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10:00 AM
March 14, 1990
Room 2128, Rayburn House Office Building

Good morning Mr. Chairman and members of the Subcommittee.


appreciate the opportunity to appear today to provide our views on
provisions of the Financial Institutions Reform, Recovery and
Enforcement Act (FIRREA) that may require some modification and to
comment on legislative initiatives to restructure the Office of
Thrift Supervision (OTS) and restrict sales of subordinated
debentures in financial institutions.

As part of our testimony we

also have attached a more complete listing of our suggested changes

Today, we will address some of the more controversial issues that
have arisen from FIRREA, including the leverage capital standard,
purchased mortgage servicing rights and insurance coverage for 457
Plan deposits.

We also will highlight other FIRREA provisions that,

based on our experience to date, will need some revision.


we will provide our thoughts on proposed legislation to restructure
OTS and restrict the sale of securities in affiliated depository

Before focusing on those issues, we believe it is important to
emphasize the numerous positive aspects of FIRREA.

Without question

it is one of the most significant pieces of financial institution
legislation passed since the Great Depression, and it ultimately will
cause sweeping changes in the operations and structure of the
financial services industry.

The most visible part of the

legislation is the mechanism created, using a combination of private
and public funding sources, to recapitalize the thrift insurance fund
and resolve the crisis in the thrift industry.

However, in the long term, perhaps the more important aspects of
the legislation are the provisions that are designed to control risk
in the system.

FIRREA has recast the structure of thrift supervision

and returned the emphasis of savings association business to home

By establishing an independent thrift insurance fund,

FIRREA has eliminated one of the basic conflicts that plagued thrift
supervision and has put in place a structure that should facilitate a
financially sound fund in the future.

By increasing deposit

insurance premiums and giving the FDIC needed flexibility to adjust
premiums within specified limits based on fund experience, both
deposit insurance funds ultimately will have a stronger financial

Supervision has been strengthened further by expanding the
enforcement authority of federal regulators and requiring savings
associations to comply with bank capital, accounting and supervisory

FIRREA also restricted allowable savings association

activities and prohibited junk bond investments.

The FDIC also was

provided with back-up enforcement authority over savings
associations, and we have established a good working relationship
with OTS.

We believe the back-up authority is proving to be a very

good idea for protecting the insurance fund that possibly should be
considered in other areas as well.

The pros and cons of individual sections of the law can be

From our perspective, however, FIRREA has made significant

strides toward preventing a recurrence of the thrift industry's


Over time, it should contribute to a stronger and sounder

thrift industry and deposit insurance system.

FIRREA represents a

good first step toward resolving the complex problem of limiting risk
to the government while maintaining a stable and efficient free
market financial system.

However, as with any first step solution to

a highly complex problem, compromise is often necessary to balance
conflicting objectives.

Based on our limited experience of only a few months, we have
identified certain sections of FIRREA where changes appear

We should point out that many of FIRREA's provisions have

only recently become effective, and their potential impact is still
not fully known.

The issues we will discuss today represent only our

initial efforts to identify needed changes.

We expect to discover

additional areas that need modification in the future as we receive
public comments and as we gain more experience with the law.

One area of concern relates to the terms of the FDIC's Board of

Under current law as amended by FIRREA, the terms of the

FDIC's three appointive directors all expire together on February 28,
1993, and the statute is unclear on a crucial point of continuity:
namely, whether the directors in office on that date will be able to
continue to serve until their successors have been appointed and

If they cannot, the FDIC will suffer a significant loss

of continuity and —

for a period of time, at least —


independence, since the Comptroller of the Currency and the Director
of OTS could well be the only FDIC directors then holding office.
Since the appointive members all serve six-year terms, the continuity
problem is likely to recur every six years.

To assure Board continuity, we recommend that the appointive
members' terms be staggered, with termination dates coming no sooner
than two years apart.

If an appointive member leaves office in the

last two years of his or her term, the President should be able to
appoint a successor for the remainder of that term and for the
succeeding term as well.

In addition, the statute should make it

clear that any director serving on February 28, 1993 may continue in
office until a successor has been appointed and qualified.
we see no reason for all appointive terms to end in 1993.

In fact,


appointed to the Board in the next three years should be assured that
they can serve for a full six-year term.

Since one of the most controversial areas of FIRREA has been the
capital requirements, we would like to comment on the leverage ratio,
purchased mortgage servicing rights and the loans-to-one-borrower

Capital leverage ratio.

The new OTS capital standards

established under FIRREA include a risk-based framework that is
similar in many respects to the risk-based guidelines that were

adopted in -early 1989 by the banking agencies.

In accordance with

FIRREA's mandate, the OTS also promulgated two other capital
standards that establish constraints on how much a thrift can
leverage its balance sheet assets.

These leverage constraints

consist of a 1.5 percent tangible capital requirement and a three
percent core capital standard.

After the transition period for grandfathered supervisory
goodwill ends at year-end 1994, the tangible capital of a savings
association essentially will be the same as its core capital.
Therefore, thrifts ultimately will need to meet a leverage ratio
requirement for both core capital and tangible capital that is
presently set at three percent.

This three percent leverage standard

is similar to the minimum leverage ratio proposed by the Office of
the Comptroller of the Currency (OCC) in November 1989.

The leverage

standard eventually adopted by the OCC is of major significance to
savings associations, since FIRREA requires the OTS to prescribe and
maintain capital standards for thrifts that are no less stringent
than the capital standards the OCC applies to national banks.

We agree with the establishment of a uniform minimum core
capital leverage requirement for all banks and thrifts.

We also

support the exclusion of loan loss reserves from the definition
of capital under a revised bank leverage standard.

However, we

are concerned about the use of a three percent core capital
requirement as the sole minimum leverage standard.


The OCC's suggested three percent core capital constraint,
in our view, should only be viewed as a subtest.

That is, we

believe a revised bank leverage standard should set forth a
minimum total capital requirement over and above the OCC's
proposed three percent core capital requirement.


additional capital could be comprised of secondary sources,
similar to the manner in which the risk-based capital guidelines
require both a minimum core capital standard and a higher
minimum total capital requirement.

The great majority of banks

now meet the existing six percent total capital standard with a
combination of core capital plus the allowance for loan losses.
Since loan loss reserves usually do not exceed one-to-two
percent of assets, most institutions presently meet the existing
bank leverage standard with a minimum of four—to—five percent in
core capital exclusive of the loan loss allowance.

Risks in the banking industry over the past decade have
increased as deposit interest rate restrictions have been lifted
and as competition has intensified.

Many of these risks are not

specifically captured in the risk-based capital framework.
Moreover, the soundness of the risk-based capital standard is
new and untested, ;;As a result, we believe that any revised
leverage standard should be maintained at a level that, in
substance, is at least as stringent as the existing six percent
total capital standard.

Assuming loan loss reserves are

excluded from total capital for purposes of a revised leverage

standard, we believe that the minimum total capital leverage
standard for banks should be at least in the four-to-five
percent range.

In essence, any revised minimum leverage capital standard
for banks should not be allowed to materially reduce the minimum
capital requirements for a significant number of institutions.
Rather, the risk-based framework should function primarily as a
vehicle for ensuring that certain banks —
significant off-balance sheet risks —

including those with

maintain additional

capital over and above a prudent leverage standard.


a leverage standard should remain a prominent part of bank
capital standards and should not be relegated to a relatively
obscure backstop role.

If the OCC decides to adopt the three percent core capital
ratio as the sole minimum leverage standard, without requiring
any higher total capital leverage standard, we believe the
standard should specifically indicate that such a minimum will
only apply to the most well-run institutions that have very high
asset quality, minimal interest rate risk and composite CAMEL
ratings of 1 under.;the Uniform Financial Institutions Rating

These requirements are similar to the ones set forth by

the Federal Reserve Board in its December 1989 proposal for
revising the bank leverage ratio.

In view of FIRREA's "no less

stringent test” for thrifts, we believe similar capital
standards ultimately should be applied to savings associations.

The FDIC hopes to reach final agreement with the OCC and the
Federal Reserve on a revised bank leverage standard by year-end
1990, the date on which a minimum risk-based capital requirement
first becomes effective.

Purchased mortgage servicing rights.

Although thrift

capital standards under FIRREA generally are required to be no
less stringent than those applied by the OCC to national banks,
FIRREA made an exception for purchased mortgage servicing

FIRREA specifically provides that the FDIC is to

prescribe the maximum amount of purchased mortgage servicing
rights that savings associations can recognize when calculating
the amount of regulatory capital under the OTS tangible capital

In addition, the OTS limitations on the amount of

servicing rights that may be recognized by a savings association
when calculating its core capital must be at least as stringent
as the limits applied by the FDIC to state nonmember banks.

The FDIC currently has no explicit limit on the amount of
mortgage servicing rights that may be recognized by a bank for
regulatory capital purposes.

Although the FDIC retains the

right to deduct mortgage servicing rights on a case-by-case
basis if they are excessive in relation to capital or the market
value of the rights, at present we do not impose an
across-the-board maximum limit.
25 percent of Tier I capital.)

(The OCC has a limit of

In view of FIRREA's mandate, the risks associated with
purchased mortgage servicing rights, and the increasing levels
of servicing rights that are being acquired by state nonmember
banks, the FDIC Board on January 30, 1990 issued for public
comment a purchased mortgage servicing rights proposal.


proposal, if adopted, would limit the amount of servicing rights
that may be recognized for regulatory capital purposes to no
more than 25 percent of core capital and, for savings
associations, to no more than 50 percent of tangible capital.
Mortgage servicing rights acquired before August 9, 1989 would
be phased-out over time, and unlimited servicing rights could be
held in separately capitalized mortgage banking subsidiaries.

Due to the risks associated with purchased mortgage
servicing rights, the FDIC has proposed to treat the total
amount of an institution's purchased servicing rights as a
single investment for determining whether excessive
concentrations exist in relation to capital.

Only in those

instances where the concentration of mortgage servicing rights
exceeds 25 percent of capital will there be a need to limit the
amount of these rights recognized for regulatory capital


At the same time, we realize this proposal is controversial
to some within the banking and thrift industries.

As a result,

we are allowing a 60-day public comment period that extends


until April 10, 1990.

The FDIC will carefully consider the

comment letters and the views of all affected parties before
making any final determination as to the merits of the existing

We wish to make it clear that we do not intend to act

on a final regulation until after we have firm data on the
institutions that would be affected, the amounts involved, and
whether the regulation would affect the inventory of
institutions that might go into the RTC.

We expect it will be

late Spring before this information will be available to us for


Another capital-related issue that

has raised some controversy is the loans-to-one-borrower
provision that now applies to savings associations.


supervisors traditionally have preached risk diversification,
particularly in the loan portfolio.

It is a fundamental

principal of sound banking that should be applied to individual
borrowers as well as to groups of borrowers with related direct,
indirect or contingent obligations.

Risk diversification is

especially important for controlling risk in the thrift
industry, where capital levels already are low and loan
portfolio concentrations already are high.

Unfortunately, it is

also a principal that has been violated all too frequently in
the past —

often with serious ramifications for the insurance


rphe FDIC fully supports the FIRREA requirement that applies
the loans-to-one-borrower restrictions as defined in the
National Bank Act to the thrift industry.

Banks have operated

successfully under these or similar restrictions for years.
However, over the years banks also have developed extensive
participation networks that effectively diversify the risk of
one borrower to more than one institution.

A properly

structured loan participation allows selling banks to
accommodate large loan requests which would otherwise exceed
lending limits, while enabling them to diversify risk, and
improve liquidity or obtain additional lendable funds.

While we see no reason why thrifts cannot operate
successfully under these restrictions, we recognize that full
and immediate implementation of these restrictions may place a
short term hardship on the industry.

The building of such a

loan-sharing network requires time to develop and mature if
thrift institutions are to continue to service their largest

For this reason, a transition rule is needed to

phase in the restrictions.

Insubstantial conversion transactions. One of the ways
FIRREA attempts to attract capital into the thrift industry and
enhance the overall value of individual savings associations is


by eliminating many of the prior impediments to mergers and
acquisitions, especially for bank holding companies.

The law,

however, discriminates against the ability of smaller
institutions to participate in deposit sales and transfers
during the 5-year period when conversion transactions are


- - -4*

Under FIRREA, ‘conversion transactions (i.e. transfers of
deposits between insurance funds —


are generally prohibited for five years.

However, FIRREA

permits one institution to acquire the deposits of another
institution and convert them to a different insurance fund if
the acquired deposits do not represent more than 35 percent of
the selling institution's deposits.

In addition, the acquired

deposits cannot represent more than 35 percent of the acquiring
institution's deposits.

When the test is applied to the selling

institution, it has the intended effect of keeping the bulk of
the deposits of the selling institution in its current insurance

However, when applied to the acquiror, the test has the

effect of discriminating against small institutions.

Because of

their size, these institutions may not be able to buy branches
without exceeding the 35 percent restriction.


well-managed and well-capitalized institutions should have the
opportunity to participate in this activity in the same way as
larger institutions.

Therefore, we believe the 35 percent test

should not be applied to the acquiring institution.

Emergency State lav override. When Congress addressed
emergency mergers, it transferred the emergency thrift-merger
statute from the National Housing Act to the Federal Deposit
Insurance Act.

As now constructed, the wording of the statute's

branching provisions could raise a barrier to the FDIC's
emergency assistance process in unit-banking states.

The provisions were designed to allow a surviving
institution to retain the branches of a thrift acquired under
the emergency procedures.

Prior to FIRREA, the survivor was

always a thrift since either the acquiring institution was a
thrift or the troubled thrift continued to survive.


banks are encouraged and stand ready to take over troubled

However, their enthusiasm for such acquisitions is

based in large part on their ability to retain the thrift's
branching network.

Unfortunately, a federal court in a unit-banking state has
read this provision so as to limit the FDIC's ability to
transfer thrift branches when the acquiror is a bank.

The court

has indicated that when a bank acquires a troubled thrift in a
unit-banking state, the resulting entity is subject to the
state's bank branching laws and, thus, the bank may not retain
the acquired thrift's branches.

We believe the court improperly

construed this provision and the construction is at odds with
the policy, structure and language of the emergency-merger

statute as a whole.

Nevertheless, the practical effect is that *

the decision reduces the value of thrifts to the banking sector,
and thereby impairs the FDIC's and the RTC's ability to arrange
mergers for them.

When the FDIC or the RTC provides assistance

for an emergency merger involving a troubled thrift, the
surviving institution should be allowed to retain the troubled
thrift's branches regardless of to whether the survivor is a
thrift or a bank.

FIRREA imposed^ a revised Qualified Thrift Lender (QTL) test
that will require savings associations to carry at least 70
percent of their portfolio assets in qualified investments by
July 1, 1993.

This test will have a substantial impact on

savings association operations.

While recognizing the intent of

the test, our concern is that interest rate risk in the thrift
industry, which is already high, could become even worse.


result could be a further deterioration of the thrift franchise

In our view, the full impact of the QTL test should be

carefully reviewed to ensure that such an unwanted result is

In conjunction with the QTL test, FIRREA also imposes
certain restrictions on savings association powers.


objective of these restrictions is to establish parallel

regulation of state and federally chartered savings associations,
in many areas and to prevent state savings associations from
engaging in activities not authorized to federal associations.
The FDIC, however, is authorized to grant exceptions to these

But, FDIC approval of exceptions is permitted

only if an institution is in compliance with its fully phased-in
capital standards.

There is no flexibility in that

Institutions not in compliance with the capital

standards cannot apply for a waiver to engage in or continue
certain activities, even when such a waiver would be clearly
beneficial to both the institution and the insurer.

In our view the law is too restrictive in this respect.


inhibits positive, creative ideas that could aid in an
institution's recovery or in a meaningful restructuring or
divestment plan.

We believe that a provision is needed allowing

more flexibility where an activity will clearly benefit an
institution and poses no risk to the insurance fund.

FIRREA requires the FDIC to issue uniform deposit insurance
regulations applicable to all insured depository institutions.
On December 21, 1989, we issued a proposed rule to implement
FIRREA's mandate in this area.

In doing so, we had to resolve

existing differences between FDIC insurance rules and those of
the FSLIC.

One of the most controversial and significant of

those differences involves so-called *'457 Plans.”

This aspect

of our proposed insurance regulation is the most frequently
mentioned issue in the many public comments we have received on
the rule.

A ”457 Plan” is a deferred compensation plan established by
a state or local government or a non-profit organization for the
benefit of its employees, which qualifies under Section 457 of
the Internal Revenue Code.

Although there is no specific

provision in the FDIC's current regulations, the FDIC staff has
taken the longstanding position that, unlike other pension
plans, deposit accounts maintained by a ”457 Plan” with an
insured bank are not entitled to pass-through insurance coverage
for the beneficiaries of the plan.

The staff's position is

based on the fact that, under Section 457 of the Internal
Revenue Code, the funds of 457 Plans are required to remain
solely the property of the employer.

This provision enables the

employer to utilize 457 Plan funds for its own purposes and
makes those funds subject to the claims of the employer's

The employer, rather than the employees, is thus

deemed to be the sole owner of the funds until they are

On this basis, the FDIC legal staff has maintained that the
employees (the plan participants) do not have any ownership
interest in the funds upon which insurance coverage could be


Thus, the funds are not insured on a pass-through


Consequently, deposit accounts at FDIC-insured banks

which are comprised of 457 Plan funds have been added together
and insured up to $100,000 in the aggregate.

In contrast, FSLIC

regulations insured 457 Plan deposit accounts at savings
associations up to $100,000 per participant.


regulation was based on the theory that 457 Plan deposits
should, as a matter of policy, be ^accorded the same insurance
provided for most other trusteed employee benefit plan deposits.

We know of no economic or policy reasons why the deposits of
457 Plans should not be afforded the same pass-through insurance
coverage that is provided for the deposits of most other
trusteed employee benefit plans.

However, our legal staff's

analysis of existing law indicates that it does not authorize
insurance to plan participants.

We are currently considering whether we can and should
expand insurance coverage to 457 Plans.

We have extended the

public comment period on our proposed insurance regulation until
March 23rd and are holding a public hearing today on the 457
Plan issue to ensure that we have all the facts at our

While there may be policy considerations favoring the

insurance of these accounts, if our final determination is that
we do not have the legal authority, we will not be able to
continue coverage for future deposits.

If there is a strong

congressional interest in providing insurance, we suggest that
Congress consider providing specific authority for deposit
insurance to 457 Plan participants.

Prior to FIRREA, the FDIC had express statutory authority to
regulate the way in which insured banks advertise their FDIC
insurance, as well as to prescribe the official FDIC sign and
regulate the manner of its use and display.

Under our authority

to regulate advertising of FDIC membership, the FDIC required all
insured banks to include the legend "Member FDIC" or equivalent
language in their advertisements.

In prescribing the new official sign for SAIF members and
authorizing the FDIC to regulate its use and use of the existing
FDIC sign, FIRREA inexplicably eliminated our authority to
regulate the way in which insured depository institutions
advertise their insurance.

This has led to an emotional and

heated debate over, for example, whether insured savings
associations may advertise themselves as "FDIC-insured" and the
extent of the FDIC's authority to resolve such disputes.

We believe it should be made clear that the FDIC can continue
to regulate deposit insurance advertising by restoring our
express authority to do so.

This authority should be broad

enough to allow the FDIC to deal with any related advertising


In addition, the official sign an institution is allowed'

to use should depend on whether the institution is a SAIF member
or a BIF member, rather than on whether it is a savings
association or a bank (as the law now is drafted), since some
banks may be members of SAIF and some savings associations may be
members of BIF.

One of the positive aspects of FIRREA is the new cross
guarantee liability of affiliated banks and savings

This provision was designed to keep

multi-institution holding companies from abandoning failing
insured affiliates.

Insured affiliates were made guarantors

because they are the direct beneficiaries of deposit insurance.

The law is a significant addition to the FDIC's resolution
arsenal, but it has not proven to be as effective as originally
expected for a variety of reasons.

First, and most importantly,

the cross guarantee only applies to institutions affiliated at
the time of failure.

This creates an incentive for holding

companies to sell or otherwise separate the healthy insured
institutions prior to a failure.

We believe the insurance fund

should be able to reach assets of formerly affiliated insured
institutions that are separated from common control relationship
within a certain amount of time prior to the failure of an
insured affiliate.

Therefore, we recommend that once a


financial institution is identified as in danger of failing,
formal notice of that determination to the holding company could
serve to legally obligate the failing institution's affiliates
under the cross guarantee provisions whether or not they are
commonly controlled at the time of actual failure.

We also have found that the required process for determining
losses delays reimbursement and therefore cannot be used in
conjunction with the resolution of the failing affiliate.


addition, because the cross guarantee only applies to insured
affiliates, even in situations where default is of little or no
concern, holding companies are finding it advantageous or
prudent to transfer traditional banking activities and assets
(such as data processing and trust operations) to nonbank
subsidiaries in order to remove assets from the potential scope
of the cross guarantee provisions.

While we do not have a ready

solution to these two areas of concern, we believe a rule that
requires a bank to be able to operate under existing rights when
a bank holding company fails should be required for safety and

FIRREA confers upon the FDIC, in its role as conservator or
receiver, the power to disaffirm or repudiate any contracts that
are burdensome, and which the FDIC determines Mwill promote the
orderly administration of the institution's affairs.”

We expect


this power will be an important tool for the FDIC and the RTC,
as we carry out our responsibilities as conservator or

It will be particularly helpful in repudiating some

employment contracts commonly known as golden parachutes.

While the general contract repudiation provisions in FIRREA
are very helpful, they may not be sufficient to deal with all
abusive golden parachutes.

These powers may need to be enhanced

to provide the FDIC with the necessary tools to deal with such

Creative lawyers and bank management can devise

deferred benefit arrangements, or time them, so that our ability
to repudiate them is made more difficult.

Further, our contract

repudiation authority is of little value in attacking golden
parachutes before an institution fails.

Specific legislation

empowering the FDIC to prohibit or limit excessive or abusive
golden parachutes, in whatever form they may take, would be

FIRREA also took positive steps with respect to real estate
appraisals by mandating major reforms in the real estate
appraisal industry.

The FDIC and the other Federal financial

institution regulators have begun the process of improving the
quality of appraisals used at federally insured institutions.
However, one anomaly that arises under FIRREA is that all
federally related transactions must have licensed or certified


appraisals by August 9, 1990, while the states have until
July 1, 1991 to install a certifying and licensing process.

Further, in our view, there is a good possibility that the
deadlines for full implementation of all aspects of the
appraisal process may not be realistic.

The expected increase

in the demand for complex appraisals, at a time when fewer
individuals may be qualified to perform those appraisals, could
delay a large number of real estate transactions and result in a
substantial cost to the FDIC and the RTC.

While lawyers,

doctors, accountants and other professions have had decades to
set up their self-regulatory professional organizations, FIRREA
gives the appraisal industry only two years to create the same
type of regulatory infrastructure.

Passing the necessary state

laws, establishing the necessary federal guidance, and then
licensing or certifying thousands of appraisers is a tall order
to complete by July 1, 1991.

To eliminate or at least reduce

this problem, some type of phase-in program should be designed.
The phase-in could decrease the initial demand for certified
appraisals and at the same time increase the number of available
certified appraisers.

Finally, the funding and operational rules for running the
Appraisal Subcommittee are proving difficult to determine.


extension of time to draw on the $5 million funding line from
the Treasury and clarification of the terms of repayment may be

restructuring ots

We have been asked to comment on legislative initiatives
that would abolish or restructure OTS.
two basic models.

One, proposed by Congressman Schumer, would

have the OCC supervise all thrifts —
chartered —

So far, there seem to be

both state and federally

and the Federal Reserve supervise thriTft holding
The other, recommended by Congressman Leach, would

have federal thrifts under the OCC, state-chartered thrifts
under the FDIC, and thrift holding companies under the Federal

As we understand the "Leach approach," the regulatory

and supervisory structure would mirror the existing system for

We are not convinced that the thrift supervision structure
should be changed at this time.

It has only recently been

changed and should be given a chance to work.

Further changes

at this time could result in unnecessary confusion, uncertainty,
and further disruption to the thrift industry.

However, if restructuring is undertaken, we strongly favor
following the bank model in which federally chartered thrift
institutions would be regulated by the OCC and state-chartered
institutions by the FDIC.

The fundamental reason for our

position is that we want to preserve the dual banking system.
From our country's earliest beginnings, states have been engaged
in the chartering and regulation of banks.

Using that

authority, states have been able to develop banking structures
that best meet their needs and that permit reaction to changing
local circumstances.

Moreover, the dual banking system has

provided an effective avenue for introducing major innovation to
the marketplace.

By placing all thrifts under the regulation and supervision
of the OCC, the incentive to remain a state-chartered
institution will vanish.

Since state supervisors depend largely

on examination fees for revenue, any significant decrease in the
number of state-chartered institutions will affect their revenue
and result in cutbacks in their supervisory programs.

Overall, it would be our recommendation that Congress resist
the temptation to make further changes to the Federal
supervisory structure at this time.

We should first gain a

better perspective on how the FIRREA-created structure
is actually operating.

Continual reorganization can be


The FDIC has been analyzing the need to restrict sales of
securities on bank premises.

We are now working on a regulation

that would prohibit the sale of securities of an insured
depository institution, its holding company, or other affiliates
on the premises of the insured institution.

The main purpose of

the regulation is to prevent abusive practices that confuse
customers into thinking they are purchasing an insured deposit,
when in fact they are buying an uninsured, unsecured

Such a regulation would protect consumers, as well

as preserve confidence in the industry.

Legislation might help

to more clearly define our authority to regulate this activity.

While there are clear benefits to regulating these
practices, and we are inclined to believe they should be
regulated, there are a number of issues that we are still in the
process of examining.

Our preliminary findings indicate that

such abusive practices are not necessarily widespread and
therefore may not warrant an additional regulatory burden.


are continuing discussions with other federal regulators to be
sure we ascertain the extent of the problem.

The legislation introduced by Congressman Schumer would
explicitly prohibit this practice.

What is already recognized

as an unsound activity would be made specifically illegal.
While strengthening federal regulation in this area is probably
a good idea, we would strongly recommend that any bill grant
definitional authority to the federal banking agencies.


inflexible statutory definitions of such terms as "ownership
interest,” "banking office" and "security" could lead to
unintended results, particularly as the marketplace and products
and services evolve.

The agencies should be authorized to

define the statutory terms as the changing supervisory
environment may dictate.

In conclusion, the FDIC believes that the changes made by
FIRREA have been very positive.

However, there are areas that

could benefit from additional changes and fine tuning.


believe that the thrift regulatory structure put in place by
FIRREA should be given time to work before it is altered again.

Thank you Mr. Chairman and members of the Subcommittee.
am prepared to answer any questions.


A number of changes to the law are necessary as a result of
FIRREA. The following suggestions reflect the FDIC's views on
some of the issues that are more substantive in nature. The list
is not intended to be exhaustive.
Suggested Changes to the Federal Deposit Insurance Act (FDI Actl


On February 28, 1993, the terms of all three of the FDIC's
appointive directors expire at the same time, and the statute is
unclear as to whether the directors then in office may continue
until a successor is appointed. Further, in the future, the
terms of the FDIC's appointive directors will again all expire at
approximately the same time. Both provisions adversely affect
FDIC operations and continuity.
The February 28, 1993 expiration date for appointive members'
terms of office should be eliminated to ensure that each can
serve a full six-year term. Further, to ensure continuity, the
appointive members' terms should be staggered, with termination
dates coming no sooner than two years apart. If FIRREA is not
amended to stagger the appointive members' terms and to eliminate
the February 28, 1993 expiration date, it should be made clear
that those appointive members then in office when their terms
expire in 1993 may continue until a successor is appointed and
confirmed. Without that clarification, the FDIC Board may have
to operate for a period of time with only two ex officio members.
If an appointive member leaves office in the last two years of
his or her term,' the President should be able to appoint a
successor for the remainder of that term and for the succeeding
term as well.


Conversion transactions (switches between BIF and SAIF) are
generally restricted for 5 years. One institution, however, may

acquire the deposits of another institution and convert them if
the deposits so acquired do not represent more than 35 percent of
the selling institution's deposits and also do not represent more
than 35 percent of the acquiring institution's deposits. This
test makes sense with respect to the selling institution, since
it effectively keeps the selling institution in the market as a
viable competitor. But it makes less sense when applied to the
acquiring institution since the test has the effect of
discriminating against smaller institutions.
The 35 percent test should not be applied to the acquiring


When a bank acquires a thrift under the Oakar Amendment, it
begins to make a payment to the SAIF based on the bank's
"Adjusted Attributable Deposit Amount.” The AADA represents the
deposits that the bank has taken over from the thrift. In
effect, the bank pays a SAIF assessment based on those deposits.
Unlike ordinary SAIF assessments, however, the payment can never
decline. FIRREA specifies that the AADA always increases: it
grows at 7 percent per year or at the bank's overall growth rate,
whichever is higher.
(The AADA is subtracted from the bank's
total assessment base for the purpose of computing BIF
This requirement can produce anomalous results if the bank is
actually shrinking rather than expanding— particularly if the
bank is troubled. The bank may be required to make
ever-increasing payments to the SAIF when its assessments would
ordinarily be teduced.
Moreover, if the bank transfers deposits back to another SAIF
member, the SAIF effectively gets a double assessment: it gets
an assessment from the acquiring thrift, and it also continues to
get the ever-increasing payment on the AADA made by the Oakar
Amendment bank.

A bank's AADA should be increased or decreased by the bank's
overall rate of growth. The AADA also should be reduced by an
amount equal to any deposits that the bank transfers to a SAIF


Before FIRREA, holding companies could effectively transfer their
system-wide losses to the FDIC by concentrating the losses in one
or two banks, and then allowing those banks to fail. FIRREA
attempted to put an end to that practice. FIRREA specifies that,
when the FDIC suffers a loss caused by the default of a
depository institution, and the institution belongs to a holding
company, the holding company's other depository institutions must
indemnify the FDIC against the loss. The "cross-guarantee" rule
was supposed to enable the FDIC to reach the good assets that
belonged to the holding company system, without regard for where
the holding company moved them.
The protection is inadequate, however. There are procedural
problems related to the timing of the enforcement procedures. As
a result, holding companies may be able to protect themselves
against cross-guarantees by selling off healthy institutions
prior to the failure of an affiliate and retaining the proceeds
at the holding-company level.
When a depository institution in a holding company system is
failing, the FDIC should be able to invoke the cross-guarantee
rules against all the depository institutions belonging to a
holding company by serving notice on the holding company that the
default by one of its affiliated institutions is "reasonably
imminent." After that date, any proceeds that the holding
company might receive as a result of disposing of an insured
affiliate should be subject to FDIC recovery regardless of where
held, and any institution sold should itself remain liable under
the cross-guarantee. Also, if the failing institution is disposed
of by the holding company prior to its failure, the company's
other depository institution subsidiaries should remain liable
under the cross



The FDIC may suspend an institution's deposit insurance
temporarily when the institution has no tangible capital— but
only if it has filed a Notice of Intention to Terminate Deposit
Insurance (which initiates an action to terminate the
institution's insurance permanently). Before the FDIC may issue
such a Notice, however, the FDIC must give thirty days notice to
the institution'-s primary Federal supervisor. The primary
regulator may agree to shorten or eliminate the time period
required for notice.
In some emergency situations, however, the FDIC must be able to
issue a temporary suspension order even though the FDIC has not
yet filed a permanent Notice. In such cases, the 30-day waiting
period negates the effectiveness of an immediate temporary
The FDIC should be able to file its Notice at the same time it
enters its suspension order in exigent circumstances.



The Administration's version of FIRREA defined the term "order
which has become final." The definition was deleted by Congress
on the assumption that it was superfluous language. The
definition is necessary since it assists the FDIC with proceeding
to enforce such orders, including, for example, cease and desist
The term "order which has become final" should be defined in the
FDI Act.



When the FDIC has successfully brought an administrative action
against an institution-affiliated person, the institution has on
occasion indemnified the person for his expenses— including any
civil money penalties and attorneys' fees--and has even pre-paid
his salary or other expenses in anticipation of the institution's
own failure. Indemnification of this kind nullifies the
deterrent effect of the administrative action. It also amounts
to a raid on the resources of the insurance funds, as the amounts
so diverted to the offending person are not available to the
institution's creditors if it fails.
The payment by an institution of attorney's fees and civil money
penalties for an institution-affiliated person against whom the
FDIC has successfully brought an administrative action, and
pre-payment of salaries or other expenses in anticipation of
failure of the institution, should be prohibited.


In the past, several courts have recognized that the FDIC has
priority over shareholders of closed institutions in claims
against directors, officers, accountants and other
professionals. The priority is based on the belief that
shareholders should be last in all meaningful ways. During the
FIRREA debate, an amendment was introduced to codify this
priority, but was not ultimately included in the legislation. A
recent court of appeals decision has ruled against the FDIC's
We recommend that legislation be enacted establishing a priority
for FDIC over shareholders for claims against directors,
officers, accountants and other professionals in failed



FIRREA provides that the assets and liabilities of the FSLIC are
transferred to the FSLIC Resolution Fund (•'FRF'*). However,
FIRREA does not state explicitly that the FDIC succeeds the FSLIC
as receiver for pre-FIRREA receiverships, nor does it make clear
the FDIC's role as manager of FRF.
In this connection, it is not clear that the FRF (and/or the FDIC
as manager of the FRF) has and may assert some or all of the
FDIC's rights under the FDI Act, or obtain appropriate benefits
under the FDI Act. For example, the question of when the D /Oench
doctrine may be asserted has arisen. In addition, lack of a
clear basis for authority to act has resulted in problems with
title companies.
Congress should clarify that the FDIC succeeds the FSLIC as
receiver for FRF receiverships, and that the FDIC has all the
rights and powers under the FDI Act with respect to these
pre-FIRREA receiverships. Congress also should clarify the
FDIC's rights and powers as manager of the FRF.


FIRREA provides that in certain emergencies the FDIC or the RTC
may override state law where necessary to accomplish a sale of a
failed savings association. A federal court has recently
indicated that, when a bank participates in an emergency
acquisition involving a troubled thrift, and the thrift is
located in a unit-banking state, the bank may not retain the
thrift's branches. We do not believe this is the intent of
FIRREA, and it hampers the speedy and cost-effective resolution
of failed thrifts.
The law should be clarified to affirm that when the FDIC provides
assistance for a merger involving a troubled thrift, and the
statutory criteria exist for an override of State law, the FDIC
or the RTC are authorized to permit the surviving institution to

-7retain the troubled thrift's branches, even if the survivor is a


FIRREA says that savings associations (as opposed to all SAIF
members) must use the SAIF sign, and that banks (as opposed to
BIF members) may use the FDIC's pre-FIRREA sign. There already
are banks that belong to the SAIF, however, and savings
associations that belong to the BIF. Accordingly, the FIRREA
rules can lead to confusion.
In addition, FIRREA eliminated— without explanation— the FDIC's
power to regulate the way in which insured institutions advertise
their insurance. This power should be restored to the FDIC in
order to make it clear that the FDIC can police the use of these
signs and the institutions' advertisements. The power should be
broad enough so that the FDIC can address various related
advertising expressions fe.a. . '»insured by the FDIC”) .
FiHally, the FDIC should have power to control other uses of the
signs and of the FDIC logo— e.q,. manufacture of the
signs and their use by nondepository institutions.
An institution's right to use the BIF or SAIF sign should depend
on whether the institution is a BIF or SAIF member, rather than
on whether the institution is a bank or savings association.
The FDIC should have authority to regulate the advertising of
FDIC insurance by depository institutions. The FDIC also should
have authority to control the manufacture, reproduction, or use
of the official signs and the FDIC logo by any person.


Insured savings associations must give the FDIC prior notice of
the acquisition or establishment of a subsidiary or of the
conduct of any new activity through a subsidiary. A few Federal
savings banks— those that were chartered as savings banks prior



to the Garn-St Germain Act— are exempt from this requirement.
There is no good policy reason to treat these savings
associations differently from the rest.
The exception should be deleted.


FIRREA improved the FDI Act's provisions that are designed to
prevent certain criminals from participation in the affairs of
depository institutions. For example, FIRREA extended the
sanctions for suspension of an indicted officer or director to
reach cases where "an agreement to enter a pre-trial diversion or
other similar program" is entered against such a party, as well
as when a "conviction" is entered against such a party.
Section 19 of the FDI Act prohibits depository institutions from
employing people who have been "convicted" of crimes involving
dishonesty or breach of trust. Section 19 is narrower than the
suspension authority of the FDI Act, however, in that it does not
include pretrial diversions or similar programs.
Section 19 should be extended to reach people who have entered
into agreements to enter a pre-trial diversion or other similar


As a result of FIRREA, uninsured savings associations must
disclose the fact that their deposits are not Federally insured.
They must make this disclosure both in their advertising and in
their periodic statements of account. The FDIC may issue
regulations prescribing the manner and content of the disclosure M
and may enforce its regulations against uninsured thrifts just as *
though they were FDIC-supervised banks.

-9The term ’’savings association" artificially and improperly limits
the application of this rule, however. For example, in some
States there are uninsured industrial banking companies--yet the
FDI Act classifies these companies as "banks," not "savings
associations." In addition, there are other nondepository
companies that market debt securities in a manner that resembles
the deposit-taking activity of savings associations.
In order to protect the public»against false or misleading
practices with respect to deposits in uninsured depository
institutions, the FDIC should be given the power to determine
when such disclosures are required.


The FDIC insures most trusteed employee benefit plan deposits on
a "pass-through" basis, i.e.. the deposits are insured on the
basis of the ownership interests of the plan participants
(employees) in the deposits. But so-called "457 plans" (deferred
compensation plans established by states, local governments, or
nonprofit organizations for their employees under section 457 of
the Internal Revenue Code) are unique in that the Internal
Revenue Code expressly provides that the funds remain solely the
employer's property and are subject to the claims of the
employer's creditors. Accordingly, the FDIC legal staff has long
maintained that 457 plan participants have no ownership interests
in the funds that would support pass-through insurance. Thus,
the FDIC position has been that, as a matter of law, 457 plan
deposits cannot have pass-through insurance even though there may
be no valid economic or policy reasons for insuring 457 plan
deposits differently from other trusteed employee benefit plans.
While the FDIC is holding a public hearing on March 14, 1990 to
clarify its understanding of the nature of 457 plans, if Congress
thinks these plans should be insured on a pass-through basis,
like other trusteed employee benefit plans, it should consider
amending the law to provide a clear legal basis for extending
deposit insurance to these plans.



10 -


FIRREA provides the FDIC, in its role as conservator or receiver,
with the power to disaffirm or repudiate contracts, including
abusive "golden parachutes" of management in a failed depository
institution. This authority, however, may not reach all abusive
golden parachutes and, in particular, does not reach abusive
arrangements in institutions that have not closed.
FDIC should be empowered, as a supervisory matter, to prohibit or
limit excessive or abusive golden parachutes in depository
institutions, no matter what form they take or when they are


FIRREA prohibits state savings associations from participating in
activities not permissible to Federal savings associations unless
the FDIC determines the activity poses no significant risk to
SAIF and the institution is in compliance with the capital
standards prescribed under section 5(t) of the Home Owners' Loan
Act. If an institution is not fully capitalized, the FDIC may
not authorize an activity even if such a waiver is clearly
beneficial to both the institution and the insurer.
The FDI Act should be amended to allow flexibility where a
determination is made that an activity will clearly benefit the
institution in its recovery and poses no risk to the insurance



11 -


FIRREA mandates major reform in the real estate appraisal
industry. All federally related transactions must have licensed
or certified appraisals by August of 1990 and each state must
have installed a certifying and licencing process by July of
1991. These deadlines may not be realistic and, as a
consequence, may cause delays in a large number of real estate
transactions due to a shortage of qualified appraisers.
We recommend that FIRREA be amended to provide a phase-in program
initially requiring certified appraisals only on large
transactions. At the same time, it also should be amended to
have a phase-in of the professional requirements in order to
increase the supply of qualified appraisers to a level sufficient
to handle the anticipated demand.


FIRREA provided the FDIC with expanded powers as receiver and
conservator. Specific provisions were made for certain
securities contracts referred to as "qualified financial
contracts." In enacting the legislation, three sentences
concerning notice requirements were inadvertently omitted, and
these omissions create inconsistencies in the statute. The FDIC
has attempted to clarify these omissions by a policy statement.
The missing sentences should be added to the statute to clarify
and affirm the FDIC position regarding these contracts and to
carry out congressional intent.


12 -

Suaaested Changes to -the Home Owners' Loan Act (HOLA)


FIRREA provides that after January 1, 1990, no State savings
association may conduct any activity impermissible for a Federal
Savings association unless the FDIC gives it prior approval.
However, certain Federal savings banks— those that were chartered
prior to the Garn-St Germain Act, and those that were once
organized as State mutual savings banks— were permitted to
continue to engage in activities and make investments to the same
extent as they were originally authorized. For example, the
affected Federal savings banks are permitted to acquire or retain
junk bonds absent our taking action under section 18(m) of the
FDI Act.
There does not appear to be any good policy reason to allow these
institutions to exercise in the first instance powers that no
other insured savings association may exercise. To be sure, the
FDIC retains the power to determine that certain activities or
practices present a serious threat to the deposit insurance fund,
but the FDIC can only act after the fact.
The grandfather rights should be deleted. In the alternative,
Federal savings banks should not continue to exercise their
grandfathered powers without the FDIC's prior approval.


The Director of OTS has authority to allow an individual Federal
savings association to exceed the 400 percent of capital ceiling
for nonresidential real estate loans if the Director finds that
the waiver will not pose a significant risk to the operation of
the association.
This standard is too narrow, and does not take into account the
broader issue of potential harm to the affected deposit insurance


the Director of OTS may grant such a waiver, the Director
be required to obtain the FDIC's concurrence. The FDIC
be able to provide its concurrence upon a finding that the
will not result in a significant risk to the affected


FIRREA makes savings associations subject to the same
loans-to-one-borrower restrictions as national banks. Thrift
institutions have not had the opportunity to develop effective
loan participation networks to accommodate large loans that might
otherwise exceed their individual lending limits, as banks have
done for years. This places a short-term hardship on the thrift
industry by restricting its ability to serve large borrowers.
Provide a transistion period to phase in the loans-to-one
borrower restrictions.