Remarks by

John D. Hawke, Jr.

Comptroller of the Currency

Before the

Independent Community Bankers of America

Las Vegas, Nevada

March 8, 2001

I come to you this morning with some good news and some bad news. I'm
going to start with the good news, in the interests of putting you in a
positive frame of mind \-- and of putting what follows into more
meaningful perspective.

It's almost impossible these days to avoid reports about the decline in
asset quality in bank portfolios. You can track this decline in the
press, in its migration from the sidebars to the headlines and into the
consciousness of some of the nation's senior pundits and economic policy
makers. Almost every week, some bank announces a new round of
write-downs and charge-offs, followed by solemn pronouncements from the
analysts that things are going to get worse before they get better.

At the OCC, our own data, reflecting the experiences of commercial banks
of all sizes, confirm this weakening. The year 2000 was the third
consecutive year of increase in the volume of large syndicated credits
that were criticized in our annual interagency review. And that increase
came about in a rapidly growing economy. Econometric models show a rise
in default risk among publicly traded U.S. companies \-- and, therefore,
a rise in credit risk in the banking system at large. Now, with the
economy in a slowdown, one investment firm projects a 50 percent
increase in loan losses this year over last. And with that increase, the
overall ratio of loan loss reserves to loans has eroded \-- from about
2.5 percent in 1993 to just over 1.5 percent last year. Future earnings
will almost certainly be impacted by the need to bolster loan loss
allowances.

You're probably thinking, "if that's the good news, I don't want to hear
the bad news." But there [is]{.underline} good news for you here. First,
we believe that the banking industry generally is better positioned to
withstand these problems than it's been at almost any other time.
Second, community banks are generally much better positioned than their
larger counterparts.

Certainly, the capital strength of the industry is now far better than
it was ten years ago. Total equity capital today stands at more than
twice what it was a decade ago, and the related ratios \-- capital to
assets and capital to loans \-- are also much healthier. Clearly,
bankers have internalized a key lesson of the 1990s \-- that it's
possible to meet all the regulatory capital requirements and still not
have the level of capital you need to weather a time of great stress.
Indeed, at a recent OCC conference, the highly respected former CEO of
one of our major banks said that one of the great lessons he learned
over the past decade was the critical importance of maintaining capital
ratios appreciably in excess of what we bank supervisors required. Never
again, he said, would he let capital fall to even the highest level
defined by the regulators.

We also believe that the industry is structurally stronger.
Consolidation over the past ten years has given us a banking system that
should be more stable and more resistant to downturns. Certainly the
whole industry is more diversified than it was a decade ago. Although
community banks are still subject to some inherent limitations in this
regard, the kinds of deep sectoral and geographic concentrations we saw
in the early 1990s \-- concentrations that proved fatal for many banks
\-- are much less common today. In addition, noninterest income has come
to play an increasingly important role in the composition of bank
earnings. The industry has taken advantage of changes in the law and
regulations to offer new products and services, thus diversifying their
income streams and reducing their dependence on volatile net interest
income.

This movement toward diversification has come as part of a dramatic
overall improvement in most banks' risk management and mitigation
capabilities. Bankers today \-- and not only the largest banks \-- are
using more sophisticated analytical tools and computer models to manage
increasingly complex risks. And bankers, even community bankers, have
far greater opportunity through the use of syndication and credit
derivatives, and through the securitization markets, to design and
structure the types of balance sheets and business franchises they
desire.

We in the regulatory community have given a great deal of thought to the
lessons of ten years ago. Our handling of the crisis of the early '90s
was widely criticized for inconsistency \-- for undue supervisory
forbearance when problems first appeared, followed by draconian
reactions when those problems had matured to the point where they could
no longer be ignored. When banks showed reluctance to provide credit
even to creditworthy borrowers, supervisors were blamed for creating a
"credit crunch." I happen to believe that credit crunches are caused by
conditions in the economy, and by banks that make economic decisions
based on their own self-interest, and not by bank examiners. I also
recognize that regulators can become an easy scapegoat for bankers to
point to when they have decided for their own reasons to tighten up.

Nonetheless, we learned a lot from that experience, and we recognize the
value of a supervisory approach that is more modulated and predictable.
Since becoming Comptroller, I've emphasized the importance of fashioning
a carefully calibrated response to changes we see taking place in the
banks we supervise. But that does not mean sitting by silently as
conditions deteriorate. It means addressing problems as we see them
developing \-- while we still may be able to do something about them \--
and doing so consistently and in a measured way. Both in public and in
our private meetings with bankers, we have addressed issues of declining
underwriting standards and eroding credit quality, and we will continue
to address these issues, keeping in mind the need to do so in a balanced
manner. The greatest contribution we as bank supervisors can make to the
maintenance of a healthy economy is to do what we can to help preserve
the ability and capacity of our banks to extend credit to creditworthy
borrowers.

Clarity is a hallmark of good communications, and we're certainly
spending more time talking to the industry, explaining our policies, and
providing opportunities for bankers to raise questions and express their
concerns. Today, if bankers think something has gone wrong in the
examination process, they can seek review by the OCC Ombudsman \-- an
option that did not exist ten years ago. More recently we have
introduced National BankNet \-- an extranet web site available
exclusively to national bankers. BankNet now not only provides useful
analytical tools, industry and risk updates, "best practices"
presentations, and internal OCC reports, but a means of communicating
directly with me, by e-mail. It will soon enable national banks to
prepare branch and relocation applications on line and submit them
electronically. And in the very near future, BankNet will handle the
majority of routine transactions between the OCC and national banks, and
give the industry the power to file electronic comments on regulatory
proposals. This is a major improvement in the ability of bankers and
regulators to communicate with one another, and it should result in
improved understanding and cooperation as we enter these more
challenging times.

Technology has also enhanced our ability to spot problems brewing in the
banking system so that we can call early attention to them. Early in my
tenure as Comptroller, I initiated a major effort to improve our early
warning tools. We dubbed it "Project Canary," alluding to the practice
of coal miners who brought canaries down into the mineshafts with them
to detect dangerous gases. Through this effort we have developed a
series of financial ratios and measures that correlate with high levels
of credit, liquidity, and interest rate risk. By applying these measures
to our population of banks, we can make better judgments about what
problems may arise and how we can deploy supervisory resources more
efficiently.

Our approach to identifying, rehabilitating and resolving banks under
stress is described in detail in an excellent new OCC publication
dealing with problem banks. It represents the distillation of year's of
experience, and should be especially useful to examiners \-- and to
bankers \-- who haven't lived through times of banking turmoil.

Inevitably, the deterioration in the quality of bank portfolios that I
mentioned earlier has affected some banks more than others. Few
community banks, for example, hold many of the speculative-grade,
highly-leveraged, and poorly underwritten assets, especially those
backed by so-called enterprise value, which have been hardest hit of
late. Indeed, the level of troubled loans at community banks has been
relatively stable. While the percentage of non-current commercial loans
at national banks with over \$1 billion in assets nearly doubled over
the last three years \-- from 0.73 percent to 1.38 percent \-- it
dropped from 1.63 to 1.59 percent at smaller banks over the same period.
Similarly, loss rates at large banks have gone from 0.17 percent to 0.63
percent, which is just about where they've been for small banks since
1997.

I'm sure you have your own theories to account for this discrepancy in
the performance of large and small banks, and I have a few theories of
my own. It may well be that community banks are especially conscientious
when it comes to minding the fundamentals of sound banking \-- keeping
your ear to the ground, being responsive to your customers, working with
borrowers in a hands-on way at the first signs of strain, pricing loans
and other products for risk, and establishing a rigorous internal
control environment. Most community bankers do not have the kinds of
pressures faced by large institutions with widely held share holdings
\-- including a battery of analysts who follow your stock and punish you
for missing earnings targets by as little as a penny a share. As a
result, you are better able to focus on long term values in a way that
will bring enduring benefits to your shareholders.

But let me caution that no one become too smug or complacent. It is not
difficult for the problems afflicting larger banks to spread from big
borrowers to small ones and from employers to employees \-- in other
words, to your customers. The sequence is a familiar one: a big company
defaults on its debt, or implements austerity measures, or lays off
workers, and the purchasing and debt servicing power of those workers is
reduced. That's when the pain is likely to start showing up in your
portfolio and bottom lines.

So what you've got, really, is a window of opportunity \-- time to take
prudent, pro-active steps to prepare for what may come, and to mitigate
the effects of future adverse changes. How much time depends, of course,
on the length and severity of the slowdown in the economy. If it turns
out to be a mere interlude before the economy regains its momentum, you
may be able to escape with only minor bruises.

For many community bankers, the test will be in how you use this window
of opportunity. It may mean doing more of what you've already been doing
\-- paying closer attention to your customers and their individual
financial condition, and tightening board and management oversight;
continuing to build capital and reserves; identifying and addressing
vulnerabilities and excesses in the loan portfolio; making fuller use of
whatever risk mitigation tools are available, including government
guarantee programs. And, to prepare for the possibility that credit
problems [do]{.underline} materialize significantly, it makes sense to
evaluate your work out capabilities to ensure that problem loans can be
resolved in an orderly way.

This is also probably a good time to review your contingency funding
plans. I know how difficult it's been for many community banks as core
deposits have dried up and reliance on wholesale funding has grown.
While this transition has not been without its benefits, including
greater diversification and flexibility, it also exposes banks to
volatility in the event that the market turns against them. That's
another reason why it's so important that community banks act decisively
to put their houses in order now, to gain and keep the confidence of the
financial community.

While some bankers might prefer that examiners ease off in their
criticisms of problematic loans, the task of bank supervision is to give
you our best assessments of the quality of your portfolios. I think we
have been doing that extremely well, and a number of bankers,
representing large and small institutions, have told me that the OCC's
balanced and consistent approach has helped them to focus on credit risk
problems and to improve deficiencies in risk identification and risk
management. You can count on us to maintain this consistent and
carefully modulated approach \-- calling things as we see them \-- in
the coming months.

In business as in sports, defense usually trumps offense. This year's
Super Bowl champions reminded us of how true that is. For bankers, too,
success in challenging times begins at home, with strong risk
management, robust internal controls, and a no- nonsense approach to
credit quality. There's still time to make sure that your defenses are
in order, so that next year, there will only be good news for us to
share.