital used for risk-based capital purposes. The proposed risk-based capital framework sets forth: ( l ) a definition of capital for risk-based capital purposes; (2) a system for calculating risk-weighted assets by assigning risk weights to balance sheet assets and off-balance sheet items; and (3) a schedule, including transitional arrangements, for achieving a minimum supervisory target ratio of capital to risk-weighted assets. The risk-based capital ratio focuses principally on broad categories of credit risk. However, the ratio does not take into account many other factors that can affect a banking organization's financial condition. These other factors include overall interest rate risk exposure; liquidity, funding and market risks; the quality and level of earnings; investment or loan portfolio concentrations; the quality of loans and investments; the effectiveness of loan and investment policies; the level and severity of problem and adversely classified assets; and management's overall ability to monitor and control other financial and operating risks. For this reason, the final supervisory judgment on a banking organization's capital adequacy may differ significantly from the conclusions that might be drawn solely from the organization's minimum risk-based capital ratio. The risk-based capital framework would apply to all international banking organizations. The ratios in the proposal have been established with a view toward maintaining a safe and sound banking system rather than achieving - the lowest common denominator. 6 - There are competitive equity concerns in light of the fact that investment banks, savings and loan associations and nonbank financial intermediaries would not be subject to the risk-based capital framework. However, efforts will continue to eliminate or minimize competitive inequities among financial Institutions of all types, to the extent that such action is consistent with a safe and sound banking system. An important question with respect to international capital standards is whether they should apply only to banks (as they do in foreign countries), or to banks Md. bank holding companies as proposed in the United States. This is a difficult question since the United States is the only country which regulates holding companies. It is our view that competitive equity would be served by not subjecting holding companies to the new risk-based capital requirements. A risk-based capital framework will not be finalized until after the Federal banking agencies have consulted further with banking regulators from other countries and carefully evaluated the public comments received in response to the current proposal. Some of what appears as new equity in banks 1s the result of double-leveraging by holding companies. for several years. Double-leverage has been a potential cause for concern Thus, the FDIC analyzes double-leverage on a case-by-case basis during the examination of individual banks. Double-leverage occurs when the parent company incurs debt and uses the proceeds to purchase equity 1n its bank or nonbank subsidiaries. Since the normal practice is to service this debt through dividends from the subsidiaries, excessive debt service - 7 - requirements of the parent can be a threat to the banks in the holding company. There have been a number of examples of bank holding company leveraging that have weakened the banks in the system. Double leverage is an important issue in the pending legislation to restructure the financial services industry. If there 1s to be an effective firewall, we must be able to protect the bank from its holding company and holding company creditors. The FDIC emphasized this position in the recent statement of protection regarding First Republic of Dallas, Texas. All % depositors and other general creditors of First Republic's banks are fully protected, but the FDIC made it clear that these guarantees DO NOT extend to the holding company creditors or shareholders. Furthermore, the assistance the FDIC provided First Republic was guaranteed by the holding company and its affiliate banks, and was collateralized by a pledge of certain assets of the holding company. The holding company banks were not allowed to pay dividends to service holding company debt. Many multi-bank holding companies coordinate their banks' activities so closely that the bank holding company system effectively operates as a single banking enterprise. Yet when a bank within the system fails, the FDIC must deal with that bank as if it were independent. In effect, the FDIC must act as if there is no connection between the failed bank and the rest of the system unless it can take some action to prevent this result. Some bank holding companies and their creditors have seen a way to turn this situation to their advantage. By concentrating poorer assets in a single bank, and then letting that bank fail, the bank holding company can shift the - cost of those assets — the FDIC. 8 - the loss it would otherwise be forced to realize ~ to This technique amounts to a misuse of the FDIC's resources, which can do substantial harm to the Federal safety net for depositors. Recent experience also has shown that creditors and shareholders can impose unwarranted costs on the Federal safety net 1n other ways as well. In some cases, the FDIC arranges open-bank assistance transactions which avoid the disruption that bank failures inflict on communities. Open bank transactions may require the consent of creditors and shareholders of the hojding company. However, in some situations creditors and shareholders have sought to "hold up" the transaction in an attempt to receive greater consideration than that to which they would have been entitled if the bank had failed. This imposes added costs on the Federal safety net. We are seeking legislation that would allow us to meet this challenge. In fact, a draft legislative proposal was circulated to the members of this Committee last week. (A copy of the draft statutory language and an explanation is contained in Appendix B.) The proposal would establish a special emergency procedure to deal with failing banks that belong to multi-bank holding companies. The procedure would allow the FDIC — in conjunction with the Federal Reserve and the banks' primary regulators — to require the consolidation of a failing bank with other banks in the holding company. It is designed to improve the asset quality of a failing bank within a multi-bank system without affecting the health of the system as a whole. We also would like to report on the status of capital in FDIC-insured savings banks. As of year-end 1987, all FDIC-insured savings banks reported positive net worths, even when their outstanding net worth certificates were not taken - 9 - into account. This is an improvement over 1983 when 5 institutions with $11.5 billion in total assets reported negative net worths when their net worth certificates were not counted. Capital levels in savings banks have increased over the last 5 years due to improved earnings performance and conversions to a stock form of ownership. From 1982 to 1985, net worth certificates totaling $710 million were issued to 29 savings banks that were experiencing severe losses due to interest rate mismatches. At year-end 1987, three banks had remaining net worth certificates outstanding aggregating $315 million. Earnings — In 1987 commercial banks had their worst year for profitability since the Great Depression. Commercial banks earned $3.7 billion, down nearly 80 percent from $17.5 billion earned in 1986. Their return on assets of 0.12 percent and return on equity of 2.02 percent were the lowest levels since 1934. A soaring loan loss provision, over 67 percent higher than 1986, fully accounted for the industry's year-to-year drop in earnings. Loan loss provisions attributable to the international operations of U.S. banks were $20.6 billion, $18 billion higher than a year earlier. Absent the extraordinary reserving for LDC loans, net income would have been roughly equal to the 1986 level. Earnings performance ratios for commercial banks have not been consistent among asset size groups or geographic locations. The largest banks reported poor earnings for 1987 due to their sizable loss provisions for international credits. After the large money center banks are excluded, the results for those banks west of the Mississippi River are poorer than those east of the Mississippi. Poor economic conditions in the energy States and Farm Belt are the primary contributor to the West's poor results. - 10 - The Southwest Region is a major area of earnings weakness. The region's banking sector is operating at a loss, with 36 percent of the banks in the region unprofitable for 1987 and the return on assets a negative 0.64 percent. A persistent high level of problem assets, despite high levels of charge-offs, points to a continuation of this problem for the region. The region's earnings also are depressed by the effect of the lowest net interest margin in the country. The region's well-publicized S&L and economic problems Influence the banks' cost of funds which, coupled with a weak loan demand and high levels of nonperforming assets, compresses the net interest margin. There have been a variety of developments in recent years that make satisfactory earnings for the banking system as a whole more difficult to achieve. Among these are poor economic conditions in certain areas of the country, the tendency of the largest most creditworthy customers to access the credit markets directly, and intensified competition from nontraditional banking business. However, the outlook for the immediate future is cautiously optimistic. Banks continue to be creative in developing new products and services to Increase their sources of income. Significant fee Income is being generated by letters of credit and swaps, markets which continue to grow dramatically. Fee Income from securities underwriting and other services is growing and would provide additional sources of income should these markets be opened to banks. The FDIC believes the banking system can provide new services and that new bank powers will provide new opportunities for profit in a safe and sound manner. Of course, proper controls and appropriate surveillance by the regulators will be necessary. - Assets — 11 Nonperforming assets at year-end 1987 are highest in the largest 25 banks and in the Southwest Region with 3.46 and 4.18 percent, respectively, of their total assets 1n nonperforming status. Insured commercial banks as a group have 2.11 percent of their total assets 1n nonperforming status as of year-end 1987. Problem assets (1 .e.. assets subject to adverse classification by the regulators) reflect trends and concentrations similar to nonperforming assets, with problem assets being 1.16 percent of total assets in the largest 25 category and 1.95 percent of total assets 1n the Southwest Region. All insured commercial banks had 0.91 percent of total assets classified as problem assets at both year-end 1987 and 1986. He believe that the asset quality problems have for the most part been identified and steps are being taken to reduce banks' risk exposure. recovery will be slow. However, There are further losses to be recognized in these acknowledged problem areas and the high levels of problem assets will remain until the economic conditions are markedly improved. Bank exposure to LDCs continues to decline as a percentage of capital. During 1987, most major U.S. banks significantly increased their bad debt reserves against loans to lesser developed countries. The money-center banks have reserves against approximately 25-30 percent of their non-trade LDC exposures. The large regional banks took additional reserves or charge-offs and now have reserves covering approximately 50 percent of their non-trade LDC exposures. Based on the use of 25 percent of export income to service debt, this level of reserving appears reasonable for present conditions. These increased bad debt reserves severely depressed earnings but had no major ramifications on the U.S. financial system. The large reserves probably have - 12 - served to enhance the flexibility banks have in dealing with LDC debt. In that regard, the Mexico/U.S. Treasury backed bond swap was less successful then originally envisaged, but it hopefully will lead to other innovative approaches under the "menu of options" to deal with the situation. Perhaps the major effect of the reserve action is that 1t has bolstered the perception that the LDC problem is concentrated, more than ever, in a handful of the largest U.S. banking companies. Asset growth, which was less than two percent during 1987, showed the smallest annual increase in almost 40 years. Banks experienced shrinkage in those loan categories suffering quality problems, i.£., agricultural, energy, commercial real estate, and international. These shrinkages were essentially offset by growth in home equity loans, which stood at $33 billion at year-end, and other consumer lending. areas. Banks continue to strive to expand lending in these new However, competition remains heavy. affects of heavy concentrations of assets. Banks realize the possible adverse Most strive to minimize this risk while continuing to serve their customers' legitimate credit needs. New products and services are being developed to help spread this risk and to take advantage of commercial banks' strengths. "Securitization" is one such practice which allows banks to emphasize one of their strengths — efficient originator of loans. being an Securitization activities, initially used in the mortgage banking area, are now expanding into other markets. They provide banks with additional sources of revenue without the capital requirements and costs associated with the warehousing of loans. Securitization also allows diversification of portfolio by region and thus helps to avoid concentration problems such as those currently being experienced in the Southwest. - 13 - Liquidity — During the latter part of 1987 banks enjoyed a large inflow of deposits at lower interest rates. stock market decline. This resulted partially from the October Up until that time, banking sector deposits had increased at a steady, albeit slow, pace. However, 1987 fourth quarter deposits grew at an annualized rate of 11.7 percent. Overall, sources of banks' funds appear stable and liquidity is adequate. However, in the Southwest Region, institutions with sizable amounts of uninsured deposits are vulnerable to sudden deposit outflows. As evidenced by First Republic, funding sources can be influenced by poor operating results and uncertain conditions. This demonstrates that market discipline by depositors and creditors still exists despite insurers actions to protect all depositors in large institutions. However, we believe that the potential trouble spots have been identified and the FDIC has shown it is willing and able to be a stabilizing influence when the need arises. The FDIC was generally satisfied with the banking system's support of the securities market during the October stock market decline. He believe the banks' response was consistent with safe and sound banking practices and they were able to assist in providing liquidity where needed. This support can be shown by a fourth quarter surge in loan demand. BANK SUPERVISION Our supervisory efforts continue to be directed toward maintaining the safety and soundness of the banking system and protecting the insurance fund against unnecessary loss. In addition to supervising directly on the federal level - 14 - some 8,000 insured state nonmember banks, we monitor the condition of approximately 6,000 national and state member banks and cooperate with the other federal and state regulatory authorities in their efforts to assure the safe and sound operation of these insured banks. One of the FDIC's primary goals has been to increase the level of onsite supervision by reducing the time intervals between onsite examinations. After evaluating our overall examination projections 1n terms of staff resources, operative procedures and the appropriate level of onsite examination, we decided to move toward more frequent examinations. Our goal now is to have an onsite examination every 24 months for well-rated institutions (those rated 1 or 2) and an onsite examination every 12 months for problem and near problem institutions (those rated 3, 4 or 5). Obviously such a goal cannot be accomplished overnight, but we have made considerable progress. Currently, we are averaging once every 34 months for satisfactory banks, once every 23 months for marginal banks and about once every 19 months for problem banks. We recently have initiated a new program for coordinating FDIC supervision with state supervision — (SAFE) Program. known as the Supervisors Annual Flexible Examination Under this program the FDIC sets annual plans for supervisory activities with state authorities. results. It is a flexible program that emphasizes Basically, we envision treating many examinations conducted by state examiners as our own. These state exams would be placed on our examination cycle database, and would be counted as examinations by the FDIC for purposes of tracking adherence to our examination schedule guidelines. Where state examinations are accepted as our own, FDIC presence in these banks for full-scope examinations would be delayed — possibly for up to an additional - 15 - two years for 1 and 2-rated banks, and an additional one year for 3-rated banks. In the case of 3-rated banks, our presence would depend on trends in the individual banks. At year-end 1987, the FDIC employed roughly 1900 field bank examiners. intend to increase this number to about 2100 by the end of 1988. We Our examiner force had declined to only 1389 in 1984 from the previous high of 1760 examiners in 1978 when we had only 342 problem banks and 7 bank failures. In contrast, there are currently over 1,500 problem banks and a possibility of up to 200 failures this year. Once we reach our goal of 2,100 we will decide whether we should expand our force further or remain at that level. We have changed our recruiting methods and standards since deciding in 1985 and 1986 to increase the field staff by 30 percent. By improving our recruitment techniques and hiring the best possible candidates, we were able to hire 421 new trainee examiners in 1987 with a collective college grade point average of 3.4 out of a possible 4.0. It will be some time before these new people are sufficiently trained to be able to carry a full load of responsibility. We are building a new training center at Virginia Square, Virginia, to improve our ability to train our field forces as well as those employed by the states. Even though we are not at our goal for examination frequency, the expanded work force has enabled us to complete more examinations in 1987 than in 1986. The number of safety and soundness examinations increased 14 percent and compliance examinations increased 60 percent during the past year. The need for effective supervision becomes even more critical as banks obtain expanded - 16 - powers and undertake to engage 1n various nontraditional activities. Effective supervision also is a necessity in limiting the federal insurance safety net to banks and not allowing it to expand to bank holding companies. A major innovation 1n our examination program has been the expanded use of automation and personal computers. He developed an automated examination report that is now utilized for all safety and soundness, trust, compliance and EDP examinations. Additionally, several specialty programs are available to assist our examiners with tasks ranging from APR calculations in consumer compliance examinations to analyses of capital adequacy. Personal computers have given our field staff immediate access to the data on the Corporation's mainframe computer and the tools to present current data in typewritten or graphic form. The automated report also provides the means to more accurately gauge overall time utilization and productivity trends. FAILED AND PROBLEM BANKS The condition of the banking system is generally sound although there continue to be areas of strain. Bank failures are at record levels. In 1987, 184 FDIC-insured banks failed and another 19 received financial assistance to avert failure, including 11 in the BancTexas group. Unfortunately, we have been setting new records each year, and this year is not expected to be an exception. As of April 30, there have been 59 failures and 13 assistance transactions which, inclusive of the First City and First Republic transactions, involve approximately 140 banks. This rate is about on a par with last year's but with more assistance transactions in the current mix. If the current pace continues, we can anticipate about 200 failures and assistance - 17 - transactions this year as well. It should be noted that almost 90 percent of these failures were west of the Mississippi River and banks in Texas alone accounted for over 30 percent of all bank failures so far this year. Although the trend is finally downward, the number of problem banks also is near the record level. As of April 30, 1988, there were 1505 FDIC-insured problem banks with total deposits of $289 billion, down from 1,575 as of year-end 1987 but still over the year-end 1986 number of 1484. In mid 1987, the number of problem banks peaked at 1624 with deposits of $300 billion. Of the problem banks, approximately 500 are agricultural banks and 158 are energy banks. Eighty nine percent of the banks on the current problem list are west of the Mississippi River and over 61 percent are in the 6 states of Colorado, Louisiana, Kansas, Minnesota, Oklahoma and Texas. It is Important to note that there is considerable turnover in the specific banks on the problem bank list. Since the number of problem banks peaked in mid— 1987 there have been 461 banks added to the problem bank list and 580 deleted from the list through April 30 of this year. Of the 580 deleted, 155 were the result of closings or receipt of FDIC assistance, 79 were the result of mergers and 346 were the result of improvements. The decline in the number of problem banks is primarily attributed to two factors, gradual improvement in the agricultural areas of the country and merger activity, particularly in Texas. We expect the number of problem banks to decline slowly although problems will continue to be severe in those areas dependent on the energy sector. The pattern of increases and decreases in the number of problem banks correlates with economic conditions. While much of the country and most - 18 - sectors of the economy now are experiencing relative prosperity, the differences among areas are much wider than has been experienced historically The areas west of the Mississippi River, with economies that are importantly based on energy, have pockets of severe recession or even depression. Most of the FDIC's problem banks today, and for the rest of 1988, are located in these distressed regions. The statistics contained in our Quarterly Banking Profile (Appendix A) indicate clearly the problems by geographic area. Deficiencies in bank management and policy exacerbate the natural tendency for banks to suffer from weaknesses in the economy. Historically, inept or abusive management has been a primary cause of problem banks and this remains true today. Management's underwriting standards and credit judgments must remain prudent even when the economy is strong so that the impact of inevitable economic downturns is moderated. Even though economic problems now are of greater importance than normal in explaining bank problems, management remains an important cause of most banks' difficulties. We do not hesitate to use our formal enforcement powers when circumstances warrant. In 1987, we initiated 91 insurance removal proceedings under Section 8(a) of the Federal Deposit Insurance Act, 130 cease and desist actions under Section 8(b) and 22 removal actions under Section 8(e). Numbers of these actions are down modestly from 1986 except in the case of Section 8(a) actions, which are higher due to including national and state member banks most of which are in the Southwest. The downturn in agriculture and energy has been so severe and protracted that today, in these depressed areas of the country, many banks with good records - 19 - and acceptable management are having financial difficulties. As regulators, we are using new approaches in supervising these institutions. that formal enforcement actions — situations — We believe while very useful and appropriate in many are counterproductive 1n those cases where management is acceptable, the bank's problems are the result of adverse market conditions, and the prospects for recovery are good, given a reasonable economic cycle. The FDIC seeks to work cooperatively with the management of such banks in a joint effort to restore the financial stability of their banks. Our Capital Forbearance program is an example of the approach which we believe has been useful and beneficial to both the FDIC and participating banks. As of April 30, 1988, the FDIC has approved 154 applications for capital forbearance, while denying 68. Of the 126 banks in the FDIC's capital forebearance program on March 31, 1988, 57 improved their primary capital ratio since being approved. There have been 27 banks which have been terminated from the capital forebearance program. Two of these institutions were removed because of improved financial condition and four others merged into healthier institutions. Six more of these banks failed and the remaining 15 were removed due to noncompliance with the capital plan. Banks participating in the program outside the west and southwest are improving. Many banks in the program throughout the country also are making good progress. Restoring financial health does not occur overnight but we believe that this program is a sound approach, which is doing the job it was designed to do. We will be evaluating the program and measuring its results carefully in the future. - 20 - A somewhat similar program (loan loss deferral) was authorized for agricultural banks by Congress last year. program. It is too early to determine the success of this However, as of April 30, 1988, 62 banks have applied for the program, with 15 applications approved, 10 denied and the remainder still under review. With regard to the role of fraud and insider abuse in bank failures, we believe that such misconduct contributed significantly to about one-third of the bank failures in 1986, 1987 and so far in 1988. Outright criminal conduct was responsible for 12 percent to 15 percent of bank failures. For example, from January 1985 through 1987, 98 of the 354 banks that failed were cited by examiners as having at least some element of fraud or insider abuse. Those 98 failed banks had assets of $2.7 billion and cost the FDIC nearly $676 million. Our experience since 1985, however, suggests a somewhat lessened impact of fraud and abuse compared to the late 1970s and early 1980s. The FDIC recognized a need to strengthen efforts to deal with fraud and abuse and has taken several major steps since 1984 to improve the situation. We published a list of time tested "Red Flags" and other warning signs of fraud and abuse to be used as an aid to examiners and auditors. We designated some 60 examiners as bank fraud specialists to be given specialized training in bank fraud and insider abuse. Later this year, an intensive, highly specialized training session will be held for these examiners. It will focus on criminal motivation, early detection and investigative techniques. Other training courses for examiners and liquidators have been developed or improved. We have published guidelines for banks to use in setting up or revising their codes of conduct and, earlier this year, we mailed to all of the banks under - 21 - our supervision our Pocket Guide for Directors, a copy of which is attached as Appendix C. The Guide provides directors with practical guidance in meeting their duties and responsibilities. These initiatives with respect to the bank fraud problem will help contain this ever-present problem by fostering public confidence and deterring future abuses. FAT 1TNG BANK RESOLUTION AND LIQUIDATION ACTIVITIES The FDIC is constantly seeking innovative ways of efficiently resolving failing bank cases and meeting our deposit insurance commitments. In light of the record number of bank failures over the past few years, we have been especially concerned that we maintain our sound cash position. This objective requires the prompt resolution of failing bank cases in a manner that minimizes our costs and cash outlays and results in the FDIC acquiring as few bank assets as possible. Thus, we are actively pursuing, whenever possible, whole bank transactions where the new owners of a failing or failed bank recapitalize the bank and assume all or substantially all its assets with the smallest possible contribution from the FDIC. This approach permits us to realize maximum value on the assets of the failed or failing bank, with only minimal disruption to existing borrower and depositor relationships and the community at large. In addition, as part of our SAFE cooperative program with state regulators we have arranged to give purchasers up to four weeks to examine a failing bank and decide whether they want to purchase it on an open or closed basis. In keeping with our desire to conserve cash while maximizing our recoveries on acquired assets, we have developed new initiatives to obtain maximum net - 22 - present value from liquidation assets in the shortest possible time. initiatives include an aggressive marketing program — These including bulk sales — designed to move loans and other assets back into the private sector; a stepped up management review of assets in litigation and large dollar assets; and an increased emphasis on seeking settlement on outstanding claims whenever practical rather than pursuing protracted litigation. However, we do not "dump" assets below current appraised values. As a result of these initiatives, we were able to collect $2.4 billion by liquidating assets from failed banks last year, a 38 percent Increase over the $1.7 billion collected in 1986. These efforts have enabled us to hold our inventory of managed assets from failed banks steady at about $11 billion despite a record number of bank failures with even greater record numbers in terms of dollars of failed assets involved. With regard to the "too big to fail" problem, we suggest that the answer depends in part on how one defines the "problem." It may be that governmental protection of the largest banks in different countries is a premise which, in the United States, tends to be defined in terms of the extent of deposit insurance protection. Certainly, our experience to date in resolving several large failing bank cases suggests that the costs and dislocations of failing to fully protect certain bank depositors and creditors appear unacceptable. Since this appears to us to be the case with regard to banks over a certain size — that is, depositor losses in such banks threaten the stability of a region or possibly the entire banking system — then we must seek instead to consider how to extend comparable protection to smaller institutions. - 23 - Appendix D provides some thoughts on various alternatives, all of which unfortunately have some undesirable side effects. Certainly the greatest threat to the sufficiency and viability of the deposit insurance fund is posed by the largest banks that might be considered "too large to fail." If depositors in these banks are to be fully protected, there would seem to be relatively little more cost to the fund in extending that protection to smaller banks as well. However, this would further reduce the market's ability to discipline the system and thus could further increase the burden of government supervision. As yet, we have found no alternative which satisfies the criteria of providing a level playing field between larger and smaller banks, maintains what is left of depositor discipline and protects our system when big banks fai1. As a matter of policy, and consistent with statutory criteria, we are attempting to resolve smaller failing bank cases in a manner that protects all depositors whenever possible. This approach tends to minimize some of the perceived disparate treatment between large and small banks. By attempting to extend full protection to depositors of smaller banks we also tend to reap the full benefits of stability to the banking system that such an approach entails. In a relatively small number of cases, however, we have no choice under current law but to pay off insured depositors up to the statutory maximum. The losses of uninsured depositors in these cases amounted to only a little more than $80 million last year, or less than .99 percent of the total deposits of all failed banks and banks receiving open bank assistance. When considered as a whole, our treatment of large and small failing banks is in most important respects remarkably similar. In virtually all cases, equity - 24 - holders and subordinated creditors are substantially wiped out or suffer severe losses and senior management and directors are replaced. Bank depositors and creditors receive ALL of their funds in the vast majority of cases. In fact in 1987, 72 percent of the failed bank's were handled by purchase and assumption transactions which assured all depositors 100 percent of their funds. ADEQUACY OF THE FUND The financial condition of the FDIC remains strong and stable despite a record number of bank failures and assistance transactions, including the second largest in our history in 1987. At year-end 1987, the insurance fund's net worth was $18.3 billion, a modest increase of roughly $50 million over the previous year. Based on current estimates of loss in 1988, including the loss on First Republic of Dallas, Texas, we may experience a small decrease in the net worth of the fund in 1988. The composition of the fund is as Important as the balance. At year end 1987, nearly 91 percent of the fund balance, or $16.6 billion, was represented by cash and liquid U.S. Treasury Securities. The amount of these liquid assets declined by only about $500 million in 1987 even though record demands were made upon our fund. The preservation of our cash is largely the result of the Innovation in handling failures which we mentioned previously. The flexibility and capacity represented by what is essentially cash is one reason we are confident that the FDIC fund remains adequate to handle any foreseeable problems in the banking system. - 25 - Even though the fund 1s strong and stable. 1t 1s not Increasing at a rate commensurate with the growth 1n deposits. In 1986 the ratio of reserves to Insured deposits dropped from 1.20 percent to 1.12 percent. continued 1n 1987 to 1.10 percent. This decline Until the number or size of bank failures declines from present historically high levels, 1t 1s difficult to foresee the ratio of Insurance reserves to Insured deposits Increasing. Indeed, a further decline 1n 1988 1s anticipated largely due to the continued economic problems west of the Mississippi. FDIC - FSLIC While we believe that the FDIC fund 1s sufficient to deal with problems 1n the banking system as we see them today, we do not have the financial capacity to function as Insurer of commercial banks, and restore the solvency of the Federal Savings and Loan Insurance Corporation as well. If additional funds are required by the FSLIC 1n the future, we believe they should be supplied without endangering the financial condition and capacity of the FDIC. We do not believe a merger of the funds 1s desirable under current conditions. Despite this view, we are studying various suggestions with respect to a merger 1n the event the Congress decides such action 1s required. In addition, we have offered whatever assistance we can to the FSLIC 1n terms of administration, asset liquidation, developing supervisory policies and procedures, training or other operational assistance. Although there are some problems 1n the banking Industry, there 1s no Inventory of operating FDIC-insured insolvent banks. and commercial bank problems — The fund 1s adequate, outside recognized troubled areas — appear to - 26 - be stabilized or on the decline. With new products banks could further improve their safety and soundness. We believe that addressing the FSLIC problem should entail an overview of the workings of the entire federal deposit insurance system. great importance. This issue is of Accordingly, we have formed a group of knowledgeable people from both within and outside the FDIC to study, and make recommendations in, this area. our study — We have asked for input from all interested parties. "A Federal Deposit Insurance System for the 90s" — We expect will be completed before year-end. CONCLUSION The banking industry is experiencing a stressful period of evolution. There are serious problems and challenges for banks, bankers the regulators and especially for the establishment of appropriate public policy by the Congress. The questions and problems are not easily answered but they can be managed. Mistakes may occur, but correcting and learning from mistakes is often better than inaction. Actions taken now will shape the health and worldwide competitiveness of U.S. banking into the next century. We look forward to cooperating with the Congress in whatever way possible to insure that the industry remains the safe and sound backbone of the U.S. economic system and a capable competitor in world markets. TABLE 1 Number and total deposits of troubled (CAMEL rating of 4 and 5 and pre-CAMEL equivalents) institutions TOTAL NUMBER OF FDIC-INSURED PROBLEM COMMERCIAL BANKS AND THRIFTS AND AGGREGATE TOTAL DEPOSITS BY YEAR (000,000 omitted) YearEnd # 0 - $300 Million Total Oeposits $300 - 1,000 ___Million___ Total f Deposits Over $1 Billion Total Deposits f Total Total Deposits 4/30/88 1,444 $ 60,651 39 $ 21,789 22 $206,413 1,505 $288,853 1987 1,509 63,743 42 22,461 24 196,246 1,575 282,450 1986 1,412 55,289 46 24,348 26 191,683 1,484 271,320 1985 1,069 41,317 41 23,217 30 132,593 1,140 197,127 1984 778 31,031 38 20,129 32 134,949 848 186,109 1983 591 26,838 31 16,513 20 85,740 642 129,081 1982 332 12,759 21 10,119 16 34,460 369 57,338 1981 197 5,659 15 9.423 11 27,482 223 42,564 1980 206 4,599 7 4,860 4 12,185 217 21,644 1979 274 6,995 11 6,559 2 6,763 287 20,317 1978 32 2 8,404 14 7,668 6 48,069 342 64,142 1977 348 10,036 13 7,307 7 44,561 368 61,904 1976 361 11,286 10 6,037 8 41,830 379 59,153 1975 303 7,641 7 3,955 2 6,517 312 18,113 1974 177 4,525 5 3,116 1 1,420 183 9,061 1973 154 2,806 2 1,499 0 0 156 4,305 1972 189 3,141 3 2,192 0 0 192 5,333 1971 239 3,504 2 1,453 0 0 241 4,957 1970 251 3,613 0 0 1 1,076 252 4,689 Source : FDIC Problem Bank List. TABLE 2 CLOSED BANKS FDIC INSURED INSTITUTIONS BY SIZE (OOO omitted) YearEnd 4/30/88 0 - $300 ____ Million____ Total # Assets $300 - 1,000 ___Million___ Total # Assets 58 $2,010,411 1 1987 181 5.644,359 1986 136 4,787,971 1985 116 2,851,969 1984 77 2,371,211 1 391,800 1983 43 1,954,397 1 778,434 1982 31 749,647 2 1,497,159 1981 7 1980 Total Total Assets 590,700 59 $2,601,111 3 1.277,618 184 6,921,977 1 561,013 138 6,965,800 116 2,851,969 78 2,763,011 45 4.136.9M 33 2,246,806 103,626 7 103,626 10 236,164 10 236,164 1979 10 132,988 10 132,988 1978 6 281,495 7 994,035 1977 6 232,612 6 232,612 1976 15 627,186 16 1,039,293 1975 13 419,950 13 419,950 1974 3 166,934 1 3,655,662 4 3,822,596 1973 5 43,807 1 1,265,868 6 1,309,675 1972 1 22,054 1 22,054 1971 6 196,520 6 196,520 1970 7 62,147 7 62,147| Source: FDIC Annual Reports 1 1 $ # Over $1 Billion Total Assets 1 1 $1,616,816 1,404,092 712,540 412,107 TABLE 3 OPEN BANK ASSISTANCE FDIC INSURED FINANCIAL INSTITUTIONS BY SIZE (000 omitted) 0 - $300 Million Total Assets YearEnd # $300 - 1,000 Million Total Assets 2 $1,285,107 Over $1 Billion Total Assets // Total 2 $41,200,000 13 $42,999,300( 9 2,551,098( 4/30/88 9 $514,193 1987 7 122,580 1986 6 220,694 1 500,000 1985 2 197,879 1 413,948 1 1 513,400 1984 1983 2 390,000 1982 2 205,203 1981 2 2,428,518 Total Assets 7 720,694 5,277,472 4 5,889,299 1 35,900,000 2 36,413,400 1 2,500,000 3 2,890,000 4 2,642,682 3 6,537,724 9 9,385,609 1 899,029 2 3,856,405 3 4,755,434 1 5,500,000 1 5,500,000 1 350,000 1 1,300,000 1 9,300 1980 1979 1978 1977 1 1976 305,000 1975 1974 1973 1 1972 1 1971 1,300,000 9,300 1970 Source: FDIC Annual Reports (A) Includes the 70 banks of First RepublicBank Corporation and the 52 banks of First City Bancorp System as one institution each. (B) Includes the 11 banks of BancTexas System as one institution. TABLE 4 CLOSED BANKS AND OPEN BANK ASSISTANCE BY FDIC FDIC INSURED INSTITUTIONS BY SIZE (OOO omitted) 0 - $300 Million Total Assets YearEnd 1 $300 - 1,000 Million Total Assets 1 # Over $1 Billion Total Assets Total // Total Assets 72 $45,600,411(A) 67 $2,524,604 3 $1,875,807 2 $41,200,000 1987 188 $5,766,939 3 $1,277,618 2 2,428,518 193 9,473,075(B) 1986 142 5,008,665 2 1,061,013 1 1,616,816 145 7,686,494 1985 118 3,049,848 1 413,948 1 5,277,472 120 8,741,268 1984 77 2,371,211 2 905,200 1 35,900,000 80 39,176,411 1983 45 2,344,397 1 778,434 2 3,904,092 48 7,026,923 1982 33 954,850 6 4,139,841 3 6,537,724 42 11,632,415 1981 7 103,626 1 899,029 2 3,856,405 10 4,859,060 1980 10 236,164 1 5,500,000 11 5,736,164 1979 10 132,988 10 132,988 1978 6 281,495 7 994,035 1977 6 232,612 6 232,612 1976 15 627,186 17 1,389,293 1975 13 419,950 13 419,950 1974 3 166,934 1 3,655,662 4 3,822,596 1973 5 43,807 1 1,265,868 6 1,309,675 1972 1 22,054 1 1,300,000 2 1,322,054 1971 7 205,820 7 205,820 1970 7 62,147 7 62,147 4/30/88 Source: 1 2 712,540 762,107 FDIC Annual Reports (A) Includes the 70 banks of First RepublicBank Corporation and the 52 banks of First City Bancorp System as one institution each. (B) Includes the 11 banks of BancTexas System as one institution. 1M7 fourth COMMERCIAL BANKING PERFORMANCE — FOURTH QUARTER, 1987 • • • • • • • U.S.BANKS POST LOWEST RETURNS SINCE THE GREAT DEPRESSION 19SrSEXTRAORDINARY LOAN LOSS PROVISIONS ACCOUNT FOR DROP IN PROFITS MIDWESTERN BANKS SHOW SIGNIFICANT IMPROVEMENT SOUTHWESTERN BANKS SUFFER LARGE LOSSES FOURTH QUARTER OPERATING INCOME UP SHARPLY FROM YEAR-EARLIER LEVELS NUMBER OF BANKS ON PROBLEM LIST DECLINES — FIRST TIME SINCE 1981 SIGNIFICANT IMPROVEMENT IN INDUSTRY PERFORMANCE EXPECTED IN 1988 Commercial banks earned $3.7 billion in 1987, down nearly 80 percent from the $17.5 billion earned in 1986, in their worst year for profitability since the Great Depression. Their return on assets of 0.13 per cent and return on equity of 2.56 percent were the lowest levels since 1934. These results had been an ticipated since the second quarter, when the na tion’s largest banks began setting aside sizable reserves for troubled loans to developing countries (LDCs). The soaring loan-loss provisions, over 67 percent higher than in 1986, fully accounted for the banking industry’s year-to-year drop in earnings. Loan-loss provisions attributable to the international operations of U.S. banks were $20.6 billion, $18 billion higher than a year ago. Absent the extraor dinary reserving for LD C loans, aggregate loan loss provisions would have declined $3 billion from a year ago, and net income would have been roughly equal to 1986's level. Chart Ptonnèng Outan ■MMO W Mcp •MK1 A — Returns on Assets and Equity at insured Commercial Banks 1835-1987 Chart B — Quarterly Net Income of FDIC-lnsured Commercial Banks, 1984— 1987 The loan-loss provisions had the positive effect of raising the aggregate allowance for loan and lease lo sse s 71 percent. At year-end, the ratio of the loss allowance to loans stood at 2.70 percent, compared to 1.65 percent at the end of 1986. The ratio of equity capital to assets fell by 16 basis points to 6.05 per cent, while the ratio of primary capital (which in cludes the lo ss allowance) to assets increased by 47 basis points to 7.69 percent. Nonperforming assets were up 29 percent from a year ago, largely due to the impaired status of LDC loans, ending the year at 2.56 percent of total assets. Most of the growth in nonperforming assets took place in the first quarter of the year; nonperforming assets shrank by $1.5 billion in the fourth quarter. The possibility that some nonaccruing LD C loans may return to accrual status in 1988 increases the poten tial for further reductions. Fourth quarter operating income was $3.2 billion, up over 25 percent from the fourth quarter of 1986, despite loan loss provisions of $7.7 billion that were nearly 12 percent higher than the year-ago period. In terest margins, which narrowed for the full year, im proved slightly during the second half of the year. They were especially strengthened in the fourth quarter in the wake of the October stock market decline, as banks enjoyed a large inflow of deposits and interest rates fell. Banking sector deposits, up only 2 2 percent for the year, grew at an annualized rate of 11.7 percent in the fourth quarter. The events of Black M onday also triggered a surge in loan de m and a s financial services firms sought to maintain liquidity. The largest banks were the greatest beneficiaries of the flight to quality; they also ex perienced a marked increase in noninterest income in the fourth quarter, especially from foreign ex change operations. Chart C — Quarterly Net Interest Margins ^983— 1987 N at Im trt t t margin (H ) 1M 3 19M IM S 'M S 1M7 A sse t growth was less than two percent during 1987, the smallest annual increase since 1948, and com mercial loans were down two percent from yearearlier levels. The four percent growth in total loans w as driven by increased real estate and consum er lending. Real estate loans outstanding at year-end actually exceeded banks’ commercial loans by $10 billion, reflecting the restructuring of banks' tradi tional operations in the face of increased competi tion. M uch of the increase in real estate lending was in the form of hom e equity loans, which stood at nearly $33 billion at year-end. T he outlook for 1988 is cautiously optimistic. Bar ring any new shocks, loan lo ss provisioning should be lower than usual this year, and profitability at money-center and regional banks will be much im proved. The effectiveness of banks' efforts to ex pand noninterest incom e so u rc e s and curb operating expense growth will be an important determinant of profitability. Com munity banks show ed improved results in 1987, with return on assets up 43 basis points at banks smaller than $100 million, and 22 b a sis points for banks in the $100-to-300 million range. Unaffected by overseas loan problems, both of these size groups, represen ting 93.5 percent of all banks, saw charge-offs and lo s s provisions decrease by 10 to 25 percent from year-earlier levels. Sm aller banks outside the Southw est should continue to show strong or im proving earnings in 1988. The Southwest will continue to be a major source of earnings weakness. The levels of problem banks and failures remain high and the region’s banking sector continues to operate at a loss. For the full year, 36 percent of the banks in the region were unprofitable and return on equity was a negative 11.81 percent. Persistent growth of nonperforming assets, despite high levels of loan charge-offs, points to more of the same this year. In contrast, the worst of the problems experienced by banks in the Midwest are behind them, and they can be expected to return soon to more traditional levels of profitabili ty. The number of Midwest bank failures was down slightly, from 48 to 40, but the number of unprofitable banks was almost cut in half. Loan charge-offs declined 22 percent compared to 1986, while at the same time, asset quality improved, as nonperform ing assets fell 6.5 percent. Midwestern banks show ed the greatest improvement over 1986 results, with a 78 percent increase in net operating income on a year-to-year basis. The results for the Northeast and, to a lesser ex tent, the Central and West regions, were dominated by the loan-loss provisioning at the big moneycenter banks. Actions by the largest banks over shadowed generally strong performance by banks in the Central region. Loan lo ss provisions were almost twice 1986 levels, halving net income, but actual loan lo sse s grew by only five percent. The Central region had the lowest proportions of both failed and unprofitable banks, and the second highest rate of loan growth. The Southeast enjoyed the strongest loan demand of the six regions, as loans grew 11.3 percent and assets by 6.5 percent. That demand, combined with strong net interest margins, yielded a regional-high return on assets of 0.93 percent. Chart D — Number of Insured Commercial Banks s. *•*.., on pDIC “Problem List" The number of banks with full-year earnings losses fell 15 percent to 2.366 in 1987, while the number of "Problem" banks leveled off, after peaking at mid year. On the whole, the number of banks on the "Problem List” increased by 102, 7.0 percent higher at the end of 1987 than 1986. This increase was the lowest, both in number of net additions and in percentage terms, since 1981. The outlook for 1988 is for fewer troubled institutions, but the number of failures is not expected to be significantly lower than 1987’s record. Industry profits for 1988 should be close to the $17.5 billion earned in 1986, as banks return to a more normal pattern of operations. Table I. Aggregate Condition and Income Data, FDIC-lnsured Commercial Banks (dollar figuras in millions) Preliminary 4tn Otr 1967 Num ber of banks reporting............................. Total employees (full-time equivalent). . 12.654 1.554,885 3rd Otr 1987 4fh Otr '966 13.851 1354.142 14200 1.563.057 -3 8 -0.5 S2.941.082 515365 600378 335.696 31.607 V9 163 - -2 0 44 3e Chance 364-674 CONOmON DATA. 49.429 1.778264 450.623 396.452 373.089 S2.942.652 579.046 580375 341329 31.066 265.778 1.796.094 47.407 1.750.687 446390 387372 358203 Total liabilities and capital................................ Nomnterest-beanng deposits................... Interest-beanng deposits . . ...................... Other borrowed fu n d s ..................................... Subordinated d e b t ............................................. All other liabilities............................................ Equity ca pita l......................................................... S2.996.428 479.073 1.853.600 361351 17.586 105354 181264 S2.942.652 450361 1316254 367.418 17328 110375 180.416 S2.941.082 532.347 1.751.121 358.964 16.993 99.411 Primary Capital............................................................ Nonperforming a s s e ts ...................... .................. Loan commitments and letters of credit Domestic office a s s e ts ......................................... Foreign office a sse ts............................................... Dom estic office deposits...................................... Foreign office d e p o sits ................................... Earning A s s e ts ............................................................... 234.471 231.492 75.914 773389 2319.010 423.642 1.922217 344396 2384.449 214304 57.667 751.859 2.532352 406.730 1.969.673 313.796 2346,897 Preliminary 4th Otr 1967 4th Otr 1966 74390 792.136 2.572.769 425.649 1.991.066 341.607 2.625339 Preliminary Full Year 1967 INCOME DATA Full Year 1966 Total interest in c o m e ............................................... Total interest e x p e n s e ......................................... N e t interest in c o m e ......................................... Provisions for loan lo s s e s ................................ T o ta l noninterest in c o m e ................................... Total noninterest e x p e n s e ................................ Applicable incom e t a x e s ................................... • N e t operating in c o m e ...................................... Seeunties gam s, n e t ............................................... Extraordinary gains, n e t ...................................... N e t In c o m e ................................................................ S244.695 144.810 99.885 36.965 41,490 96.933 5.425 2.052 1,436 219 3 .70 7 S237.806 142.824 94.982 22.075 35.890 9 0247 5.288 13262 3,950 274 N e t c h a r g * o f f s ............................................................ N e t additions to capital s to c k ....................... C a s h dividends on capital s to c k ................ 15.901 2.506 10.620 Tabi« II. % Change 2.9 14 273.102 1.756.650 28.903 1.727.747 463327 357323 392.185 182246 -7 2 -4.8 4.0 71.0 29 -2.8 109 -4 9 19 1 S2.996.428 599.135 568.971 350.361 29,317 259.909 1,827.693 Ô O Total A s s e ts ............................................................... Peal estate lo a n s ......................................... Commercial & industrial loans Loans to individuals...................... — Farm lo a n s ......................................................... Other loans and le a se s.......................... Total loans and leases............................. L E S S : R e sen « for lo s s e s .................... N e t loans and leases..................................... Temporary investm ents................................ Securities over 1 y e a r ................................... All other a s s e ts ................................................... 5.9 07 3.5 62 -0.5 9.4 29.0 54 1.6 4.1 1.1 8.9 3.0 % Change 9.852 24.196 494 .17 .4 8 6 2.6 -84.5 -63.6 -20 .1 -7 8 .8 $64.270 36.392 25.878 7.725 12.070 25.691 1.381 3.151 42 38 3231 2.510 961 61 3.532 14 3 66 11.6 225 62 179 6 255 -9 5 6 -3 77 -8 5 16350 32 44 9228 -3 .9 -2 2 .7 15 1 5253 1.392 3.650 5.448 2.251 3245 -3.6 -38.2 12.5 5.2 6 75 15.6 74 57.865 33.593 24.272 6.924 111 Salactad Indicators, FDIC-lnsured Commercial Banks 1961 Return on assets............................................ . 0.78V. . 1982 0 .7 1V . 1963 0.66 V . 1964 0.65 V . 1966 0 70 N 1966 1967 0.64 V . 0 13 V . Return on e q u ity .............................................. 1336 12.11 10.70 10.73 113 1 1018 256 Equity capital to a s s e t s .......................... 563 567 6.00 6 15 620 621 605 Primary capital r a tio ................................... 6.39 647 1.85 6.91 19 7 591 18 7 769 N/A 659 1.97 722 Nonperforming assets to assets . . 195 246 089 N et chargeoffs to lo an s.......................... 037 056 0.67 099 936 8.12 6 75 0 76 711 084 Asset growth r a te ......................................... 8.86 762 195 N et operating income g row th............. -0 6 2 -369 340 630 1.196 1530 1691 2453 -16 2 0 2784 -84 53 Num ber of unprofitable b a n k s ___ 76 0 741 Num ber of problem b a n k s ................... 196 326 603 800 1.096 1.559 Num ber of failed/assisted banks . . 7 34 45 78 118 1.457 144 N /A — N ot available 2.366 201 Table HI. Preliminary Fourth Quarter 1987 Bank Data (Dollar figures in billions, ratios in % ) Asset Size Distribution All Banks N u m b e r o f b anks r e p o r tin g ................................ T o ta l a ss e ts ........................... Total d e p o s its ..................... ... */• total b a n k s ......................... A s s e t share ( '/ • ) .................. D e p o s it s h a m (•/•) — Num ber of unprofitable b anks . . . N u m b e r o f tailed! assisted b a n k s .................. 13,654 $2.9984 2 .3 3 2 7 10 0 .0 % less than S100 $100300 Million Million 10 8 9 1 $392-6 13001000 $15 Millon Billion Geograonic Distnbution Greater than $5 Billion 74 Ten Largest Banks 18 7 6 $302.8 266.1 13 7% 10.1 1 1 .4 535 S 2 72 2 22 6 4 19 % 9.1 9 .7 268 $589.6 455.1 2 .0 % 19.6 19.5 0 .5 % 254 238 10 $679.9 496.2 0 .1 % 22.7 21.4 $761.3 5364 EAST Northeast Region 1.079 $ 1 .1 7 9 7 865.0 7 .9 % 39.3 3 7.1 Southeast Region 1.916 $406.5 323.2 14 .0 % 13.6 13.9 WEST Central Region Midwest Region 3.042 u rn 3230 $2084 16 3 7 2 3 7% Southwest Region 7.0 7.0 2.860 $2799 2293 20.9% 93 9.8 l| 11 1! 4 100.0 100.0 350.5 79 8% 13 .1 15.0 3 ,4 78 38 55 28 7 78 35 21 2 160 418 395 746 1288 SO 46 2 2 0 0 0 1 0 1 14 26 9 .8 6 % 9 .8 3 % 9 .8 4% 9 .79 % 9 .4 4 % 9 .83% 8 9 3% 5.89 3.9 7 5.34 4.49 2.09 387.1 222% 16.0 16.6 H 1 Yield C ost earn N e t il Net n exp« essa Net o incoi Retun Retun N et o loan; Perform ance ratios (annualized) Yield o n earning assets C o s t o f fu n d in g earning a s s e t s .................. N e t interest m argin . . . N e t noninterest e xp ense to earning a s s e t s .......................................... N e t operating in com e to a ssets — Re turn o n a ss e ts — Re turn o n e q u i t y .............. N e t charge-offs to loans and leases — 1 0 .1 1 % 10 .46 % 10 .18 % 10 4 8 % 1 0 .1 7 % 5.35 4.49 558 453 5.92 454 623 3.95 714 3.34 6.53 3.64 545 434 5.56 3.88 5.56 427 5.61 3.32 5 (year-t 4 3 .12 2 .76 272 2 .47 2.01 1.06 15 2 2.45 206 2.02 273 z 042 043 7 .1 4 084 023 2.65 0.62 0.63 8 15 0.51 0.53 7.56 0.40 041 1.04 18 7 25.98 0.57 0.61 112 7 0.78 020 11.5 8 048 048 723 0 .7 7 0 74 9.89 -1.0 8 - 1 .1 2 -18 .0 2 0 0 6.32 -0 2 0 -0 .19 -3.68 Net cl Interet Interet Net in Loan I Nonim Noninl 1 .1 5 15 5 1.16 12 1 1.32 175 0.39 0.71 1.14 1.10 19 9 2.43 2 .7 0 % 18 3 % 15 0 % 1.6 0 % 1.8 5 % 293% 4.6 5 % 3 15% 12 8 % 224% 2 2 1% 3.09% 3 1.8 7 19 3 641 38 8 4.24 755 2 44 5 43 75 1 1.04 12 7 1.8 7 6.81 7.53 653 7.80 7.46 858 5.80 6.07 7.55 5 7.36 228 5 .11 7.01 10, Growl ó i 7 irv • Condition R atios L o s s allow ance to loans and l e a s e s ___ N o n perform ing assets to a s s e t s ................................... E q u ity capital r a tio ___ Prim ary capital r a tio . . . N e t loans a nd leases to a s s e ts ..................... — N e t assets rephceabie in one year o r less to a s s e ts ................................... 3 2.48 6.05 7.6 9 2.09 8.61 9.36 1.75 7.62 8 35 6.88 7.69 59.31 5 1.10 56.61 60.91 63.08 61.21 5 9 19 59.61 60.14 57.56 5 3 15 53.90 65 -7 .2 6 -9 4 6 -7 .7 3 -7 .4 3 -8 2 1 -8 8 1 -4.06 -6 0 5 -1 2 .1 1 -4 60 -1 3 .6 7 -11.3 9 -3 1 .9 % 3.0 40 7 1 .0 -1 6 29.0 22 4 .0 % 4.6 6.9 10 .7 -3 3 .4 0.4 4 .1 48 48 2 .4 68 -3 7 .1 84% 10.0 92 98.8 113 4 - 1 .8 % - 1 .3 -3 .0 14 0 7 -6 2 2 49.6 02 -1 6 .3 14.6 212 24 -28 .0 452 80 126.3 89.5 7 G ro w th Ra te s (year-to-year) A s s e t s ............................................. Ea rn in g a s s e t s ..................... Lo a n s and le a s e s .............. L o s s re s e rv e ............................ N e t c h a r g * o f f s ..................... N o n p e rfo rm in g assets . D e p o s i t s ...................................... E q u ity c a p i t a l......................... Interest in com e . . . . . . Interest e x p e n s e .................. N e t interest in c o m e . . . L o a n loss e x p e n s e ___ N on in tere st in com e . . . N on intere st e xp e n se . . N e t operating incom e . N e t in c o m e ............................... -OS 1 1 .1 14 .3 6.6 1 1 .6 225 67 7 55 -8 5 48 4 .7 N /M N /M 5 .9 % 78 10.4 16.6 -2 1 .0 95 5.4 88 98 81 10 .1 -3 2 2 68 6.4 16 3 8 75 2 7 .7 % 98 12.0 218 - 1 .4 19 7 6.1 8.6 115 13 .1 95 -2 5 88 9.5 262 -0 4 94% 10 .7 14.9 435 42.9 4 1 .7 9.1 1 1 .7 25.4 282 22.0 392 36.8 225 -1 0 8 -2 9 3 583 98 0.8 24.9 315 15.6 157.0 232 18 5 N/M N/M 4 1% 5.1 5.9 123.8 22 645 4 .7 -2 7 19.9 2 7.1 88 42.6 442 13 2 -3 .0 -1 3 4 65% 76 112 18 2 445 15 7 59 10.3 11.6 13 6 92 14 1 15.5 45 339 37 3 .5 % 4.1 6.9 65.6 237 0.9 4.3 -0 2 9.0 10.1 7.6 75.5 202 44 - 1 7 .1 -28.5 1.0 % 14 32 16.9 -13 .4 -6.5 1.5 57 45 17 52 -28.9 -5 7 02 833 267 -7 .3 % -7 4 -8 4 19 7 -32 2 315 -7 0 -1 2 .1 -4 9 6 il * -4 4 -5.6 -3 2 2 1.3 -0 1 N/M N/M 0.6 4 R E G l O N S : N orthe a st — C on n ectic u t, Deieware. Distríct of C olum pia. M am e. Maryiand. M assachusetts. N e w Hem pshire. N e w Jersey. N ew Y o * . Pennsytvan!* Puerto R ic o . R h o d e (stand. Verm ont S o uthe ast — Alá b em e , F lo n d a . Georgia. M ississippi. N o rth C aro lin a South C aro lin a Tennessee. Virginia W est Virginia Central — Illinois. In d ia n a Ke n tu ck y, M ichigan. O h io . W isconsm M idw e st — lo w a Ka nsas. M in n e s o ta M tssoun, N e b ra sk a N orth D a k o ta South Dakota S o u th w e st — Arkansas. Lo u is ia n a N e w M éxico. O k ia h o m a Texas W e s t — A ta s k a A n zo n a , C a iiio m ia Colorado. Haw aii. idano. M o n ta n a N e v a d a O re g o n . Pacific Isiands. U tah. W ashington. W yom m g Chi Table IV. Preliminary Full-Year 1987 Bank Data (Dollar nguns in billions, ratios in % ) Asset Size Distribution ► All Banks Num ber of unprofitabia b anks......................................... Num ber o f tailed/ assisted b a n k s .............. Lass than $100 $100300 Million MiHion $3001000 Million $1-5 Billion Geographic Distribution Gruter than $5 Billion Ten Largest Banks EAST WEST Northeast Region Southeast Region Central Region MiCwest Region Southwest Region •Vest Region 23 6 8 2470 174 62 33 18 9 104 230 184 412 1.038 398 201 186 12 3 0 0 0 3 6 7 40 116 33 Performance ra te s Yield on earning assets C ost o f fu n d in g earning a s s e t s ............... N e t interest m a rg in . . N e t noninterest exp e nse to e a rn in g a s s e ts ............... ........................ N e t operating incom e to a s s e t s . . . Return o n a s s e t s ___ Return o n e q u i t y ------N et charge-offs to loans a nd le ase s . . . 9 .5 3 V . 9.65 V . 949V. 9.66 V . 9 .6 2 % 945% 9 .9 9 % 9 .7 5 % 9 .5 4 % 9 .1 9 % 9 .6 5 % 8 .7 0 % 9 .8 3 % 5.6 4 349 522 4 .4 3 4 17 4 .4 1 523 4 .4 3 544 428 5 .7 3 342 642 3 .1 7 623 342 5 .1 7 447 5.36 343 545 420 5.38 322 5 10 4 .73 2 .1 6 246 246 243 247 1.9 8 14 1 1 .7 4 248 213 1.9 5 243 293 0 .0 7 0 .1 3 2 .5 6 043 048 6 .7 0 0 .7 5 041 10 4 1 0.6 2 0 .6 7 9.59 043 0 .5 7 8 .7 7 -0 .0 5 -0 .0 0 -0 .0 1 -0 4 9 -0 4 1 •18 2 9 -0 2 2 -0 .1 3 -2 .9 6 048 0.93 1 7 .1 6 0 .4 1 0.45 828 0.66 0.68 1 1 .4 8 -0 .6 6 -0 .6 1 - 1 1 .8 1 -0 .0 5 -0 .0 1 -0 .3 2 0 .8 9 1 .1 4 041 0.95 0.92 14 4 0 .6 7 0.61 0.69 0.68 147 1.99 1.08 1 6 .1 V . 6.0 1.6 1 1 .6 54 13 .0 1 0 .7 13 .6 -0 .9 2 4 .4 % 114 7 .4 16 .6 3 5 .7 4 0 .6 % 1 1 .6 112 12 1 14 14 1 8 .7 15 .9 N /M N /M -2 6 .9 % 3.8 64 - 1 .1 1 7 3 .8 23.6 9 .1 N /M N /M 7 .5 % 10 2 1 1 .6 7 .7 2 0 3 .7 2 74 12 6 N /M N /M 52% 12 - 1 .9 64 96.1 10 .1 54 -4 2 3 -4 5 .5 - 2 2 .4 % -1 2 8 % - 1 1 .5 -12 9 -9 .1 - 1 7 .6 44 -0 .4 N /M N /M - 1 1 .3 % •2 .6 -8 .3 4 .4 Grow th R a te s (ye a r-to -ya a r) N et c h a r g e c t f s ............... interest i n c o m e ............... Interest e x p e n s e ___ Net interest in c o m e . . Loan loss a s p e n s # .. . Noninterest in c o m e . . Noninterest e x p e n s e . N te p p e ra tin g in c o m e \ J p n c o m e .......................... - 3 .9 V . 2 .9 1 .4 52 6 74 15 .6 7 .4 -8 4 4 - 7 8 .8 -2 1 2 V . -1 0 4 V . -1 2 34 - 5 .7 -1 4 4 .9 94 -2 3 .8 - 1 6 .1 10 4 114 62 9.0 5 1 .0 284 12 4 114 22 .9 15 .5 - 3 .7 - 1 2 .1 248% 5 .1 1.4 94 23.6 114 7 .0 10.6 04 - 1 .6 - 4 .7 26 -1 9 2 12 4 4 .1 7 7 .6 - 1 .4 429 20 4 .3 N /M N /M NOTES TO USERS COMPUTATION METHOOOLOOY FOR PERFORMANCE AND CONOTDON RATIOS All ncorm figure« used in cNcuteting performance ratio« represent «mount* for that penod. annualized (multiplied by the number of periods m a yew t*‘l. * * * t *^3 tfCxHty used in eaieuiating performance ratio« represent average amounts for the period (begmmng<foenod amount plus *n*of<p*nod mount plus any psnods in between, divided by the total number of periods). All «se t and liability figures used m calculating the condition redos represent amounts as of the end of the quwer. DEFINITIONS Federal regulators assign to each financial institution a uniform composite rating, based upon an evaluation of financial and operational entene The rating potato on I tc jft of 1 to S in tsconding Ofdtr of supttviiofy coocom. “ProWtrrr bonks art those institutions with financial. operational or manaQsnjs weaknesses that psaan their continued financial viability. Depending upon the degree of ns* and supervisory concern, they v s rated either -A" or "S" penlng Aseats—all loans and other investments that earn interest, dividend or fee income. on Earning A ssets—total interest, dividend and fee «com e earned on loans and investment» as a percentage of average *»m ng assets of Fundtag Earning Ass et«—total interest expense paid on deposits and other borrowed money as a percentage of average evnmg assets, intsrset Margin—the difference between the yield on earning assets and the cost of funding them, i«.. the profit margin a bank awns on its toms md «vestments [’** Nommenet Expense total noninterest expense, excluding the expense of pranding for loan tosses, toss total noninterest « c ome A measure of bmks' ovemesd costs ^U einees? *ncoin* “ ,ncom* before gams (or tosses) from securities transactions and from nonreeumng items. The profit earned on omks regut» bwwon Assets net income fndudtog securities transactions and nonrecurring items) as • percentage of average tot» assets. The basic yardstick of b»ik profitability on te sty —net income ae e percentage of everags total equity capital. Chaigs-^fu —to t» toana and leaesa charged off (rammed from balance sheet because of uncoUectibility) during the quarter, tots amounts recovered on toons and t e n charged off. Aaaota—ttw awn of loans p*al<hje 90 days or more, loans in nonaoerual status and noninvestment re» «stats owned other than bank premises. Capri»—tot» equity capit» piue the »towance for loan and toaae tosses plus minority interests in consolidated subsidiaries plus quWfymg mandatory convertible “ (cannot exceed 20 percent of tot» pnm»y capital), toes intangible assets except purchased mortgage servicing ngnts. Leans end Leases—tot» loans and leases less unearned income »id the »towance for io»i and lease tosses. Assets Aephoaabie In On* Year or Lees—»1 assets with interest rates that art repnesabto « on* y»v or toss plus assets with rem»mng maturity of one y e» or less. rj* *** •'•btiities that art repriced or due to mature with« one y e» of the reporting date A positive v»u* indicates that banns' «com e from assets «s more sensitive to ~ms « interest rates than is the expense of their liabilities, and wee versa for a negative v»ue. pporary investments—the sun of interesttoeWng balances due from depository institutions, fedsr» hinds sold and resold, trading-account assets and investment ^unties with remaining maturities of one y e » or lest. E«penee—the quarterly addition to the io»i toss teserve that will keep the balance of the reserve adequ»« to absorb the ouw ers anticipated loan tosses. *3u«sts for copigs of and subscriptions to the FDIC Quarterly Banking Profit# should ba mada through tha FDIC's Offica of ta Communications, 550 17th Strsat N.W„ Washington, O.C. 20429; tsisphons (202) 89*6996. APPENDIX B DRAFT— MAY 12, 19SS EMERGENCY CONSOLIDATIONS Analysis Kany bank holding companies coordinate their banks' activities so closely that the bank holding company system effectively operates as a single banking enterprise. Yet vhen a bank within the system fails, the FDIC must deal with such bank individually. In effect, the FDIC must act as if there is no connection between the failed bank and the rest of the system. Some bank holding companies and their creditors have seen a way to turn this situation to their advantage. By concentrating poorer assets in a single bank, and then letting that bank fail, the bank holding company can shift the cost of those assets— the loss it would otherwise be forced to realize on them— to the FDIC. This technique amounts to a misuse of the FDIC's resources, which can do substantial harm to the Federal safety net for depositors. Recent experience has also shown that creditors and shareholders can interfere with the Federal safety net in other ways as well. In many cases it is in the best interest of the local community and of the banking system for the FDIC to arrange open-bank assistance transactions. These transactions are designed to avoid the disruption that a bank failure would inflict on a community. Cpenbank transactions may require the consent of creditors and shareholders of the holding company, however. In a number of cases the creditors and shareholders have delayed these transactions in an attempt to receive greater consideration than they would have been entitled to if the bank had failed. These creditors and shareholders have imposed added costs on the Federal safety net because of the FDIC's desire to prevent the closing of the bank. The bill seeks to address these problems by establishing a special procedure to deal with failing banks that belong tc multi-bank holding companies. The procedure is designed to improve the asset quality of a failing bank within a multi-bank system without affecting the health of the system as a whole. The process begins when a bank's charterer— State or Federal— notifies the FDIC that a bank is in danger of failing, and asks the FDIC to start the process. The FDIC then decides whether the special procedure will reduce the risk to the FDIC fund, or alternatively, whether local economic conditions are such that resort to the special procedure is justified. If so, the FDIC may then certify to the Federal Reserve Board that it is necessary for the Board to exercise the new special powers made available under the bill. Upon making the certification, the FDIC may specify one of the following new powers for the Board to exercise: — The Board can order more of its healthy — The Board can order the failing bank; — The Board can order core of its healthy the holding company to transfer the stock of one or banks to the failing bank; the company to merge one or more of its banks into the company to merge the failing bank into one or banks; and/or - 2- — The Board say order the company to provide such assets or services to the failing bank as may be needed for the bank to continue to conduct its normal business operations— e.g., bank buildings or data processing services. The FDIC's recommendation may specify that the Board may exercise some or all of these povers. The Board say only exercise the powers that the FDIC has specified. On the other hand, the FDIC cannot cospel the Board to take the action that the FDIC has recossended. The Board must sake a reasonable effort to see that the transaction does not involve the transfer of sore assets to the failing bank than the bank needs to regain its health, taking into account the circumstances of the case. The FDIC say recommend a transaction, and the Board say order it, even if the assets so transferred to the failing bank are not sufficient to restore the bank to solvency. Before the FDIC may sake any recommendation to the Board, the FDIC must provide advance notice of the proposed transaction to every charterer— State and Federal— of every bank that would be involved. Each charterer has 48 hours to object to the recommendation. If any charterer objects within that time, the FDIC may only issue the recommendation if the FDIC's board of directors acts unanimously. The Board has complete control over the specifics of any transaction that it orders pursuant to the FDIC's recommendation. The Board controls the procedures and scheduling. Ko party may challenge an order issued by the Board or any action required by the Board in connection with any such transaction. Anyone who may be harmed by a Board-ordered action can take advantage of the bill's compensation provisions, but may not prevent the transaction from going forward. Ko private contract can prevent or interfere with a Board-ordered transaction. Conversely, if a court declines to enforce a private contract because doing so would interfere with such a transaction, the court's action will not disturb the contract rights of the parties as among themselves. Anyone who believes that a Board-ordered transaction has diminished the value of any valid and enforceable debt the bank holding company or any subsidiary bank might owe him, or of any equity interest he may own in the bank holding company or in any subsidiary bank, can apply to the Board within thirty days and ask the Board to appraise the debt or the equity interest. The Board must determine the value of any such debt or equity. Then, if the person tenders the debt or equity to the FDIC, the FDIC must buy it at the appraised value. This procedure provides full compensation for anyone whose property rights may be harmed by a Board-ordered transaction. It is the only procedure available to claimants for seeking such compensation. The appraisal-and-tender rights created by this Act are only available to independent owners of the debt or equity of the bank holding company or of an -3 - affiliated ban?:, the bank holding company itself and its affiliates are not given any such rights. The appraisal-and-tender rights apply to any debt and any equity, but only to debt or equity that someone holds on or before the effective date of this Act. Anyone who acquires debt or equity after that date does not have appraisal-andtender rights. There are two exceptions to the cut-off. A person who is owed money for goods or services that the bank holding company or bank has procured in the ordinary course of business may tender the debt to the FDIC no matter when the debt was incurred. In addition, a person who owns shares in a subsidiary bank may tender them to the FDIC no matter when he acquired them. This latter provision protects someone who has bought a minority share in an independent bank, and who continues to hold that share after the majority owners have sold their shares to a bank holding company. A resulting bank may keep any branches or other offices it acquires as a result of a Board-ordered merger. DRAFT—KAY 1 6 , 1988 EMERGENCY CONSOLIDATIONS S E C . ___. EM ERGENCY C O N S O LID A T IO N S .— S e c tio n 5 o f th e » i n k H o ld in g Company A c t o f 1956 i s amended by i n s e r t in g nev s u b s e c tio n s (g) and (h) a t th e end th e r e o f r e a d in g as f o l l o w s : " ( g ) EM ERGENCY C O N S O LID A T IO N S ; PREEM PTION O F S TA TE AND FE D E R A L L A V S .— N o tw ith s ta n d in g any o th e r p r o v is io n o f t h i s A c t , o r o f F e d e r a l o r S ta te b a n k ru p tc y la w s , o r o f any o th e r F e d e r a l o r S t a t e law o r o f th e c o n s t it u t i o n o f any S t a t e , o r o f any c o n tr a c t o r o th e r in s tru m e n t o r s e c u r it y — "(1) C O N SO LID ATIO N S R E Q U IR E D .— Upon c e r t i f y i n g t o th e Board t h a t i t i s n e c e s s a ry f o r th e Board t o e x e rc is e th e powers made a v a ila b le by t h i s s u b s e c tio n ( g ) , th e C o rp o ra tio n may recommend t h a t th e B o a rd : M(A ) O rd e r a bank h o ld in g company t o cause any o r a l l o f i t s a f f i l i a t e d banks t o be re o rg a n iz e d as s u b s id ia r ie s o f a bank s p e c ifie d i n su bp arag rap h ( 1 1 ) ( A ) ; " (B) O rd e r a bank h o ld in g company t o cause any o r a l l o f i t s s u b s id ia r y banks lo c a te d in th e same S ta te as a bank s p e c ifie d in su b p arag rap h ( 1 1 ) (A) t o merge w i t h , o r t o purchase th e a s s e ts and assume th e l i a b i l i t i e s o f , such b a n k ; " ( C ) O rd e r a bank h o ld in g company t o cause a bank s p e c ifie d in su b p a ra g ra p h ( 1 1 ) (A) t o merge w i t h , o r t o purchase th e a s s e ts and assume th e l i a b i l i t i e s o f , any o r a l l o f th e bank h o ld in g com pany's o th e r s u b s id ia r y banks t h a t a re lo c a te d i n th e same S ta te as such b a n k; " ( D ) O rd e r a bank h o ld in g company t o c o n t r ib u t e o r t r a n s fe r o r p ro v id e t o a bank s p e c i fi e d in subparagraph ( 1 1 ) ( A ) , o r t o r e q u ir e any o f i t s s u b s id ia r ie s t o c o n t r ib u t e o r t r a n s f e r o r p ro v id e t o any such b a n k , such a s s e ts o r s e rv ic e s as a re c u s to m a r ily u t i l i z e d by a bank i n th e co n du ct o f i t s b u s in e s s o r o p e r a t io n s ; o r "(E ) O rd e r a bank h o ld in g company t o ta k e any c o m b in a tio n o f a c tio n s s p e c i f i e d i n p a ra g ra p h s (A) th ro u g h ( D ) . "(2 ) BOARD F O Y E R S .— "(A ) A U T H O R IT Y .— " (i) The B oard s h a ll have a u t h o r i t y t o compel any bank h o ld in g company t o consummate a t r a n s a c t io n recommended by th e C o rp o ra tio n under p a ra g ra p h ( 1 ) . The Board may r e q u ir e th e bank h o ld in g company and any s u b s id ia r y th e r e o f t o ta k e such a c tio n in c o n n e c tio n w ith any such t r a n s a c t io n as th e Board may deem n e c e s s a ry o r a p p r o p r ia t e . - 2- " (ii) Upon a d e te rm in a tio n t h a t an emergency no lo n g e r e x i s t s , the Board may o rd e r any bank b o ld in g company s u b s id ia r ie s w hich were r e o r g a n iz e d as s u b s id ia r ie s o f a bank under subparagraph (A) o f p a ra g ra p h ( 1 ) t o be o rg a n ize d as d i r e c t s u b s id ia r ie s o f th e bank b o ld in g com pany. Zn so e v e n t s h a l l th e Board o rd e r such a r e s t r u c t u r in g t o occu r i n le s s th a n t h i r t y days from th e d a te o f i t s o rd e r. " ( B ) P R O C ED U R ES .— A ny a c tio n re q u ir e d b y th e Board under subparagraph (A ) s h a l l be consummated i n accordance w ith such p rocedu res and sch edu les as th e B oard may p r e s c r ib e . E x c e p t as p ro v id e d i n c la u s e ( i i ) o f su bp arag rap h ( A ) , any t r a n s a c t io n o rd e re d by th e B o a rd , and any a c tio n r e q u ir e d by th e Board in c o n n e c tio n w ith any such t r a n s a c t i o n , s h a l l be consummated im m e d ia te ly i f th e Board so o r d e r s . " ( C ) J U D I C I A L R E V IE W .— No o rd e r is s u e d by th e B oard under t h i s p a ra g ra p h ( 2 ) , and no a c tio n r e q u ire d by th e Board under t h i s p aragraph ( 2 ) , s h a ll be s u b je c t t o re v ie w by any c o u r t . "(3 ) C O N S U LT A T IO N .— " (i) R E Q U IR E D .— B e fo re making any recom m endation under p a ra g ra p h ( 1 ) , th e C o r p o r a tio n s h a ll c o n s u lt th e r e le v a n t s u p e rv is o r o f any bank in v o lv e d i n th e recommended t r a n s a c t i o n . - (ii) N O T I C E .— The C o rp o ra tio n s h a ll p ro v id e th e r e le v a n t s u p e rv is o r a re a s o n a b le o p p o r t u n i t y , and in no e v e n t le s s th a n f o r t y - e i g h t h o u rs , to o b je c t t o th e C o r p o r a t io n 's recom m endation. " (iii) R IG H T TO O B J E C T .— I f th e r e le v a n t s u p e r v is o r o b je c ts d u rin g such p e r i o d , th e C o rp o ra tio n may make a recom m endation under p a ra g ra p h ( 1 ) o n ly b y a unanimous v o te o f i t s Board o f D i r e c t o r s . " ( 4 ) O F F IC E S A C Q U IRED I N C O N S O LID A T IO N S .— Any o f f i c e o p e ra te d as a branch o r home o f f i c e by a bank in v o lv e d i n a t r a n s a c t io n o rd e re d by th e Board under p a ra g ra p h (2) may be o p e ra te d as a bran ch o r home o f f i c e by any bank t h a t a c q u ire s i t p u rs u a n t t o such t r a n s a c t i o n . "(5 ) A P P L IC A T IO N O F C ER T A IN LA W S.— " (A) BANK B O LD IN G COHPANY A C T .— " (i) S EC T IO N 2 . — So lo n g as a bank t h a t i s o rd e re d under p a ra g ra p h (2 ) t o a c q u ire a f f i l i a t e s as s u b s id ia r ie s rem ains i t s e l f a s u b s id ia r y o f a bank h o ld in g com pany, th e term 'b a n k h o ld in g com pany' as d e fin e d i n s u b s e c tio n 2 (a ) o f t h i s A c t s h a l l n o t in c lu d e a bank i f such bank w ould o th e rw is e be deemed t o be a bank h o ld in g company s o l e l y because i t h o ld s s to c k i n th e shares o f a n o th e r bank o r b a n k s , and has a c q u ire d such s to c k p u rs u a n t to th e a c t io n r e q u ir e d by th e B o a rd . -3 " (ii) S EC TIO N 3 . — No a c tio n re q u ire d by th e Board under paragraph (2) s h a ll r e q u ir e an a p p lic a t io n t o o r a p p ro v a l by th e Board under S e c tio n 3 o f t h i s A c t . " ( B ) N A T IO N A L BANNING A C T .— No a c tio n re q u ir e d by th e Board under p a ra g ra p h (2) s h a l l be s u b je c t t o th e re q u ire m e n ts o f th e N a tio n a l B a n king A c t s p e c ifie d i n S e c tio n 20 o f P u b lic L a v 8 6 -2 3 0 . " ( C ) F E D E R A L D E P O S IT INSURANCE A C T .— No a c tio n re q u ire d by th e Board under p a ra g ra p h (2) s h a ll be s u b je c t t o th e re q u ire s e n ts o f s e c tio n 1 3 ( f ) o r o f s e c tio n 1 8 ( c ) o f th e F e d e r a l D e p o s it In s u ra n c e A c t . " ( D ) H A R T -S C O TT -R O D IN O A C T .— No a c tio n r e q u ire d by th e Board under p a ra g ra p h (2) s h a l l be s u b je c t t o th e re q u ire m e n ts o f th e H a r t - S c o t t R o d in o A n t i t r u s t Im provem ents A c t o f 1 9 7 6 . "(6 ) P R IV A T E P A R T IE S I N E L I G I B L E TO PR EV EN T C O N S O LID A T IO N .— (A) L IM IT A T IO N ON RIGHTS OF P R IV A T E P A R T I E S .— No c o u rt s h a ll g iv e e f f e c t t o any r i g h t s o r powers c o n fe rre d on any p e rs o n , w hether such r i g h t s o r powers a re c o n fe rre d by S ta te o r F e d e r a l s t a t u t e o r by th e a r t i c l e s o r b y -la w s o f th e bank h o ld in g company o r o f any s u b s id ia r y th e r e o f o r b y any deb t o r e q u it y s e c u r it y o f any such bank h o ld in g company o r s u b s id ia r y th e r e o f o r by any o th e r c o n tra c t o r o th e r in s tru m e n t o r o th e r w is e , and any p r o v is io n o f any such s t a t u t e o r s e c u r it y o r a r t i c l e o r b y - l a v o r c o n tr a c t o r in s tru m e n t s h a ll be v o i d , i n s o f a r as g iv in g e f f e c t t o any such r i g h t s o r powers w ould im p a ir th e a b i l i t y o f th e bank h o ld in g company o r o f any s u b s id ia r y b a n k : " (i) or t o ta k e any a c tio n re q u ir e d by th e Board under p a ra g ra p h ( 2 ) , " ( i i ) as p a r t o f a t r a n s a c tio n o rd e re d by th e Board under p ara g ra p h ( 2 ) , t o p le d g e , s e l l o r o th e rw is e t r a n s f e r s e c u r it ie s o r a s s e ts o f th e bank b o ld in g company o r o f any s u b s id ia r y bank t o th e C o r p o r a tio n i n c o n n e c tio n w ith a t r a n s a c t io n a u th o r iz e d by S e c tio n 13 o f th e F e d e r a l D e p o s it In s u ra n c e A c t . " ( B ) R E F U S A L TO EN FO R C E RIGH TS NOT OCCASION O F D EFA U LT OR OTHER IM P O S IT IO N O F P E N A LT Y OR GROUND FOR A S S ER TIO N OF D E R IV A T IV E R IG H T S .— The f a i l u r e o f a c o u rt t o g iv e e f f e c t t o any r i g h t s o r powers under su b p arag rap h (A ) s h a l l n o t c o n s t it u t e an e v e n t o f d e f a u lt o r o c c a s io n o f im p o s itio n o f any p e n a l t y . No consequent e f f e c t o f such f a i l u r e t o e n fo rc e th e r i g h t s o r d u tie s o f any p e rso n s h a l l c o n s t it u t e an e v e n t o f d e f a u l t o r o c c a s io n o f im p o s itio n o f any p e n a l t y . No p e rso n may a s s e rt any r i g h t s o r p o w e rs , w hether such r i g h t s o r powers a re c o n fe rre d by S ta t e o r F e d e r a l s t a t u t e o r b y th e a r t i c l e s o r b y -la w s o f th e bank h o ld in g company o r o f any s u b s id ia r y th e r e o f o r by any deb t o r e q u ity s e c u r i t y o f any such bank h o ld in g company o r s u b s id ia r y th e r e o f o r by any o th e r c o n tr a c t o r o th e r in s tru m e n t o r o th e r w is e , i f such person w ould be u n a b le t o a s s e rt such r i g h t s o r powers b u t f o r th e f a i l u r e o f th e c o u r t t o g iv e e f f e c t t o r i g h t s o r powers under subparagraph ( A ) . "(C) NO OTHER CONSENTS NECESSARY.— E x c e p t as p ro v id e d in t h i s s u b s e c tio n ( g ) , any a c tio n r e q u ire d by th e Board under paragraph (2) s h a l l be consummated w ith o u t th e n e c e s s ity o f n o tic e t o , a p p ro v a l fro m , o r co n se n t o f s h a re h o ld e rs , c r e d i t o r s , p a r t ie s t o c o n t r a c t s , l e s s o r s , i n s u r e r s , o r any o th e r persons o r g overn m e n ta l a u t h o r i t i e s . (7) N IG H T O r A P P R A IS A L .— " ( A ) DEB TS O r BANE HOLDING COMPANIES AND O r A I T I L I A T E D B A N K S .— Any c r e d i t o r o f a bank h o ld in g company s u b je c t t o an o rd e r is s u e d b y th e B o a rd u n d er p a ra g ra p h ( 2 ) , and any c r e d i t o r o f a bank d i r e c t l y in v o lv e d i n a t r a n s a c t io n i n c o n n e c tio n w it h such o r d e r , may a p p ly t o th e Board f o r an a p p r a is a l o f th e v a lu e o f any v a l i d and e n fo rc e a b le d eb t owed t o such c r e d i t o r : p r o v id e d , t h a t n e it h e r th e bank h o ld in g company n or any a f f i l i a t e t h e r e o f , o th e r th a n a perso n who i s an a f f i l i a t e s o l e l y because such p erson h o ld s shares f o r in ve s tm e n t purposes i n such bank h o ld in g company o r a f f i l i a t e t h e r e o f , may f i l e an a p p lic a t io n t o th e B o a rd u n der t h i s subparagraph ( A ) • "(B ) SHAREHOLDERS I N BANK HOLDING COM PANIES. — Any person h o ld in g s h a re s i n a bank h o ld in g company s u b je c t t o an o rd e r is s u e d by th e B oard under p a ra g ra p h (2) may a p p ly t o th e Board f o r an a p p r a is a l o f th e v a lu e o f such s h a re s : p r o v id e d , t h a t no a f f i l i a t e o f such bank h o ld in g com pany, o th e r th a n a person who i s an a f f i l i a t e s o l e l y because such p e rso n h o ld s shares f o r in v e s tm e n t purposes in such bank h o ld in g com pany, may f i l e an a p p lic a t io n t o th e Board under t h i s subparagraph (B ). "(C ) SHAREHOLDERS IN A F F I L I A T E D B A N K S .— Any person h o ld in g sh ares in a bank d i r e c t l y in v o lv e d in a t r a n s a c tio n i n c o n n e c tio n w ith an o rd e r is s u e d by th e B oard under p ara g ra p h (2) may a p p ly t o th e Board f o r an a p p r a is a l o f th e v a lu e o f such s h a re s : p r o v id e d , t h a t no a f f i l i a t e o f such b a n k , o th e r th a n a person who i s an a f f i l i a t e s o l e l y because such p e rso n h o ld s sh a re s f o r in v e s tm e n t purposes in such b a n k , may f i l e an a p p li c a t io n t o th e Board under t h i s su bparagraph ( C ) . (8) T I K E L I M I T S .— " ( A ) L I M I T R E LA T E D TO T IK E O F CONSUMMATION O F T H E T R A N S A C T IO N .— Ho a p p l i c a t i o n under p a ra g ra p h ( 7 ) may be made more th a n t h i r t y days a f t e r th e d a te o f consummation o f th e t r a n s a c t io n o rd e re d by th e B oard under p a ra g ra p h ( 2 ) . " ( B ) L I M I T R E L A T E D TO T I K E O F A C Q U IS IT IO N O F T H E DEBT OR S H A R E .— No a p p l i c a t i o n under su bparagraph (A ) o r su bparagraph (B) o f p a ra g ra p h (7 ) may be made based on a d eb t o r sh a re a c q u ire d b y th e a p p lic a n t on o r a f t e r [t h e e f f e c t i v e d a te o f t h i s A c t ] : p r o v id e d , t h a t t h i s s u b p a ra g ra p h (B) s h a l l n o t a p p ly t o a p erson m aking a p p lic a t io n based on a d e b t owed f o r goods o r s e r v ic e s p ro c u re d by th e bank h o ld in g company o r bank in th e o r d in a r y cou rse o f b u s in e s s . -5 - -(9 ) BOARD A P P R A IS A L S .— " ( A ) BOARD A U TH O R IZED TO BARE A P P R A IS A L S .— Whenever a person f i l e s an a p p li c a t io n w ith th e Board under p arag rap h ( 7 ) , th e Board s h a ll d e te rm in e th e v a lu e o f any d eb t o r sh a re based upon an a p p r a is a l. The a p p r a is a l s h a l l be f i n a l and b in d in g on a l l p a r t i e s . " ( B ) B A S IS FOR A P P R A IS A L .— The v a lu e o f any d e b t o r sh a re s h a ll be based upon th e v a lu e i t w ould have had i f t v e r y bank s p e c ifie d i n su b p arag rap h ( 1 1 ) (A ) had been c lo s e d on th e d a te o f th e o rd e r iss u e d by th e B oard under p a ra g ra p h ( 2 ) , w ith th e C o rp o ra tio n p a y in g a l l in s u re d d e p o s it s , th e a s s e ts l i q u i d a t e d , and th e r e s u l t in g fun ds a p p lie d tow ard s a t i s f y i n g a l l o th e r v a l i d and e n fo rc e a b le l i a b i l i t i e s o f such b a n k , w ith th e re m a in d e r, i f a n y , a llo c a te d t o th e s h a re h o ld e rs o f such b a n k . A ny d e te rm in a tio n o f v a lu e a ls o s h a ll in c lu d e c o n s id e ra tio n o f any c o n s e q u e n tia l e f f e c t s r e s u l t in g from such c lo s in g th a t would have o c c u rre d t o o th e r s u b s id ia r ie s o f th e bank h o ld in g company. " ( C ) R U LEX A K IN G A U T H O R IT Y .— The Board s h a ll p rom u lgate r u le s p r o v id in g th e p ro c e d u re s f o r m aking a p p lic a tio n s and a p p ra is a ls under t h i s su b p a ra g ra p h ( 9 ) . "(D ) STANDARD O F REVIEW FOR A P P R A IS A L S .— Any person o b ta in in g an a p p r a is a l from th e Board and d is a g re e in g w ith th e a p p ra is a l so e s ta b lis h e d may seek re v ie w o f th e a p p r a is a l i n accordance w ith th e p r o v is io n s o f s e c tio n 9 o f t h i s A c t : p r o v id e d , t h a t no a p p r a is a l o f any d eb t o r sh a re s h a ll be s e t a s id e u n le s s th e Board has ac ted a r b i t r a r i l y and c a p r ic io u s ly i n s e t t i n g th e v a lu e o f such debt o r s h a re . "(10 ) F D IC C O K P EN S A T IO N .— " ( A ) TEN D ER BY A P P L IC A N T .— No l a t e r th a n tw e n ty days a f t e r c o m p le tio n o f an a p p r a is a l under subparagraph ( 9 ) (A) and re vie w o f any c h a lle n g e t h e r e t o , an a p p lic a n t may te n d e r t o th e C o rp o ra tio n any deb t o r sh are so a p p r a is e d . An a p p lic a n t may accom plish th e te n d e r by s u rre n d e rin g th e d e b t in s tru m e n t o r sh are t o th e C o rp o ra tio n o r by p r o v id in g such o th e r e v id e n c e o f th e d e b t o r o w n ersh ip i n t e r e s t as th e C o rp o ra tio n may re a s o n a b ly r e q u i r e . " ( B ) F D IC COKPENSATION A U T H O R IZ ED ; SU B R O G A TIO N .— Upon te n d e r o f any d e b t o r s h a re under su bparagraph ( A ) , th e C o rp o ra tio n i s a u th o r iz e d and d ir e c t e d t o a c q u ire any such d e b t o r s h a re from th e a p p lic a n t and t o com pensate th e a p p lic a n t p ro m p tly i n th e amount d ete rm in e d by th e Board u n d e r p a ra g ra p h (9 )• Upon p r o v id in g com pensation t o any person under t h i s su bp arag rap h ( B ) , th e C o r p o r a tio n s h a ll be su b ro g a te d t o a l l r i g h t s o f such p e rso n a r i s i n g o u t o f such d e b t o r sh a re t o th e e x te n t o f such c o m p e n s a tio n . " ( C ) R U LEK A K IN G A U T H O R IT Y .— The C o rp o ra tio n i s a u th o r ize d and d ir e c te d t o p ro m u lg a te r u le s p r o v id in g p ro ce d u re s f o r r e c e ip t and payment under th e p r o v is io n s o f t h i s p a ra g ra p h ( 1 0 ) • " (D ) F D IC COMPENSATION AS S O LE R EM ED Y .— The p rocedu re e s ta b lis h e d by t h i s p a ra g ra p h (10 ) s h a ll be th e s o le Beans by which any person Bay seek com pensation f o r any lo s s occasio ne d by an a c tio n o rd e re d b y th e B o a rd under p a ra g ra p h ( 2 ) . "(11) STANDARD FOR C E R T IF IC A T IO N .— The C o rp o ra tio n Bay c e r t i f y t h a t i t i s n e c e s s a ry f o r th e B oard t o e x e rc is e th e powers Bade a v a ila b le by t h i s s u b s e c tio n (g) o n ly i f : " ( A ) BANK I N DANGER O F C L O S IN G .— The c h a r te r in g a u t h o r i t y f o r an in s u re d bank has n o t i f i e d th e C o r p o r a tio n t h a t th e bank i s in danger o f c l o s i n g , as d e fin e d i n S e c tio n 1 3 ( f ) ( 8 ) o f th e F e d e r a l D e p o s it In s u ra n c e A c t , and " ( B ) REDU C TIO N O F R IS K TO T D IC F U N D .— The C o rp o ra tio n has d e te rm in e d , i n i t s s o le d i s c r e t i o n , e i t h e r : " (i) T h a t such a c tio n w i l l le s s e n th e r i s k t o th e F e d e r a l D e p o s it In s u ra n c e fu n d , o r " (ii) T h a t se ve re f i n a n c i a l c o n d itio n s e x i s t which th re a te n th e s t a b i l i t y o f a s i g n i f i c a n t number o f in s u re d banks in th e community where th e bank s p e c ifie d in subparagraph (A) i s lo c a te d o r i s B a k in g lo a n s o r i s d o in g b u s in e s s , o r th e s t a b i l i t y o f in s u re d banks p o s s e s s in g s i g n i f i c a n t f i n a n c i a l re s o u rc e s in any such com m unity. " ( 1 2 ) BOARD A C TIO N TO B E L IM IT E D I N K E E P IN G V IT H NEEDS O F S IT U A T IO N .— In e x e r c is in g th e a u t h o r i t y c o n fe rre d under t h i s s u b s e c tio n ( g ) , th e Board s h a l l Bake a re a s o n a b le e f f o r t t o a ssure t h a t any t r a n s f e r o f a s s e ts o r s e c u r it i e s t o a bank s p e c ifie d in su bparagraph ( 1 1 ) ( A ) , and any t r a n s f e r o f a s s e ts o r s e c u r it i e s i n c o n n e c tio n w ith a B e rg e r i n v o l v in g a bank s p e c ifie d i n su bp arag rap h ( 1 1 ) ( A ) , s h a ll n o t exceed an amount th a t i s re a s o n a b ly n e c e s s a ry t o p r o v id e adequate c a p i t a l i z a t i o n t o such bank o r any succe sso r th e re to . "(13 ) D E F I N I T I O N S .— F o r th e p urpose o f t h i s s u b s e c tio n ( g ) : " ( A ) F D I C .— The term 'C o r p o r a t i o n ' Beans th e F e d e r a l D e p o s it In s u ra n c e C o r p o r a t io n . "(B ) R ELE V A N T S U P ER V IS O R .— " (i) COM PTROLLER O F T H E C U R R EN C Y.— I n th e case o f a n a t io n a l b a n k , th e t e r n 'r e l e v a n t s u p e r v is o r ' Beans th e O f f i c e o f th e C o m p tro lle r o f th e C u r r e n c y . " (ii) S TA T E BANK S U P ER V IS O R .— In th e case o f a S ta te -c h a r te r e d b a n k , th e term 'r e l e v a n t s u p e r v is o r ' Beans th e S ta te bank s u p e r v is o r o f any such b a n k . -7|(h )(1 ) CERTAIN RESTRICTIONS PROHIBITED.— No p r o v is io n o f any c o n tra c t en te re d i n t o by a bank h o ld in g company o r s u b s id ia r y th e r e o f on o r a f t e r [th e e f f e c t i v e d a te o f t h i s A c t ] s h a l l be e f f e c t i v e i f : " ( A ) i t p r o h i b i t s o r r e s t r i c t s i n any manner th e s a l e , t r a n s f e r , pledge o r conveyance b y a bank h o ld in g company o r a bank s u b s id ia r y o f a bank h o ld in g company o f shares o r a s s e ts o f a s u b s id ia r y bank o r p r o h ib it s th e s u b s id ia r y bank from s e l l i n g , t r a n s f e r r i n g , p le d g in g o r con veyin g any o r a l l o f i t s s h a re s , a s s e ts o r l i a b i l i t i e s t o any e n t i t y o th e r th a n th e h o ld in g company; and " ( B ) such s a l e , t r a n s f e r , p le d g e o r conveyance ta k e s p la c e i n c o n ju n c tio n ir it h o r as a p a r t o f a s s is ta n c e p ro v id e d by th e C o rp o ra tio n under s e c tio n 1 3 ( c ) o f th e F e d e r a l D e p o s it In s u ra n c e A c t and th e C o r p o r a tio n re q u e s ts such s a l e , t r a n s f e r , p ledg e o r conveyance as a p a r t o f such a s s is ta n c e . " ( 2 ) COM PLIANCE WITH F D IC REQUEST NOT OCCASION O F D EFA U LT OR OTHER IM P O S IT IO N O F P E N A L T Y .— Any com pliance w ith such a re q u e s t o f th e C o r p o r a tio n s h a l l n o t c o n s t it u t e a d e f a u lt o r « v e n t o f d e f a u lt under such c o n t r a c t , and s h a l l n o t g iv e r i s e t o th e im p o s itio n o f r i g h t s o f a c c e le r a t io n , damages, o r o th e r w is e . " ( 3 ) D E F I N I T I O N .— F o r th e purpose o f t h i s s u b s e c tio n (h) th e term • C o r p o r a t io n ' means th e F e d e r a l D e p o s it In s u ra n c e C o r p o r a tio n . APPENDIX C Pocket Guide for Directors Guidelines for Financial Institution Directors* Financial Institution Directors C h an g e in the financial m arketplace has created a m ore competitive and challenging en vironment for all financial institutions. A s a con seq u en ce o f this ch an ge, the role of the financial institution board m em ber has grown in im portance an d com plexity. This Pocket G uide h as been d ev elo ped by the Federal D eposit Insurance C orporation to provide directors of financial institutions with accessible and practical guidan ce in m eeting their duties an d responsibilities in a changing environm ent. T h ese guidelines have been en dorsed by the B o ard o f G overn ors of the Federal R eserve Sy stem , the Office of the Com ptroller of the Currency and the Federal H om e L o an B ank B o ard . We hope this Pocket G uide will help to m ake the director’s job on e that can be approach ed with clarity, assurance and effectiveness. If you are helped in m eeting these go als, then the larger goal of maintaining confidence in the safety and so u n d n ess of our financial system will also be achieved. Sincerely, L. William Seidman Chairman Federal Depoctt Insurance Corporation Robert L. Clarke u . n o p e, Jr. fe d e r a l d e p o s it in s u r a n c e c o r p o r a t io n Washington, D C. February, 1988 General Guidelines A financial institution’s board o f directors o v e rse e s the condu ct o f the institution’s business. T h e board o f directors should: • select an d retain com peten t m an ag em en t; • establish, with m an ag em en t, the institution’s long an d short term business objectives, an d ad o p t o p e ra ting policies to achieve th ese objec tives in a legal an d sou n d m anner; • monitor operation s to ensure they are controlled ad eq u ately an d are in com pliance with law s an d policies; • o versee the institution’s business perform an ce; an d • ensure that the institution helps to m eet its com m unity’s credit n eed s. T h ese responsibilities are govern ed by a com plex fram ew ork o f federal an d state law an d regulation. T h e guidelines d o not m odify the legal fram ew ork in an y w ay an d are not intended to cover every co n ceivable situation that m ay confront an in sured institution. R ather, they are intended only to offer gen eral assistan ce to directors in m eeting their responsibilities. Underlying these guidelines is the assum ption that directors are m aking an honest effort to d eal fairly with their institutions an d to com ply with all applicable law s an d regu la tions, an d follow so u n d practices. Maintain Independence T h e first step both the board an d in statutory an d regulatory d ev elo p m en ts p e r dividual directors should take is to establish tinent to their institution. Directors sh ould an d m aintain the b o ard ’s in d epen d en ce. work with m an ag em en t to d ev elo p a p ro Effective corporate go vern an ce requires a gram to k e e p m em b ers inform ed. Periodic high level of cooperation betw een an briefings by m an ag em en t, co u n sel, auditors institution’s board an d its m an agem en t. or other consultants might be helpful, an d N evertheless, a director’s duty to o versee m ore form al director edu cation sem in ars the condu ct of the institution’s business should be con sidered. n ecessitates that each director exercise T h e p a c e of ch an ge in the nature of in depen den t ju dgm en t in evaluating financial institutions to d ay m a k es it p a r m an ag e m en t’s actions an d com peten ce. ticularly im portant that directors com m it Critical evaluation of issu es before the a d eq u ate tim e in order to be inform ed b o ard is essential. Directors w ho routinely participants in the affairs of their institution. ap p ro v e m an ag em en t decisions without exercising their own inform ed judgm ent are not serving their institutions, their stockh olders, or their com m unities ad eq u ately . Keep Informed Ensure Qualified Management The board of directors is responsible for ensuring that day-to-day operations of the institution are in the hands of qualified Directors must keep them selves informed m anagem ent. If the board becom es of the activities and condition of their institu dissatisfied with the perform ance of the chief tion and of the environment in which it executive officer or senior m anagem ent, it operates. They should attend board and should address the matter directly. If hiring a assigned committee meetings regularly, and new chief executive officer is necessary, the should be careful to review closely all board should act quickly to find a qualified meeting materials, auditor’s findings and replacement. Ability, integrity, and experi recom m endations, and supervisory com ence are the most important qualifications for munications. Directors also should stay a chief executive officer. abreast of general industry trends and any Supervise Management T h e se policies should be form ulated Su p erv ision is the broadest of the b o ard ’s duties an d the m ost difficult to to further the institution’s bu sin ess plan describe, a s its sc o p e varies according to in a m an n er consistent with safe an d the circum stances of each c a se. C o n se so u n d practices. T h ey sh ould contain quently, the following su ggestion s should pro ced u res, including a system of inter im b e view ed a s general. nal controls, d esign ed to foster sou n d practices, to com ply with law s an d Establish Policies. T h e board of regulations, an d to protect the institution directors should ensure that all signifi again st external crim es an d internal can t activities are co vered by clearly fraud an d ab u se. co m m u n icated written policies which Monitor implementation. can be readily u n derstood by all T h e b o ard ’s policies should establish m ech an ism s for em p lo y e es. All policies should be providing the board the inform ation m onitored to ensure that they conform n ee d e d to m onitor the institution’s with ch an g es in law s an d regulations, operation s. In m ost c a se s, th ese eco n om ic conditions, an d the institu m ech an ism s will include m an ag em en t tion’s circum stances. Specific policies sh ould cover at a % reports to the b oard. T h ese reports minimum: should be carefully fram ed to presen t in • loan s, including internal loan form ation in a form m eaningful to the review pro ced u res b oard. T h e appropriate level o f detail an d frequency of individual reports will • investm ents vary with the circum stances o f each in • asset-liability/funds m an agem en t stitution. R eports generally will include information such a s the following: • profit planning an d budget • capital planning • the incom e an d e x p e n se s of the • internal controls Ji • com pliance activities I institution • capital outlays an d a d e q u a c y • audit program • loan s an d investm ents m a d e • conflicts of interest • p ast d u e an d n egotiated loan s and • co d e of ethics investm ents Experience h as show n that certain • problem lo an s, their presen t status asp ects of lending are responsible for a an d w orkout p ro gram s great numl>er o f the problem s e x • allow an ce for possible loan loss perien ced by troubled institutions. T h e • concentrations o f credit im portance of policies an d reports that j • lo sses an d recoveries on sales, col reflect on loan docum en tation, perform an ce, an d review can n ot be overstated. lection, or other dispositions of i asse ts i Provide for independent reviews. • funding activities an d the m a n a g e The board also should establish a m echanism m ent of interest rate risk for independen t third party review an d • perform an ce in all o f the ab ov e testing o f com pliance with b oard policies past p er a s to peer groups’ a re a s co m p ared to an d pro ced u res, applicable law s an d form an ce a s well regulations, an d accuracy of information perform an ce provided by m an agem en t. This might be accom plish ed by an internal auditor • all insider transactions that benefit, directly or indirectly, controlling reporting directly to the b oard, or by an sh areh olders, directors, officers, exam ining com m ittee of the b oard itself. e m p lo y ees, or their related interests In addition, a com prehensive annual audit by a C P A is desirable. It is highly • activities undertaken to en sure c o m reco m m en d ed that such an audit in pliance with applicable laws (in clude a review of asset quality. The cluding am o n g others, lending board should review the auditors’ find limits, con su m er requirem ents, an d ings with m an ag em en t an d should the B an k S ecrecy Act) an d any m onitor m an ag em en t’s efforts to resolve significant com pliance problem s • an y extraordinary d evelopm en t like- an y identified problem s. ' In order to discharge its gen eral o ver ly to im pact the integrity, safety, or profitability of the institution R ep orts should be provided far en o u gh in ad v an c e of board m eetings .< an y q u estion s raised by the reports. audit com m ittee should have direct responsibility for hiring, firing, an d i to allow for m eaningful review . M an ag e m ent sh ould be a sk ed to resp on d to sight responsibilities, the board or its j evaluating the institution’s auditors, an d f j Avoid Preferential Transactions sh ould h ave a cce ss to the institution’s A void all preferential transactions involv regular corporate counsel an d staff a s ing insiders or their related interests. Finan requ ired. In so m e situations, outside cial transactions with insiders m ust be directors m ay wish to consider em ploy b eyo n d rep roach . T h ey m ust be in full ing indepen den t counsel, accou ntan ts or com plian ce with law s an d regulations con other experts, at the institution’s e x cerning such transactions, an d be ju dged p e n se , to advise them on special prob according to the sam e objective criteria lem s arising in the exercise o f their u se d in transactions with ordinary oversight function. Su ch situations might cu stom ers. T h e basis for such decisions include the n eed to dev elo p appropriate m ust be fully d ocu m en ted . Directors an d resp o n se s to problem s in im portant officers w ho perm it preferential treatm ent a re a s of the institution’s perform ance or o f insiders breach their responsibilities, can o peration s. e x p o se th em selves to serious civil an d criminal liability, an d m ay e x p o se their in- a Heed supervisory reports. B o ard m em b ers should personally review any reports of exam ination or other su p er visory activity, an d any other cor resp o n d en ce from the institution’s su pervisors. A ny findings an d recom m en d atio n s should be review ed careful ly. P rogress in addressin g identified problem s should be tracked. Directors sh ou ld discuss issu es of concern with the exam iners. stitution to a greater than ordinary risk of ' loss. Pocket Guide for Directors — Guidelines for Financial Institution Directors, are available from the Office of Corporate Communications, C opies of this publication, Federal Deposit Insurance Corporation, 5 5 0 Seventeenth Street, NW, Washington, D .C . 2 0 4 2 9 , or through the Board of G overnors of the Federal Reserve System , the Federal H om e L oan Bank Board and the Office of the Comptroller of the Currency. A m ore detailed discussion of a director’s role and responsibilities is available in the Office of the Comptroller of the Currency’s The Director's Book — The Role of a National Bank Director, which is new book, available from the Communications Division, Office of the Comptroller of the Currency, W ashington, D .C . 2 0 2 1 9 . APPENDIX D INEQUITIES IN THE DEPOSIT INSURANCE SYSTEM There always has been some degree of inequity in the deposit insurance treat ment of large and small failing banks. Specifically, there has been a tendency to handle large failing banks in a manner that protects uninsured depositors and other general creditors from loss while smaller failing banks are more frequently subject to a statutory payoff, thus uninsured creditors are exposed to loss. In recent years, the FDIC has occasionally placed a de facto "guarantee“ on the liabilities of certain institutions (more accurately! the FDIC has made a commitment to handle the bank(s) in a manner that would not result in losses to general creditors). This action has been taken in situations where there is a perceived threat to the stability of the banking system. This "guarantee" has been limited to three cases: Continental Illinois in 1984; First City and First Republic in 1988. The FDIC is well aware of the competitive distortions that result from taking an action that permits an institution to issue liabilities "guaranteed" by the U.S. Government. Thus, such action has not been taken lightly. A variety of suggestions have been made that are designed to ameliorate the distortions associated with an outright guarantee. While each of the sugges tions is intended to achieve equity, each also would have some negative impacts. The following is a brief summary of the pros and cons of each proposal. • Depositor Discipline. The ability of the FDIC to provide more protection than the statutory limit would be restricted. This suggestion would remove inequity between large and small banks. However, it could lead to an unacceptable level of instability in the banking system. • Raise Insurance Premiums for Large Banks. Premiums would be based on total liabilities that fall in the same creditor class as deposits. This suggestion would bring the insurance cost for large institutions more in line with de ‘facto coverage, thus reducing inequities. However, these added costs may overly restrict large banks' ability to compete in global markets. Larger banks may respond by shifting business to noninsured subsidiaries, thereby reducing premium income. • Provide 100 Percent Deposit Insurance To All Banks. This would be the most straightforward way of providing all depositors with the same treat ment regardless of the size of their bank. The cost to the FDIC fund would be negligible (at least in the short run) because most depositors are already protected. Furthermore, it would be easier to handle failures because there would be no need to compute insured deposits on payoff; an entire deposit base could be transferred easily, leaving behind credi tors and contingent claims. - 2- A full Insurance approach, however, would completely eliminate depositor discipline and might raise longer-term insurance costs. It also would remove incentives for spreading deposits to smaller banks to maximize Insurance coverage. • Modified 100 Percent Deposit Insurance Coverage. This suggestion would not extend 100% coverage to certain deposits such as negotiable time deposits. Only transaction accounts and consumer and local business-type time deposits would get full coverage. Such an approach would reduce big bank/small bank inequity without com pletely eliminating depositor discipline. It does reduce depositor discipline, and it doesn't eliminate big bank/small bank inequities. Therefore, this suggestion represents only a partial solution. • limit Business Activities of Banks Operating Under 100 Percent Guarantee. This approach would require that rates on deposits be kept below market rates; business solicitation (letters of credit, etc.) would be restricted to existing customer base. If used, it would minimize damage to bank competitors. However, some customers might still be attracted by the insurance guarantee without added solicitation. Moreover, this suggestion does not resolve the big bank/small bank equity issue. • Restrict the Full Insurance Guarantee to Existing Deposit Accounts. This suggestion would not permit a bank to use an insurance "guarantee" to attract new business, therefore minimizing damage to bank competitors. However, it would limit the ability of a bank to replace outflows with new deposits. It also would create massive recordkeeping problems for the bank, and for the FDIC if the bank is ultimately paid off. Further more, it may lead to market confusion over what is, and what is not, insured. It does not resolve the small bank/large bank equity issue. • Extend Guarantee to Other Banks in State. Providing a full insurance guarantee to all banks operating in the same state would preserve intra state equity. However, inequities would remain with respect to out-ofstate competitors. Furthermore, banks within the state operating with 1002 insurance might raise new supervisory issues.
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