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Statement of
Martin J. Gruenberg, Vice Chairman,
Federal Deposit Insurance Corporation
On
Exploring the Balance Between
Increased Credit Availability
and
Prudent Lending Standards
before the
Financial Services Committee
U.S. House of Representatives
2128 Rayburn
House Office Building
March 25, 2009

Chairman Frank, Ranking Member Bachus and members of the Committee, I
appreciate the opportunity to testify on behalf of the Federal Deposit Insurance
Corporation (FDIC) on the balance between increased credit availability and prudent
lending standards.
As federal insurer for all banks and thrifts, and primary federal supervisor for just over
5,000 state chartered banks, the FDIC is very aware of the challenges faced by financial
institutions and their customers during these difficult economic times. Among the
greatest strengths of our economy is the diverse collection of over 8,000 FDIC-insured
depository institutions that operate almost 100,000 offices in every corner of our nation.
Bankers and examiners know that prudent, responsible lending is good business and
benefits everyone.
Adverse credit conditions brought on by an ailing economy and stressed balance
sheets, however, have created a difficult environment for both borrowers and lenders.
The deterioration in the economy in recent months has contributed to a decline in both
the demand and the supply of credit. Resolving the current economic crisis will depend
heavily on creditworthy borrowers, both consumer and business, having access to
lending.
In response to these challenging circumstances, banks are clearly taking more care in
evaluating applications for credit. While this more prudent approach to underwriting may
mean that some borrowers who received credit in past years will have more difficulty
receiving credit going forward, it should not mean that creditworthy borrowers are
denied loans. Unfortunately, in such a difficult environment, there is a risk that some
lenders will become overly risk averse. As bank supervisors, we have a responsibility to
assure our institutions, regularly and clearly, that soundly structured and underwritten
loans are encouraged.

In my testimony, I will briefly describe the trends in the availability of credit and the
conditions currently creating obstacles to credit availability. I also will describe the bank
examination process and address concerns that banks are receiving mixed messages
from their supervisors. Finally, I will discuss the efforts the FDIC is making to encourage
prudent lending by the institutions we supervise.
Use and Availability of Credit Over the Business Cycle
Following the intensification of financial market turmoil in September 2008, the U.S.
economy experienced a marked deterioration in performance from what already was a
recession level. During the fourth quarter, real gross domestic product (GDP) declined
at an annualized rate of 6.2 percent, the largest decline in any single quarter since
1982. Payrolls have declined by just under 3 million jobs since September, bringing total
job losses during the recession to 4.4 million. The unemployment rate rose to 8.1
percent in February 2009, compared to just 4.9 percent when the recession started in
December 2007.
This rapid deterioration in business conditions has had important effects on both the
demand for, and the supply of, credit. The demand for business credit tends to vary
over the business cycle with the level of spending on new capital equipment and
inventories. During the fourth quarter of last year, business spending on nonresidential
equipment and structures declined at an annualized rate of over 21 percent -- the
largest quarterly decline since 1975. Private inventories fell by almost $28 billion during
the year (adjusted for inflation), the largest annual decline since the 2001 recession.
Amid this downturn, loan performance has deteriorated and lenders have tightened
lending standards. According to Standard and Poor's (S&P), the 12-month default rate
on U.S. high-risk loans rose to 4.35 percent in December, up from 0.26 percent a year
earlier.1 Meanwhile, the Federal Reserve Senior Loan Officer Survey shows that large
lenders have progressively tightened standards on loans to both large and small
business borrowers since late 2007.2
Surveys of small businesses conducted by the National Federation of Independent
Business (NFIB) show that while small business loans have clearly become harder to
obtain, deteriorating business conditions appear to represent an even larger problem. In
an NFIB survey conducted in January, the percent of respondents who said that loans
were "harder" to get in the last three months outnumbered those who said loans were
"easier" to get by 13 percentage points, the highest margin since 1981.3 At the same
time, however, the percent of respondents who said that sales were "lower" in the last
three months outnumbered those who said sales were "higher" by 31 percentage
points, the highest margin in the 35-year history of the survey.
Given that the center of the current crisis has been in residential mortgage lending, the
effects on loan demand and the availability of credit have been even more pronounced
in the case of U.S. households. Net borrowing by U.S. households exceeded $1 trillion
annually in 2004, 2005 and 2006, fell to $849 billion in 2007, and declined to $51 billion

in 2008.4 During the peak borrowing years, some 87 percent of household borrowing
was comprised of mortgage debt. As in the case of business credit, the shrinking
volume of household credit reflects trends on both the demand side and the supply side
of the equation.
A significant contributing factor behind the contraction in the volume of credit in recent
months has been the virtual shut-down of the private securitization market. Private-label
securitization played an increasingly important role in bank funding through 2007, but
declined precipitously in 2008. It was the securitization market that fueled much of the
growth in residential and commercial real estate lending in the earlier part of this
decade, so the impact of this tightening is felt particularly in these sectors.
As they face a very difficult economic environment, businesses and households are
curtailing their spending, which tends to reduce the volume of credit they wish to obtain
in the aggregate. Meanwhile, rising unemployment and falling business profits are
reducing the creditworthiness of some business and household borrowers at the same
time that lenders are raising credit standards in response to higher loan losses. In a
normal economic cycle, these trends will tend to self-correct over time; however, the
current environment appears particularly challenging.
Bank Credit Quality and Lending Activity
Fourth quarter financial results demonstrated considerable stress for FDIC-insured
institutions. The industry posted an aggregate loss of $32 billion over the quarter, as
revenues were outpaced by increased expenses of provisions for loan losses, goodwill
writedowns, and trading losses. Asset quality also continued to deteriorate. At year-end,
the ratio of noncurrent loans to total loans at insured institutions climbed to 2.93
percent, doubling from just one year earlier.5 This is the highest noncurrent rate for the
industry since fourth quarter 1992, when the noncurrent rate was 2.94 percent.
Noncurrent rates rose rapidly during 2008, reflecting the slowing economy and growing
inability of some businesses and consumers to make loan payments. Net charge-offs
also rose steadily in 2008, climbing to an annualized rate of 1.92 percent in the fourth
quarter -- the highest level in the 25 years that institutions have reported quarterly net
charge-offs.
These credit problems are most pronounced in construction and development lending,
where the percent of noncurrent loans stood at 8.55 percent as of year end 2008 -- a
marked increase from 3.22 percent at year end 2007. Steady declines in performance
are also evident in other loan types such as residential mortgages, credit cards and
commercial real estate. Because of the rapid slowdown in the economy and the
protracted distress in the real estate sector, it seems clear that credit quality will
continue to be problematic this year.
The fourth quarter bank and thrift financial reports also show that lending activity has
slowed. Year-end 2008 Call and Thrift Reports showed aggregate loan balances of $7.9
trillion, reflecting a decline of 1.4 percent during the fourth quarter and a smaller decline

of 0.4 percent from year-end 2007. While many factors -- including loan sales, writedowns, payments, and originations -- can affect loan balances, changes in loan
balances can also reflect changes in lending patterns over time. Prior to the third
quarter of 2008, the industry had reported an increase in total loans outstanding in 25
consecutive quarters dating back to third quarter 2002.
Fourth-quarter loan growth at FDIC-insured institutions tended to vary according to the
size of the institution. Table 1 shows that largest institutions, those with assets over
$100 billion, reported a decline of 3.4 percent in loan balances while the smallest, those
with assets under $1 billion, showed an increase of 1.5 percent. In fact, the fourthquarter decline in loans outstanding at FDIC-insured institutions was driven mostly by
large declines at some of the biggest banks. More than half of the insured institutions
with assets greater than $100 billion reported a decline in loan balances during the
quarter, and the change in loan levels at the three institutions with the greatest
decreases represented more than 100 percent of the total industry decline in loans
outstanding.
Table 1. Loan Growth by Asset Size Groups, Fourth Quarter 2008
(Dollar amounts in billions)
Asset Size

> $100
Billion
> $100
Billion
$1 - $10
Billion
< $1 Billion
All Insured
Institutions

Number of
Institutions

Number
Reporting
Decline in
Loans

Number
Reporting
Increase in
Loans

Aggregate
Net Change
in Loans
($ Billions)

Percent
Change

22

13

9

($142.7)

-3.4%

92

43

49

$6.9

0.4%

561

179

382

$8.2

0.8%

7,630

2,657

4,973

$15.6

1.5%

8,305

2,892

5,413

($112.0)

-1.4%

Source: Call and Thrift Financial Reports
The data also point to some important differences in portfolio structure between small
banks and large banks that may account for the relative stability of loan balances at
small banks. On average, community banks at the end of fourth quarter 2008 had a
higher ratio of core deposits to assets than did banks with assets over $1 billion.
Community banks also reported a higher average ratio of loans to assets than larger
banks. These differences suggest that, at least in this stressful period, the business

model that relies on funding through core deposits and relationship lending, which has
been adhered to by many community banks, has proven to be resilient.
The Role of Bank Supervision
The FDIC is committed to ensuring that examiners carry out their responsibilities in an
objective and even handed manner. Examiners are expected to closely review and test
bank management's assessment of risk, market conditions, policy parameters, and use
of any federal financial assistance. The examination process focuses on assessing
banks' own risk management process and identifying any weaknesses for consideration
and action by bank management.
In the period leading up to the credit market disruption, regulators should have been
more aggressive in their supervisory approach to high risk credit practices that
contributed to our current economic problems. While the banking supervisors issued a
number of warnings to the industry and provided guidance for enhancing risk
management, in hindsight, the agencies should have been more vigilant about some
institutions' outsized risk exposures and underwriting practices.
Some have suggested that bank supervisors are now contributing to adverse credit
conditions by overreacting to current problems in the economy and discouraging banks
from making good loans. Borrowers report that banks are reluctant to lend and some
are attributing this to the bank examination process. In particular, concerns have been
expressed that bank examiners are discouraging banks from making loans in an effort
to preserve capital, or that examiners are requiring banks to engage in aggressive exit
strategies with borrowers who are experiencing difficulties in their businesses,
particularly those involving real estate.
The FDIC understands the critical role that credit availability plays in the national
economy, and we balance those considerations with prudential safety and soundness
requirements. Through our formal and on-the-job training process at the FDIC, field
examiners are taught how to review banks' policies, lending and investment practices,
financial reporting, and management performance. Based on their findings, examiners
communicate their observations to superiors and bank management both orally and in
writing. The examiners are instructed on how to deliver their observations without
infringing on bank management's day-to-day decision-making and relationships with
customers.
A number of discussions have taken place with the FDIC's regional management to
raise sensitivity to issues of credit availability. FDIC senior management has reiterated
that examiners should be encouraging banks to continue making prudent loans and
working with customers facing financial difficulties.
Many members of the FDIC's supervisory staff served through the 1980s and 1990s as
regulators and have an average tenure of nearly 16 years. Given their seasoning as
regulators, our examiners are keenly aware that credit extended by banks is critical to

local economies across the country. Most FDIC examiners live in the communities of
the banks they examine, and are very familiar with the local markets and economic
trends.
We also have heard criticisms that regulators are requiring widespread re-appraisals on
performing real estate loans, which then precipitate write-downs or a curtailment of
credit commitments based on a downward revision to value. While we encourage banks
to review collateral valuations when a borrower's financial condition has materially
deteriorated or loan covenants have not been met, periodic credit reviews, including
collateral assessments, by bank management are a long-standing credit practice. Bank
management has considerable flexibility in making collateral assessments, both for
individual loans and portfolio reviews, and we have not revised our supervisory
expectations in the current environment. In cases where market values of collateral
have significantly deteriorated and the borrower also is seeking a modification of loan
terms, we have encouraged banks to work with the borrower during this difficult period.
It is our hope that banks can reach mutually-advantageous workout arrangements that
take into account the borrower's financial position and the collateral's valuation and
result in a re-structured, and stable credit relationship.
In regard to fair value accounting, we are faced with a situation in which an institution
confronted with even a single dollar of credit loss on its available for sale and held to
maturity securities must write down the security to fair value, which includes not only
recognizing the credit loss, but also the liquidity discount. The FDIC has expressed its
support for the idea that the Financial Accounting Standards Board (FASB) should
consider allowing institutions facing an other-than temporary-impairment (OTTI) loss to
recognize the credit loss in earnings but not the liquidity discount. The FASB last week
issued a proposal that would move in this direction.
The FDIC understands the tight credit conditions in the market and is contributing to a
number of efforts to improve the current situation. Over the past year, we have issued
guidance to the institutions we regulate to encourage banks to maintain the availability
of credit. Moreover, examination professionals have received specific instruction on
properly applying this guidance within the context of FDIC supervised institutions.
On November 12, 2008, we joined the other federal banking agencies in issuing the
Interagency Statement on Meeting the Needs of Creditworthy Borrowers (FDIC FIL-1282008).6 This statement reinforces the FDIC's view that the continued origination and
refinancing of loans to creditworthy borrowers is essential to the vitality of our domestic
economy. The statement encourages banks to continue making loans in their markets,
work with borrowers who may be encountering difficulty during this challenging period,
and pursue initiatives such as loan modifications to prevent unnecessary foreclosures.
In light of the present challenges facing banks and their customers, the FDIC hosted a
roundtable discussion earlier this month focusing on how regulators and financial
institutions can work together to improve credit availability. Representatives from the
banking industry were invited to share their concerns and insights with the federal bank

regulators and representatives from state banking agencies. The attendees agreed that
open, two-way communication between the regulators and the industry was vital to
ensuring that safety and soundness considerations are well balanced with the critical
need of providing credit to businesses and consumers. I believe this was a very
productive meeting, and look forward to working with the industry and our colleagues at
the other agencies to ensure credit remains available during this challenging period.
One of the important points that came out of the session was the need for ongoing
dialog between bankers and their regulators as they work jointly toward a solution to the
current financial crisis. Toward this end, Chairman Bair announced last week that the
FDIC is creating a new senior level office to expand community bank outreach. In
conjunction with this office, the FDIC plans to establish an advisory committee to
address the unique concerns of this segment of the banking community.
As part of our ongoing supervisory assessment of banks that participate in federal
financial stability programs, the FDIC is taking into account how available capital is
deployed to make responsible loans. It is necessary and prudent for banking
organizations to track the use of the funds made available through federal programs
and provide appropriate information about the use of these funds. On January 12, 2009,
the FDIC issued a Financial Institution Letter titled Monitoring the Use of Funding from
Federal Financial Stability and Guarantee Programs (FDIC FIL-1-2009),7 advising
insured institutions that they should track their use of capital injections, liquidity support,
and/or financing guarantees obtained through recent financial stability programs as part
of a process for determining how these federal programs have improved the stability of
the institution and contributed to lending to the community. Equally important to this
process is providing this information to investors and the public. This Financial
Institution Letter advises insured institutions to include information about their use of the
funds in public reports, such as shareholder reports and financial statements.
Internally at the FDIC, we have issued guidance to our bank examiners for evaluating
participating banks' use of funds received through the TARP Capital Purchase Program
and the Temporary Liquidity Guarantee Program, as well as the associated executive
compensation restrictions mandated by the Emergency Economic Stabilization Act.
Examination guidelines for the new Public-Private Investment Fund will be forthcoming.
During examinations, our supervisory staff will be reviewing banks' efforts in these areas
and will make comments as appropriate to bank management. We will review banks'
internal metrics on the loan origination activity, as well as more broad data on loan
balances in specific loan categories as reported in Call Reports and other published
financial data. Our examiners also will be considering these issues when they assign
CAMELS composite and component ratings. The FDIC will measure and assess
participating institutions' success in deploying TARP capital and other financial support
from various federal initiatives to ensure that funds are used in a manner consistent with
the intent of Congress, namely to support lending to U.S. businesses and households.
Conclusion

FDIC-insured banks are uniquely equipped to meet the credit needs of their local
markets, and have a proven tradition of doing so, through good times and bad. Banks
should be encouraged to make good loans, work with borrowers that are experiencing
difficulties during this challenging period whenever possible, avoid unnecessary
foreclosures, and continue to ensure that the credit needs of their communities are
fulfilled. In concert with other agencies and departments of the federal government, the
FDIC continues to employ a range of strategies designed to ensure that credit continues
to flow on sound terms to creditworthy borrowers.

1 "U.S. Corporate Default Rate Forecasted to Reach All-Time High of 13.9% in 2009,"
Standard and Poor's RatingsDirect, January 23, 2009.
2 Federal Reserve Board, Senior Loan Officer Opinion Survey on Bank Lending
Practices, http://www.federalreserve.gov/boarddocs/SnLoanSurvey/
3 NFIB Small Business Economic Trends, February 2009,
http://www.nfib.com/object/IO_39981.html - PDF 768k (PDF Help)
4 Federal Reserve Board, Flow of Funds, Table F.2.
5 Noncurrent loans are loans that are past due 90 days or more or that are in
nonaccrual status.
6 See: http://www.fdic.gov/news/news/press/2008/pr08115.html
7 See: http://www.fdic.gov/news/news/financial/2009/fil09001.html

Last Updated 3/25/2009