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S e on Delivery
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Sgptember 11, 1985

Statement by
Paul A* Volcker
Chairman, Board of Governors of the Federal Reserve System




before the
Committee on Banking, Bousing and Urban Affairs
United States Senate

September 11, 1985

I appreciate the opportunity to be here today to comment
.
on proposals for reforming the Federal deposit insurance system
and to review some other elements of the appropriate federal
approach toward depository institutions*
In the light of recent and current problems in banking
and thrift institutions, such a review is natural.

At the same

time, as proposals for changing deposit insurance and supervisory
arrangements for depository institutions are reviewed, we should
not lose sight of their successes, both in the past and in coping
with the present strains.
For many years, the number of failed depository institutions
was miniscule relative to the number of such businesses.

Recently,

there has been a significant increase in actual or near failures,
and the financial system as a whole has been under greater strain.
But the points of particular pressure have been dealt with in a
manner that has avoided contagious chain reactions, and the
health of other financial institutions and the economy has not
been undermined.




As intended by the Congress, no small depositor

-2of any federally insured institution has lost money because of a
bank failuref and losses to larger depositors and other creditors
of banking organizations have been very limited, without calling
upon support of the general taxpayer.
As we review this experience, it is also natural and
appropriate that you consider whether improvements need to
be made in the functioning of our deposit insurance and
supervisory systems*

We have indeed seen a number of

organizations, including some larger ones, fail or be
forced into merger or reorganization in the past few years.
And, while that number has remained comparatively small, the
reports of our federal and state examiners reveal that a
sizable number of additional institutions have serious problems.
Considerations of how to deal with these problems and, indeed,
how to turn around the recent trends, are thus in order.
In part these problems are traceable to the heightened
degree of competition to which institutions are now subject,




—3—

a development fostered in large part by technological and
financial innovations both at home and abroad.

Those innovations,

in turn, have been accompanied by, and in good part forced, greatly
relaxed regulation of interest rates paid on deposits.

Some

institutions have importantly expanded asset powers.
The economic environment has also changed in a way that
has increased the risks in highly aggressive banking practices*
That change was punctuated by a major recession in the early
1980s, which itself strained the finances of many businesses
and individuals•

But we also had a vigorous recovery and expansion,

and ordinarily credit quality would be expected to show marked
improvement after the first year or so of recovery.

That has not

happened so far during the current expansion.
In significant part, that is because the nation has also
been going through the more fundamental process of moving from a
condition of accelerating and anticipated inflation to one of
much more moderate price pressures generally.

In fact, downward

price pressures in some previously inflated sectors of the economy




-4have been evident, and real interest rates have been unusually
high*

Many ventures thought likely to be profitable by financial

institutions and their customers during an inflationary period
have turned out not to be so.

The energy, shipping, agricultural,

and real estate areas are replete with examples.
Moreover, patterns of thinking shaped during inflationary
times are hard to dispel.

Thus, some projects undertaken by

entrepreneurs and financed by depository institutions—and sometimes
those roles are combined—still seem to depend importantly for
their success on increased prices, particularly with respect to
some kinds of real estate development.
The strength of the dollar in international currency
markets has also been a factor adding to pressures on the
manufacturing, mining, and agricultural sectors, even as
the economy as a whole has grown substantially.

A number of

important foreign borrowers in Latin America and elsewhere,
who were favored lending outlets during the highly inflationary




-5period, have found themselves in an over-extended position in the
current economic climate,
I believe a third major source of our current problems'
can be traced to certain changes in banking and public attitudes
that emerged gradually as memories of earlier difficulties faded
from consciousness and the postwar economy and financial markets
displayed remarkable—indeed virtually unprecedented—growth
and stability.

Banks ended World War II with unusually high

liquidity and strong capital positions.

It was natural and

healthy that these funds would be more actively employed over
timef and that the extreme caution bred by depression would be
dissipated.

In the absence of signs of real difficulty for several

decades, a new generation of managersf directors and regulators,
basing their judgments on postwar experience, shifted the focus
of bank policies away from concerns with safety and toward greater
risk-taking in a quest for larger profits in a highly competitive
environment.




In time, and further induced by the inflationary

-6expectations bred in the 19708, these tendencies were carried
beyond prudent limits in a few institutions.
These risks have been aggravated more recently by reactions
of some managers, particularly in the thrift industry, to a prolonged period of extreme earnings pressures in their traditional
lines of business.

Implicitly or explicitly, they decided, in

effect, to "roll the dice" by undertaking particularly risky
activities generating immediate profits or the hope for large
gains over time.

From the standpoint of managers or owners,

the chance of failure of the institution was already large, and
should sizable losses rather than gains materialize, depositors
would, in any event, in whole or in part, be protected by deposit
insurance.
One general question before you is the extent to which these
changes in attitude and behavior have been inadvertently encouraged
by the federal "safety net"—indeed the extent to which the very




-7success of those arrangements, in protecting individual depositors
and the financial and economic stability generally, has also
encouraged some depository organizations to assume inordinate
risks for both the institutions and the insurance system*
One aspect of the dilemma for the authorities is that
institutions mayf consciously or unconsciously, build into their
decision-making the view that deposit insurance and the availability
of discount window credit will give added time and leeway to deal with
unforeseen problem situations that may arise, thus making institutions
less self reliant and less concerned about risk despite the vulnerability of equity owners.

Depositors and creditors of banking

organizations themselves, because of the safety net, may anticipate
that the "government," in the last analysis, will take actions to
protect them against loss, so they can be relatively indifferent
to the risk exposure of depository institutions.

That is obviously

the case for insured depositors who, by design, rely on the federal
insurance backing their deposits rather than on the financial health
of their banking institution for the return of their money.




The other side of the dilemma is that the "safety net"
provides an essential public service, not only in protecting
small depositors, but also in avoiding spreading fear among
depositors generally, thus undermining the stability of the
system as a whole.

Instilling discipline at the expense of a

financial debacle would be a pyrrhic victory.
Clearly, part of the challenge is to maintain a strong
and effective safety net while minimizing adverse side effects
on excessive risk taking.

One important means of maintaining such

balance is that management and owners of failed and distressed
institutions are not, and should not, be immunized from the
consequences of bad decision-making and excessive risktaking.
Stockholders lose when a bank has failed or gotten into trouble;
management has lost jobs and reputations.

Moreover, recent

events confirm that uninsured depositors and creditors do not
feel entirely free of potential risk, and some recent events have
alerted managements to the importance of maintaining confidence.




There is one aberrant situation that has been of strong
and understandable concern to the insuring agencies*

I touched

earlier on the apparent temptation of some thrift institutions,
finding themselves with negative earnings and impaired capital
and concerned about their ability to restore profitability through
adherence to normal business practices, to channel funds into
risky financial ventures*

In some cases, these practices are

directly aided and abetted by the fact that the institution is
able to obtain more sizable funds than would otherwise be possible
by issuing insured deposits at relatively high rates, quite often
through the auspices of a broker.

Such insured deposits have

been highly attractive because they have provided interest returns
above the general market level, and because they are fully insured
and free of risk regardless of the condition and activities of
the issuing institution.

Given this potential for abuse, we have

supported the concept of strict limitations on certain insureddeposit brokerage activities.




-10In sum, the burden of my remarks is that the insurance
system, the safety net, and the processes of banking supervision,
faced with the strongest challenge in decades, have functioned with
remarkable effectiveness to protect the stability of the banking
£ysteirw

We must not impair that effectiveness*

At the same

time, we want to learn all that we can from recent experience to
encourage a still stronger, self-reliant system, to deal with the
sources of strain, and to speed a return to a situation in which
active use of the safety net is reduced.

In that process, we

want to build on the existing strengths of the system, and to
encourage the efforts already strongly underway among many depository
institutions to improve their own positions.

Perhaps it is also

worth emphasizing that this is no time for overreaction—for
encouraging the pendulum of attitudes and policies by either
managements or officials to swing to the point that reasonable
innovation, risk-taking, and growth is stifled by unwarranted
fear and uncertainty*




-11Market Discipline
One approach toward maintaining a balance between stability
and risk-taking would involve reinforcing, or duplicating by other
means, disciplines inherent in the market process*

Ideas along this

line run from more frequent disclosure of information about the
condition of banking and thrift institutions to increasing the
frequency and the certainty of loss that large depositors and
other creditors would suffer in the event of failed institutions*
The concept is thatf by intensifying the consequences of bad
decision-making, depository institutions—their managements,
directors, shareholders and depositors and creditors—will be
more sensitive to risk, promoting safer and sounder practices.
Obviously, sensitivity of depository institutions and
their customers to the consequences of risk-taking is fundamental
to prudent banking.

Any manager blinded to that fact by years of

tranquility has been forcibly reminded by recent events.

But

our financial history demonstrates unambiguously the dangers of
relying on market discipline alone.




Prior to the 1930s, market

-12discipline did not prevent bank failures or systematically discourage excessive risk-taking—until after periodic crises had
occurred, at great expense to the economy generally.

Indeed,

the entire rationale for the establishment of the Federal Reserve
and the FDIC lay in the realization that institutions at the
core of our payments and financial systems have a unique importance
for the stability of the economy generally.
Recent years have seen considerably more public disclosure
of loan concentrations and other matters.

Normally, the presumption

should be in favor of wide disclosure in the interest of full
market information to investors, within limits imposed by customer
or competitive confidentiality.

But such disclosure provides

limited protection at best against imprudent lending or other
risks, which are usually not apparent in simple listings of
concentrations and which, indeed, often are exposed after the
fact.
The question remains of striking an appropriate balance.
Experience suggests strongly that creditors and investors find




-13-

it difficult or impossible in practice to make reliable incremental
appraisals of the degree to which institutions are taking excessive
risks prior to the time the consequences of such activities become
readily apparent.

To take one example, the Continental Illinois

Bank was an investment favorite, praised for aggressive expansion,
virtually until the eve of the exposure of massive problems
in its loan portfolio.
in the energy area.

Those problems were initially centered

But aggressive energy lending, in the

environment of the 1970s and early 1980s, was considered
appropriate and desirable in the marketplace for many banks,
and those banks were generally characterized by high earnings,
stock prices, and growth.

Investors and depositors detected and

reacted to the problems only after it was clear that a highly
aggressive lending posture in the energy area had yielded bitter
fruit.

Then left untempered, the reactions would have been so

strong as to undermine a number of banks' prospects for viability,
with widespread secondary repercussions.

A similar pattern of

years of complacency, even when the general nature and size of




-14the lending is well known, could be cited in the growing loan
exposures of multinational banks to developing countries,.

Similarly,,

the exposure of thousands of small agriculturally oriented banks
is today viewed very differently than only a few years ago*
In other words* in an inherently uncertain worldr subject
to changes in objective circumstances and fashion, the prescience
of market forces is necessarily limited and sentiment quickly
reversible.

Once it becomes reasonably clear that an institution

has difficulties, sharp swings in attitude can undercut orderly
solutions, posing risks to other banks and the financial system
in general.
There is no doubt that market forces ultimately are capable
of, and do, impose a severe discipline.
of that.

We want to take advantage

But we would also like those disciplines, to the extent

feasible, to work consistent with constructive solutions to problems*which takes time, rather than to exact its lesson at the expense
of economic stability generally.




-15-

In striking that balancef the Federal Reserve has not
favored proposals that would have the federal agencies themselves?
as a general rule, disclose detailed cease and desist orders or
other disciplinary action they have issued against banking organizations.

Such routine disclosure may at times exacerbate an already

delicate situation and make more difficult the task of federal
regulators seeking an orderly and appropriate resolution of
problems that are, in factf "curable*"

Larger banking organizations

with widespread public ownership are already required to disclose
material changes in circumstances, including the official
enforcement orders bearing on their outlook*

There are situations

in which detailed disclosure by a banking agency itself might
serve a useful or necessary purpose, particularly when the
management is not actively and wholeheartedly moving to deal with
its problems.

But that is not ordinarily the case*

Rather, the

entire procedure will often become more, and unnecessarily,
adversarial, making it more difficult for examiners to obtain




-16information or engage in a frank exchange of views? and tying up
limited supervisory and enforcement manpower in legal proceedings•
Risk Based Insurance
One proposal that has been set forth, as a kind of substitute
for direct market discipline, to achieve greater control over
risk-taking by depository institutions—and also to make the
depository insurance system more equitable—is to shift from the
present flat-rate deposit insurance premium system to a risk-based
system.

In concept, institutions taking a significantly riskier

position would be required to pay higher premiums than conservatively
managed organizations*
In principle, the proposal appears logical and attractive.
It seems undeniably fair to require those institutions exposing
the insurance fund to greater risk to pay higher premiums to
compensate for that risk, an approach long followed by private
companies in all areas of insurance.
But there is reason to question the practical benefits of
such an approach.




If differential insurance premiums are to

-17effectively deter excessive risk-taking, the range between premiums
charged institutions exposed to relatively great risk and those
operating more conservatively would have to be fairly wide*

But

such a wide range for premiums implies more precision in gauging
the risk exposure of different institutions or different types of
lending than may be objectively possible, or that is widely
perceived as fair*

We don't, for instance, want to indiscrimately

place a drag on commercial lending, or agricultural lending, or
energy lending.

The size of the insurance premiums might be

interpreted as a kind of credit rating, but it would be too crude
to bear that burden.

And I don't see, in practice, how the premiums

could be "fine-tuned" before problems in fact emerge.
It may be possible, for instance, to get general agreement
as to the relative riskiness of broad categories of balance sheet
positions.

All would agree, for example, that private loans are

more risky than Treasury securities; that a low liquid asset ratio,
particularly if accompanied by heavy reliance on purchased money,




-18is more risky than a high ratio? that a marked imbalance between
asset and liability maturities is more risky than a close balance*
But once past those relatively broad concepts, consensus becomes
much more difficult to achieve.
There are many less tangible factors—-such as the quality
of an institution's management, its internal controls, and its
credit standards whatever the lending area—that affect the
riskiness of an operation and should be taken into account.

The

principal differences in the quality and relative riskiness of
loan portfolios lies within broad loan categories, as much or
more than between them.
Bank examiners, of course, make such judgments.

But there

would be great drawbacks to basing premiums on the already difficult,
and inherently qualitative, judgments contained in bank examinations.
limited.

Such judgments are fallible and our forecasting ability is
To reflect those judgments routinely in large changes

in insurance premiums, involving both public notice and higher
costs, could well diminish prospects for effective remedial action.




-19Some have suggested the problems inherent in ex ante
identification of risk could be dealt with by levying premiums
on an ex post basis—that is, to charge institutions experiencing
losses higher premiums*

But does it really make sense to levy

punitive premiums under such conditions, placing an added drain
on the earnings of an institution with substantial problems, and,
in effect, announcing that added burden to the world?

Rather,

would it not often work at cross purposes with the efforts that
federal regulators would be making at such times to restore the
institution to health?
I recognize that, even if the possibility of using sharply
differentiated insurance premiums as an effective deterrent
to excessive risk is limited, some distinctions based upon the
general characteristics of a bank or thrift may appear more
equitable in terms of relative contributions to the insurance
funds.

Moreover, there may be certain types of loan and invest-

ment situations which are clearly so risky relative to the "norm"
that a sharply higher insurance premium could be clearly justified,




-20That might be the case, for example, with real estate development
activities of the kind that some institutions are actively
developing, as permitted by some states*

But I would have to

question, if the risks are so evident, whether such activities are
appropriate for depository institutions at all.
As 1 have emphasized to this Committee before in this
connection, I am deeply concerned about the increasing tendency
of states to provide powers for state-chartered institutions
operating under the protection of the federal safety net that may
be inconsistent with prudent banking or thrift operations.

That,

indeed, seems to me an area where action is urgently needed.
Other Reforms in Deposit Insurance
I should like to comment briefly on several other proposals
for reforming the deposit insurance system that have been advanced
in recent years.

One such proposal is to move the deposit insur-

ance limit back down to a significantly lower level.

It is

reasoned that this will result in a larger proportion of deposits
being subject to loss should an institution fail, and, by increasing




-21risk exposure, encourage depositors to be more selective in placing
their funds with institutions.
The precise level for assured insurance protection is, of
course, arbitrary, and I have myself resisted the large increases
enacted in the past*
of paper*

But we are not dealing with a blank sheet

Depositors and financial markets generally are accustomed

to, and presume maintenance of, the present $100,000 level.
It seems likely that if insurance coverage were reduced
somewhat, the main effect would be that most smaller depositors
with amounts to place that exceed the cutoff would simply channel
them into two or more deposit accounts with different institutions.
Accordingly, costs to depositors and the banking system would
be raised.

If the insurance level were to be sharply lowered,

the proportion of "runable" deposits at all institutions would
increase, increasing the potential instabilities of the
system at a time of strain.




-22-

In concept, looking further into the future, there may
be some merit to increasing, in a careful and limited way? the
effective risk exposure of larger depositors? inducing them to
make a more careful assessment of the conditions of organizations
in which they are placing funds, and working in a marginal way
to encourage more prudent banking practices.

But those depositors

are not entirely without risk today, and I do not believe this is
the time to inject more uncertainty into the system*

Any changes

in this respect should be made, in my judgment, only in more
settled circumstances, and with long lead times.
I believe a fair description of the present approach in
operating the "safety net" is to provide full protection for
depositors within the insurance limits but also to protect all
depositors when that is practically feasible at reasonable cost
through mergers or otherwise, taking account of the costs of
alternatives, including the effects on the community and banking
stability more generally.




The number of cases in which that

protection has not been possible and feasible in practice has
been very small, for banks large or small.
to me to remain broadly appropriate.

That approach seems

It does not commit the FDIC

or the FSLIC to full protection in every circumstanced-such as
when some combination of huge potential losses, unknown contingent
liabilities, and possibilities of fraud could clearly impose
excessive costs relative to practical alternatives*

In a few

cases, a full payout to insured depositors alone has been necessary.
As the Committee knows, there has been some testing by the
FDIC of a modified payoff technique*

This technique involves

deriving an estimate of the proportionate amounts of the uninsured
depositor claims that are likely to be recovered from the liquidation of a closed institution's assets and then paying that amount
to the depositor immediately rather than waiting until the liquidation is completed.

Any recovery above that minimum is to be

passed through after it is realized.

That approach, I believe,

could be an improvement over the delayed payoff approach that is
routine in general bankruptcy proceedings, since it helps reduce




-24the side effects of uncertainty and reduced liquidity to which
depositors are otherwise exposed.

But I do not envisage such an

approach as a satisfactory substitute for the so-called "purchase
and assumption" technique or other forms of assistance when
those alternatives are feasible and costs reasonable*
In considering that or other new approaches, careful
consideration must be given to the uncertainties inherent in change
at a particularly sensitive time.

In that spirit, proposals that

might partially insure larger depositors, but at the same time
increase the risk of loss or illiquidity of an uninsured fraction,
could be debated.

But any change in that respect should be

announced far in advance, and implemented with great care.
Proposals to require institutions to pay the same premiums
on their deposit liabilities at overseas branches, and at International Banking Facilities, as they do on all other deposits booked
in the U.S., deserve careful review.

These depositors benefit

from the greater stability of financial conditions that result from
the deposit insurance system as much as do other large depositors.




-25Thus, it seems fair that banking organizations choosing to fund
part of their operations overseas—and that proportion can be
"managed18—should be subject to the same insurance costs as those
that rely on domestic sources of funds.
At the same timef extending insurance costs to foreign
branch deposits changes the relative cost burdens among our
depository institutions, affects incentives to branch abroad,
and raises some competitive questions vis-a-vis banks abroad.

A

fuller assessment of the pros and cons appears to me in order
before proceeding definitively, and if a decision is made to
implement the proposal, it should probably be phased-in over a
period of years.
Proposals also have been advanced for merging the FD1C
and FSLIC insurance funds.

In principle, this would appear

appropriate if and as these depository institutions are required
to adhere to equivalent regulatory and supervisory standards, and
particularly if their powers broadly coincide.




There has been

-26some movement in those directions, but there also remains a good
ways to go*
Whether one would want to proceed more immediately to merge
the funds would appear to depend on how the advantages are weighed,
in current circumstances, of bringing the larger resources of the
FDIC fund to the support of the savings and loan industry.

Against

that advantage there is a legitimate question as to whether monies
contributed by commercial banks and mutual savings banks should
now be made available to protect the depositors of savings and loan
associations*

At the least, the importance of bringing the regu-

latory and supervisory standards of the two industries into alignment promptly would be greatly reinforced*

But, in addition, I

believe the Congress, in addressing such a proposal, should
consider possible means for bolstering the size of the FSLIC
fund or the relative contribution of the savings and loan industry
should it decide to authorize such a merger*




-27Qther Initiatives
Apart from the initiatives in the deposit insurance area
I have just reviewed, I believe there are other actions—-indeed
more important actions—-that are being taken and that can be taken
to strengthen further our depository system and achieve greater
assurance that it will continue to function safely and efficiently.
Federal insurance and other elements of the federal
"safety net" necessarily imply a clear federal interest in
how the protected funds are employed and managed.

To some degree,

strong supervision can minimize the need for, and demands uponf
the "safety net."

And no insuror can afford to be indifferent

to the behavior of the insured.
All the federal agencies, individually and in cooperation,
have taken steps to strengthen the supervisory and, where necessary,
the regulatory process.

I can speak directly here only of the

Federal Reserve, where a number of steps are underway to implement
a comprehensive program for further strengthening our supervisory
and regulatory activities.




-28As you may recall, in conjunction with the other bank
regulatory agencies, we have over the past few years tightened
significantly our capital standards applicable to banks and bank
holding companies.

These standards were first put in place on

a formal basis in the early 1980s and have helped to reverse the
earlier downtrend in capital asset ratios.
We now have under active review, as do the other federal
bank supervisors, proposals for supplementing the existing standards*
One objective is to take account of the rapid growth in "offbalance sheet" risk exposures and declines in liquidity,
particularly at larger banking organizations.

To some degree,

the simple capital/asset ratios that are at the center of our
current guidelines contribute to those developments? institutions
work to improve those ratios by holding down asset growth partly
by limiting liquid asset holdings and by assuming off-balance
sheet commitments in lieu of direct lending.
We can and are approaching the problem in part through
strengthening the crucial process of examination, emphasizing that




-29existing standards are minimums that can and should be exceeded
depending upon the risk profile of an institution.

We are also

carefully considering several variants of proposals for quantifying
a risk-related capital measure to supplement the present approach^
I anticipate that one or more approaches will be set out for public
comment before the end of the year.
In adopting such an approachf we face some of the same
difficulties that I outlined in connection with risk-based deposit
insurance, particularly the difficulty of assigning appropriate
weights to different broad asset categories.

But these standards

potentially can be applied, and bank performance monitored, in
the context of a detailed examination process, and the approach
has the further potential advantage of contributing to international
comparability.
The Chairman of the FDIC has proposed phasing-in an increase
in the minimum capital requirement for banks to 9 percent, permitting
the increase to be in the form of subordinated debt.

That is another

initiative that I find attractive in concept and worthy of study.




-30The idea is that market discipline would be reinforced at the
margin without further jeopardizing depositors--indeed, consistent
with stronger depositor protections—by requiring banks to find a
larger market for debt (or equity) that would have no insurance
protection.

At least as important in my viewf the added capital

v/ould provide an extra cushion of protection against the possibility
of loss to depositors and the deposit insurance fund.
The Federal Reserve also has under active review other
proposals for modifying the structure of regulations and guidelines in place to see that banking organizations meet appropriate
standards in conducting their business activities.

Specifically,

we are preparing standards to guide a bank holding company with
respect to appropriate policies toward cutting or eliminating the
payment of dividends when and if the organization is experiencing
significant problems.

We are also actively considering, within

our present authority, appropriate limitations on bank holding
companies undertaking particularly risky activities that may be




-31sanctioned by state law but which appear to extend beyond the
intent and framework of federal legislation.
Meanwhile, we have underway a number of significant steps
to enhance our ability to identify, and seek correction of, problem
situations at individual banking organizations.

The frequency

and intensity of examinations and inspections of larger banking
organizations is being increased, while at the same time we seek
to increase cooperation and coordination in the examination of
smaller organizations with other federal agencies and state
banking authorities.

Indeed, if states are willing and have the

required resources, we would plan to increase our reliance on
their examinations of smaller banking organizations*
Communications with the boards of directors of large
organizations with problems are being upgraded in content and
official participation.

Where warranted, we will make full use

of our statutory powers to see that banking organizations cease
activities that are causing them harm and adopt policies that
will restore their financial health*




-32Con_cl_us_ion
At a time in which domestic and world economies are subject
to many imbalances and distortions9 banking systems here and
abroad have been burdened more heavily than in many years, and we
have seen some unaccustomed failures and reliance on the "safety
net«"

That alone justifies a review of steps to ensure that our

banking institutions/ and their supervisory agencies, are following
policies and practices consistent with the earliest possible
return to robust health and full self-reliance*
But in making that review, let us not overlook the many
continuing elements of strength in the banking system that enable
it to deal with points of pressure.

The vast majority of our

depository institutions have absorbed and adjusted to a less
favorable financial and economic environment in a way that retains,
and even reinforces their resiliency.

Capital ratios are

improving, profitability has generally been maintained, well-run
thrift institutions, at present interest rates, have the potential
for rebuilding capital* and I sense managements of most




-33institutions have acted to review lending standards and control
systems,

It is these factors that support confidence and

prospects for the future•

At the same time, the "safety net'3 has

operated with great effectiveness? it has done what it is supposed
to do and what the American public has expected*

It will continue

to do so.
The issues you are reviewing are as complex as they are
important.

There is a need to proceed—but to proceed with all

due caution~-so that any changes will in fact contribute to
reinforcing solutions to our current difficulties and to a stronger
banking system, not the reverse.

I have indicated that the

Federal Reserve has been moving to improve its regulatory standards
and strengthen its supervisory capabilities.

As you know, the

other federal agencies responsible for supervising depository
institutions are taking steps.
Our problems have been manageable.
so.

They should remain

We welcome the cooperation of the Congress in that effort,

not simply with respect to the questions under review today,




-34but more importantly and fundamentally in dealing with the
underlying sources of the imbalances and distortions in our
economy and financial system.