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Statement by
Robert C. Holland, Member
Board of Governors of the Federal Reserve System
before the
Committee on Banking, Housing and Urban Affairs
United States Senate
S. 2304

March 26, 1976




I am pleased to appear before this Committee
on behalf of the Board of Governors of the Federal
Reserve System, to discuss the Board's reasons for
recommending the enactment of legislation embodied in
S. 2304.

Let me try to summarize the proposals and

the Board's views thereon in rather general terms,
and then respond to any specific questions.
These proposals arise from a number of studies
which the Federal Reserve conducted in the aftermath of
the banking difficulties of recent years.

One objective

of those studies was to determine whether there were
some feasible new measures that would decrease the
incidence of specific banking difficulties or would
increase the effectiveness of remedial regulatory action
once a particular bank difficulty was identified.

In

fact, those studies have turned up a number of construc­
tive suggestions for reducing banking problems without
at the same time unduly interfering with the effective
conduct of banking business.
Some of those suggestions involved changes in
procedures or regulations which the Federal Reserve

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could introduce under its existing authority, and
we have done so.

But several suggested steps needed

statutory authorization.

We have refined those ideas,

in coordination with the other Federal bank regulatory
agencies, and they are now embodied in the present S. 2304,
submitted jointly on behalf of all three agencies.
The legislative proposals in S. 2304 can be
divided into three general categories:

(1) proposals

for civil penalties for violations of various provisions
of Federal banking law which presently carry no penalties
or carry only criminal penalties;

(2) a proposal to

restrict dealings with insiders; and (3) proposals
to increase and streamline the ability of the agencies
to take remedial a c tions.
An examination of the present restrictions on
the operation of banks and actions of bank officers,
directors, and employees indicates that in many
instances violations of those restrictions carry either
no penalties or solely criminal penalties.

The

Board's experience with the operations of the criminal
penalty provisions under the Bank Holding Company Act




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is that the application of these provisions is a slow
and tedious process.

Furthermore, in order to obtain

a conviction it must be established that the violation
was willful.

Courts in the past have read this as

requiring a showing not only that the individual
intended to take the action, but that in so doing
the individual intended to break the law.

This is a

very difficult matter to prove, and it is believed
that these difficulties of proof have decreased the
effectiveness of the criminal remedy as a deterrent
to particular actions in violation of the Act.
There are other provisions of banking law for
which there are either inadequate or no deterring penalties
attached to

any violation.

For instance, section 23A

of the Federal Reserve Act places stringent limitations
on transactions between affiliates.

Violation of this

provision, however, currently carries no civil or
criminal penalties.

In recent experience, two examples

have come to the Board's attention which, in the
Board's opinion, involved violations of section 23A
with respect to transactions between the banking and







- 4 nonbanking affiliates of a holding company.

In both

instances, these transactions contributed heavily to
the ultimate failure of the banking subsidiary.

Once

these transactions came to the attention of the
appropriate regulatory authorities, the only available
remedy would have been a cease-and-desist order under
the Financial Institutions Supervisory Act of 1966
requiring reversal of the transaction.

However, since

the funds were no longer available to accomplish such a
reversal, this represented a hollow remedy indeed.
The Board strongly believes that the existence
of an expeditious civil penalty procedure will act as
a deterrent to this kind of activity and should
significantly decrease the incidence of it.

For this

reason, the Board has recommended in the proposed
legislation that civil penalties be applied to
violations of the Bank Holding Company Act, section 23A
of the Federal Reserve Act, section 22 of the Federal
Reserve Act relating to loans to officers and directors,
(as proposed to be amended), violations of final
cease-and-desist orders, and certain other provisions.

- 5 In order to help insure that these penalties would only
apply in an appropriate and equitable manner, the proposed
bill provides that, in assessing the amount of the penalty,
the responsible agencies must take into account the financial
resources and good faith of the person or organization
charged with the violation, the gravity of the violation
and the history of previous violations.

Any penalty so

assessed may be collected by Court action and would be
subject to judicial review.
The second area covered by this bill is the
establishing of appropriate limitations on banking
transactions with insiders.

The history of banking

difficulties over the last few years indicates that, in
numerous instances, banks have encountered difficulties
by virtue of having incurred excessive risks through a
high concentration of loans to "related persons."

The

Board recognizes that, in the banking industry as a
whole, major abuses by insiders are not common.

The

Board further recognizes that the board of directors of
a bank or bank holding company typically includes a number
of community leaders, not the least of whom are officials




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of various businesses in the area.

Lending to such

insiders and their enterprises follows naturally and,
in the case of smaller financial institutions in
smaller communities, is almost inevitable.

Such

lending, to the extent it is made on an arm's-length
basis to creditworthy borrowers, is not objectionable
in and of itself, and in fact such loans may well help
the community and at the same time benefit the bank.
If an insider is prepared to abuse his banking
connections, however, and the bank is compliant, he
may effectively pyramid the resulting risks to the
bank by exploiting his position to obtain credit for
or through firms he controls.

Accordingly, the Board

has concluded that on balance it would be wise to
place aggregate limits on the amount of lending on
behalf of any insider by his bank in order to prevent
the incurring of excessive risk through such lending.
The proposed legislation would therefore place a
limitation on loans to any officer, director, or
shareholder who owns more than 5 per cent of the
stock of the lending bank.




This limitation would

- 7 aggregate all loans or extensions of credit to such
an officer, director, or shareholder and his controlled
corporations and provide that the aggregate may not
exceed the statutory limit on loans to any one borrower
established by Federal or State law.

I should alert

the Committee that, among the three kinds of insiders
I have just mentioned -- officers, directors, and
important shareholders -- public policy considerations
weigh least heavily toward adoption of these restrictions
when it comes to aggregating loans of all interests of
an

"outside director".

Such restrictions might well

discourage some individuals from serving as directors
who would otherwise provide valuable experience and
advice for the bank.

On balance, however, the Board

believes that the establishment of such a limitation
for each of these insiders is a prudent step.
The third problem area which this bill addresses
is a strengthening of supervisory power to take remedial
actions once difficulties have been discovered in a
financial institution.

We see a particular need to

strengthen the remedial powers provided in the Financial




- 8 Institutions Supervisory Act of 1966, and we have
recommended a number of changes in that Act.
The most important of these changes relates
to the ability of the banking agencies to remove an
officer or director, or prohibit a shareholder from
participating in the conduct of the affairs of a
bank, when such individual's conduct is causing or
is likely to cause substantial financial harm to
the bank.

Under present law, to take such action,

the agencies must establish that the individual
(1) has participated in a violation of law or of a
final cease-and-desist order, breaches of fiduciary
duty, or unsafe and unsound practices, (2) that his
action is seen as causing substantial financial loss
to the bank or damage to depositors and, further
(3), that the acts complained of constitute personal
dishonesty on the part of such individual.

The Board

believes that, if an individual is grossly negligent
or inept in the operation of a banking institution,
and the findings set forth in (1) and (2) above are
made, he should be removed regardless of whether his




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actions constitute personal dishonesty.

Accordingly,

we recommend the adoption of the proposed provisions,
which would authorize the appropriate regulatory
agencies to remove the offending individuals in such
circumstances.

We believe that the present hearing

and judicial review provisions of the Act are sufficient
to shield innocent individuals from arbitrary and
capricious agency action.
We have also recommended a number of other
technical changes to the Financial Institutions
Supervisory Act which we believe would increase
its effectiveness.

I would be happy to answer

questions about any of them at the conclusion of my
statement.
Another urgent remedial power requested for
the Board is that it be given the power under the
Bank Holding Company Act to order the divestiture of
a banking or nonbanking subsidiary whenever it has
reasonable cause to believe that the continuation of
that nonbanking activity or ownership of a banking




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or nonbanking activity constitutes a serious risk to
the financial safety, soundness, or stability of a
bank holding company’
s subsidiary banks.
We recognize that such a remedy is an extreme
one.

However, we believe that a key function of a bank

holding company is to contribute to, rather than
detract from, the financial stability of its subsidiary
banks.

Several instances have come to the Board's

attention in which adverse developments and publicity
with respect to a bank holding company's nonbanking
activities have had a very adverse impact upon, and
even caused the failure of, a banking subsidiary.
We therefore believe that it is important for the
Board to have such legislation available in order
to protect banking subsidiaries in appropriate
instances.

The proposed legislation provides for

due notice and opportunity for hearing.

It provides

that the divestiture may be by sale or by pro rata
distribution and, in order to assure that the activity
threatening the bank is terminated as rapidly as




- 11 possible, sets a relatively short time frame within
which this is to be accomplished.
A final remedial provision that I would call
to your attention lies outside the bill presently
before the Committee.

That is our proposal to allow

a failing bank to be acquired by an out-of-State
holding company when no satisfactory alternative for
preserving the bank's services exists.

This proposal

was earlier introduced as part of S. 890, but it has
generated some opposition from observers concerned
over breaching the traditional bar to interstate
banking.

Yet since that bill was introduced, two

significant instances have arisen requiring sales
of a failing bank when the communities involved might
have been better off if an emergency interstate
acquisition of that size had been permissible.

I

urge this Committee to consider and act favorably




on this proposal, even as it already has on the
companion bill to eliminate the statutory 30-day
delays in emergency bank holding company acquisitions.

- 12 I believe the people in the few unfortunate communities
affected would be well served.
We realize that each one of the proposals
I have mentioned this morning can be said to involve
certain costs or burdens as well as benefits.

We

have tried to aim only at demonstrated problems,
not hypothetical ones.

We have designed the proposed

legal powers so as to minimize unwanted side effects,
and we have included provisions that give protection
or room for accommodation to legitimate business needs.
The remaining inconveniences or inefficiencies that
this legislation may cause we believe are justified
by the added protection it affords to banks and the
banking system.
In conclusion, we believe that these proposals
zero in on specific identified weaknesses in the
regulation and supervision of bank holding companies
and banks.

Adoption of these proposals would, in

the Board's opinion, have a deterrent effect and
thus decrease the number of occasions on which







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supervisory action would be necessary in order to
correct problems existing in banking institutions.
Furthermore, in those instances where the problems
do occur, these provisions would increase the
effectiveness of agency response.

We urge favorable

consideration by this Committee.

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