Remarks by

John D. Hawke, Jr.

Comptroller of the Currency

Before the

North Carolina Bankers Association

Pinehurst, North Carolina

October 22, 2002

Most people visit this lovely resort for a break from life's stresses
and tribulations. But this is also a place for serious contemplation
about the challenges that we face as a society. That's what has brought
presidents and heads of state to Pinehurst for many years; it's what
brought the North Carolina Bankers Association here for this year's
management team conference, and it's what brings me here to join you
today.

These are nothing if not challenging times -- for our country, facing
new and knotty threats from abroad; for our economy, which continues to
struggle for positive momentum; and for the banking industry, whose
health is inextricably linked to its operating environment -- an
environment that holds more than the usual brace of challenges.

Challenge is by no means synonymous with crisis, of course, and, indeed,
the continued vitality of the U.S. banking system is often cited as a
major reason why the national economy continues to holds its own --
however precariously \-- rather than slipping back into a dreaded
"double-dip" recession. Here in North Carolina, for example, the banking
system can be characterized as generally stable or improving -- much
better than one would expect given the recent performance of the state's
economy and a significant source of the state economy's underlying
strength.

Preliminary second quarter 2002 data for all North Carolina commercial
banks show a 10 percent increase in net income, compared to the same
period in 2001. Assets are up, though by a lesser percentage. More than
twice as many institutions reported earnings gains over the previous
period; the percentage of unprofitable institutions dropped by nearly a
third. ROE and ROA were significantly up, as was capital; nonperforming
assets were down.

As I've suggested, these performance data are especially noteworthy
given the conspicuous, if no doubt transitory, weaknesses in the state's
economy -- an unemployment rate that has been averaging close to seven
percent, above the national average; a slowdown in housing starts; and
slow progress in narrowing the gap between the richest and poorest
citizens of this great state. The latest Federal Reserve Beige Book
pointed to signs of stress in the state's crucial farm economy, and
rising vacancy rates in commercial real estate. And that was before the
dismal September on Wall Street, which presumably did nothing to bolster
the confidence of those in North Carolina responsible for purchasing and
hiring.

Not all the challenges confronting North Carolina bankers -- and U.S.
bankers generally-- relate to the current economic uncertainty. Some of
those challenges have more to do with secular changes in the business of
banking \-- changes that were already very much in evidence back in the
innocent days when people were convinced that the business cycle had
been repealed by the microchip revolution.

The consolidation of commercial banking in this country has been going
on for a very long time and for a good many reasons. A certain
percentage of the bank mergers of the past decade undoubtedly occurred
for no other reason than that it became possible to do them. The
Riegle-Neal Act of 1994 tore down the barriers to interstate branching,
and bankers with interstate ambitions sometimes sought to achieve them
on the quick. Since then, bank mergers have been driven by more
fundamental considerations. Bankers have sought to capitalize on
economies of scale, to leverage investments in technology, to diversify
geographically, and to broaden product offerings to a more demanding and
sophisticated financial consumer.

The results, as you know, have been mixed. While it is certainly true
that not all of the promised benefits of this merger activity have
materialized for banks, neither have most of the concerns of the
critics. As the members of this audience can attest, our financial
markets remain highly competitive; our citizens and our communities are,
with few exceptions, exceedingly well served by depository institutions;
commercial credit has remained widely available, to small businesses and
large, on reasonable if not easy terms; employment in the banking
industry has not declined appreciably, if at all; and there has been no
shortage of new entrants to the banking business, despite the generally
inhospitable economic environment.

Yet the structure of U.S. banking [has]{.underline} changed in
consequential ways, and that change is nowhere more plainly visible than
here in North Carolina. Indeed, North Carolina may be [the]{.underline}
state whose fortunes -- and whose very identity as a banking center --
are most closely bound up with the trend toward financial consolidation.
It's easy to forget how startling it would have seemed just 15 or 20
years ago to suggest that Charlotte would become one of the world's
great banking centers. But it has become just that -- thanks not only to
the legal, economic, and technological developments I've already
mentioned, but also to the vision and leadership of larger-than-life
North Carolina bankers like Ed Crutchfield, Hugh McColl, and John
Medlin, as well as to the equally hardworking but perhaps less heralded
North Carolina bankers who lead this organization and those who make up
its rank-and-file.

North Carolina's extraordinary rise to national and world prominence as
a banking center -- and as an economic power -- is reflected in numbers
that are at odds with national trends. In only five states of the union
are there more commercial banks today than there were in 1984. North
Carolina \-- which went from 68 in 1984 to 72 today \-- is one of them.

Yet when one focuses on the [distribution]{.underline} of North Carolina
banking assets, the picture comes into closer convergence with national
trends. In 1984, the three largest North Carolina banks held 63 percent
of total state assets. Today, the three largest control 95 percent. To
slice it another way, where the 65 smallest North Carolina banks (out of
a universe of 68) shared 37 percent of state banking assets in 1984, the
69 smallest share five percent today. Obviously the pie has grown
tremendously over that period, with total assets increasing by about
thirty-fold, but that simply highlights the vast dominance --
statistically speaking, at least \-- of the very largest banking
corporations -- which, of course, carry on their business not only in
North Carolina, but throughout the country.

If you happen to represent one of those big banks, chances are that you
take enormous and justifiable pride in those numbers -- numbers that
affirm everything you have worked to achieve. But what if you're here at
Pinehurst representing the Millennia Community Bank of Greenville, with
\$24 million in assets \-- the smallest commercial bank in the state?
What do these numbers mean to you?

The answer may be, much less than one would expect. When we look back
years from now, the performance of community banks in the era of banking
consolidation will stand as one of the truly inspiring stories of our
economic age. Against daunting odds, community bankers have succeeded in
keeping their franchises relevant and profitable through judicious
adoption of technology, strict controls over operating costs, and a
fixed focus on customer service and local responsiveness. You would
probably dismiss the suggestion than any of you are heroes, but by
demonstrating that there's a place for individual initiative even on a
landscape dominated by giants, heroes are what you are nevertheless.

The consolidation of the banking business has been almost as much of a
challenge for bank supervisors as it's been for bankers themselves. It's
forced us to modify an approach to bank supervision that has been in
place at the OCC -- and at the federal and state agencies that have
modeled their supervision after ours \-- for many decades. That approach
was founded on the notion that commercial banks big and small were banks
at the core -- more alike than different, vulnerable to the same
environmental forces and human mistakes. But experience has taught us
that banks at either end of the spectrum -- and North Carolina is richly
endowed with both types \-- present very different risks to themselves
and to the public interest, and necessitate official oversight of a
wholly different nature and degree. The noncomplex procedures we now use
for most community banks and the continual onsite presence we maintain
at banks in our large bank program reflect this bifurcation. For the
OCC, it's involved a totally different way of doing business.

Banking consolidation has also exposed what I believe are serious flaws
in the way we fund supervision. I should say, "additional serious
flaws," because I have already expounded at considerable length about
the unfairness of a system that requires national banks to bear the full
cost of their own supervision [and]{.underline} to subsidize a
significant portion of the supervision of their state-chartered
competitors. The OCC, as you may know, has proposed to deal with that
inequity with a plan that would draw upon earnings from the Bank
Insurance Fund to offset the costs of [all]{.underline} supervision --
state and national -- and do away with the assessment-based system that
was introduced back in the horse-and-buggy days. Such a change would
place state and national banks on an equal footing, and end the
discriminatory arrangement that delivers benefits to one favored class
of financial institutions and forces national banks \--and U.S.
taxpayers -- to foot the bill. I want to make very clear that our
proposal would have significant benefits for state banks, because it
would eliminate the need for state supervisors to impose any direct
assessments on them.

Fairness aside, perhaps the most damning indictment of our current
funding arrangement is that it undermines the very purposes for which it
was established: the safety and soundness of all commercial banks and
the health of our system of dual chartering options for those same
banks.

It seems difficult to defend a funding system that, in times of economic
stress, forces supervisors to turn to well-managed banks for the
resources supervisors need to deal with problem institutions -- another
kind of unfair subsidy. But that's exactly what our current system does
with regard to national banks.

It seems difficult to defend a system that has created a marketplace for
charters -- "bazaar" may be a better term \-- in which cost seems to be
the principal thing that counts and qualitative factors -- such as
supervisory philosophy and responsiveness, examination quality, and the
scope of permissible activities -- are frequently disparaged or
disregarded.

In fact, the subsidy renders meaningless any qualitative inferences that
might otherwise be drawn from the fee disparity -- about the relative
efficiency of state and national supervisors, for example -- because
state assessments reflect only about 22 percent of the total costs of
delivering supervision to state banks.

If I'm making widgets and some third party is generous enough to pick up
78 percent of my costs, I can probably afford not to worry too much
about my efficiency and still sell my product for a lot less than the
competition.

Maybe it's not so remarkable after all that this is a system that still
has such vocal defenders.

The main reason why people defend such a system, I gather, despite these
grievous and widely acknowledged defects, is that they're afraid that
the alternative might be worse. They're afraid, especially, that under
any fair and rational system of supervisory funding, some state banks
might convert to the national charter, with potentially damaging
institutional consequences for state supervisors and their federal
counterparts involved in state bank supervision.

Here's where the trend toward industry concentration has cut
uncomfortably close to the bone for bank supervisors. It's to be
expected that we'd find the largest number of charter conversions among
the largest pool of banks. Indeed, between 1990 and 2002, more than 90
percent of stand-alone flips out of the national charter -- that is,
those that occur in the absence of a merger or acquisition \-- involved
community banks under \$500 million in assets. Those are the
institutions that tend to feel cost-cutting pressures most intensely and
that are most likely to be attracted by the prospect of saving a few
thousand dollars a year.

For the supervisory agency, the financial impact of such conversions is
usually manageable. It can even be a positive if, as is the case at the
OCC, the assessment structure is progressive, with community banks
generally paying less than the pro rata share of their supervisory
costs. Indeed, while we always regret it when a community bank decides
to relinquish its national charter, the bank's action can often result
in a net gain to our bottom line.

When a bank exceeds a certain size, however, its conversion can be
damaging to the supervisory structure, for the departure of a
well-managed larger bank may diminish resources that are needed to deal
with more troubled institutions. And as large banks grow larger, the
potential impact of a conversion gets disproportionately greater.

If that's true for the OCC, with its 2200 national banks \-- the largest
of which represents 16 percent of the total assets in the national
banking system and 10 percent of total OCC assessment revenues \--
consider the vulnerability of half of the state banking departments, in
which a single state bank accounts for more than 25 percent of the bank
assets under state supervision. In eight states -- including North
Carolina -- a single state bank accounts for more than 50 percent of the
assets under state supervision. In any of those states, the loss of a
large bank, to conversion, merger, or failure, could be devastating.

In that light, one can understand why some state supervisors might dig
in their heels in opposition to the OCC's proposal to rationalize the
supervisory fee structure -- even though our proposal would clearly be
beneficial for the banks they supervise. Over the years, a view has
taken hold -- a view that I believe is quite erroneous -- that lower
assessments are about all that the state charter has to offer, and that
if the fee disparity were reduced or eliminated, state banks would flee
en masse to the national charter.

But that needn't be the case, and I don't believe it would be. The state
bank charter is not in such a state of decrepitude that it needs \$1
billion a year in federal subsidies to shore it up -- and I am surprised
that the supervisors of state banks would implicitly take a contrary
view.

For much more than a century, against far longer odds than it faces
today, state banking has competed successfully through the application
of grit, innovation, supervisory responsiveness, and other qualitative
attributes that have unfortunately been cheapened in the current
obsession with assessments. I am convinced that we can restore fairness
of our system of supervisory funding, maintain the vitality of state
supervision, and reinvigorate the system of dual chartering that
contributed so significantly to the proud and productive history of
commercial banking in our country.

Reforming our system of supervisory funding is no panacea. But I believe
it's as good place as any to start.