United States Government Accountability Office

GAO Report to Congressional Committees

DEPOSIT 

INSURANCE 

Assessment of 

Regulators’ Use of 

Prompt Corrective 

Action Provisions and 

FDIC’s New Deposit 

Insurance System 

February 2007 

 

GAO-07-242 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

February 2007

DEPOSIT INSURANCE

Assessment of Regulators' Use of Prompt 

Corrective Action Provisions and FDIC's 

New Deposit Insurance System 

Highlights of GAO-07-242, a report to 

congressional committees 

The Federal Deposit Insurance 

Reform Conforming Amendments 

Act of 2005 required GAO to report 

on the federal banking regulators’

administration of the prompt 

corrective action (PCA) program 

under section 38 of the Federal 

Deposit Insurance Act (FDIA). 

Congress created section 38 as well 

as section 39, which required 

regulators to prescribe safety and 

soundness standards related to 

noncapital criteria, to address 

weaknesses in regulatory oversight

during the bank and thrift crisis of 

the 1980s that contributed to

deposit insurance losses. The 2005

act also required GAO to report on

changes to the Federal Deposit 

Insurance Corporation’s (FDIC)

deposit insurance system. This 

report (1) examines how regulators

have used PCA to resolve capital 

adequacy issues at depository 

institutions, (2) assesses the extent 

to which regulators have used 

noncapital supervisory actions 

under sections 38 and 39, and 

(3) describes how recent changes 

to FDIC’s deposit insurance system

affect the determination of 

institutions’ insurance premiums. 

GAO reviewed regulators’ PCA 

procedures and actions taken on a 

sample of undercapitalized

institutions. GAO also reviewed the 

final rule on changes to the

insurance system and comments 

from industry and academic

experts. 

 

In recent years, the financial condition of depository institutions generally 

has been strong, which has resulted in the regulators’ infrequent use of PCA 

provisions to resolve capital adequacy issues of troubled institutions. Partly 

because they benefited from a strong economy in the last decade, banks and 

thrifts in undercapitalized and lower capital categories decreased from 1,235 

in 1992, the year regulators implemented PCA, to 14 in 2005, and none failed

from June 2004 through January 2007. For the banks and thrifts GAO 

reviewed, regulators generally implemented PCA in accordance with section 

38. For example, regulators identified when institutions failed to meet 

minimum capital requirements, required them to implement capital 

restoration plans or corrective actions outlined in enforcement orders, and 

took steps to close or require the sale or merger of those institutions that 

were unable to recapitalize. Although regulators generally used PCA 

appropriately, capital is a lagging indicator and thus not necessarily a timely

predictor of problems at banks and thrifts. In most cases GAO reviewed, 

regulators had responded to safety and soundness problems in advance of a 

bank or thrift’s decline in required PCA capital levels. 

Under section 38 regulators can take noncapital supervisory actions to 

reclassify an institution’s capital category or dismiss officers and directors 

from deteriorating institutions, and under section 39 regulators can require 

institutions to implement plans to address deficiencies in their compliance 

with regulatory safety and soundness standards. Regulators generally have 

made limited use of these authorities, in part because they have chosen 

other informal and formal actions to address problems at troubled 

institutions. According to the regulators, other tools, such as cease-anddesist orders, may provide more flexibility than those available under 

sections 38 and 39 because they are not tied to an institution’s capital level 

and may allow them to address more complex or multiple deficiencies with 

one action. Regulators’ discretion to choose how and when to address 

safety and soundness weaknesses is demonstrated by their limited use of 

section 38 and 39 provisions and more frequent use of other informal and 

formal actions. 

Recent changes to FDIC’s deposit insurance system tie the premiums a bank 

or thrift pays into the insurance fund more directly to the estimated risk the 

institution poses to the fund. In the revised system, FDIC generally 

(1) differentiates between larger institutions with current credit agency

ratings and $10 billion or more in assets and all other, smaller institutions 

and (2) requires all institutions to pay premiums based on their individual 

risk. Most bankers, industry groups, and academics GAO interviewed and 

many of the organizations and individuals that submitted comment letters to 

FDIC on the new system generally supported making the system more risk 

based, but also had some concerns about unintended effects. FDIC and the 

other federal banking regulators intend to monitor the new system for any 

adverse impacts. 

www.gao.gov/cgi-bin/getrpt?GAO-07-242.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Yvonne D. 

Jones at (202) 512-8678 or jonesy@gao.gov. 
Contents 

Letter 1

Results in Brief 5 

Background 9

Since the Enactment of FDICIA, the Financial Condition of 

Depository Institutions Has Been Strong and Regulators’ On-site 

Monitoring Has Been More Frequent 16 

Regulators Used PCA Appropriately in Cases We Reviewed and 

Other Enforcement Actions Generally Preceded Declines in 

These Institutions’ PCA Capital Categories 22 

Regulators Have Made Limited and Targeted Use of the Noncapital 

Supervisory Actions Available under Sections 38 and 39 38 

FDIC Has More Tightly Linked Deposit Insurance Premiums to 

Institutional Risk, but Some Expressed Concerns about Certain 

Aspects of the New System 44 

Agency Comments 55 

Appendix I Objectives, Scope, and Methodology 56 

Appendix II Comments from the Board of Governors of the 

Federal Reserve System 60 

Appendix III GAO Contact and Staff Acknowledgments 62

Tables 

Table 1: Definitions of Risk 10 

Table 2: PCA Capital Categories 13 

Table 3: Sampled Institutions with PCA Taken to Address Capital 

Deficiencies 25

Table 4: Sampled Institutions Where Use of PCA Was Not Required 28 

Table 5: Institutions with Material Losses and PCA to Address 

Capital Adequacy, 1992-2005 35 

Table 6: Distribution of Institutions among Risk Categories in 

FDIC’s Previous Deposit Insurance System, as of 

December 31, 2005 45 

Table 7: Base Rate Premiums by Risk Category under FDIC’s New 

Deposit Insurance System 48 

Page i GAO-07-242 Deposit Insurance
Figures 

Figure 1: Total Assets, Total Net Income, Return on Assets, and 

Return on Equity for Federally Insured Commercial Banks 

and Savings Institutions, 1992-2005 17 

Figure 2: Number and Percentage of Institutions in PCA Capital 

Categories, 1992-2005 18 

Figure 3: Number of Problem Institutions and Total Assets, 1992-

2005 20

Figure 4: Failed Banks and Thrifts and Their Estimated Losses, 

1992-2005 21

Figure 5: Section 38 Mandatory and Discretionary Requirements 24 

Figure 6: Institutions on Regulator Watch Lists 30 

Figure 7: Timeline of Enforcement Actions, FDIC Open Bank 1 31 

Figure 8: Timeline of Enforcement Actions, New Century Bank 32 

Figure 9: Timeline of Enforcement Actions, Compubank 33 

Figure 10: Timeline of Enforcement Actions, Georgia Community 

Bank 34

Figure 11: Regulators Use of Section 8(e), 1992-2005 41 

Figure 12: Regulators Use of Section 39, 1995-2005 43 

Abbreviations 

BSA Bank Secrecy Act 

CAMELS capital, asset quality, management, earnings, 

 liquidity, sensitivity to market risk

FDIA Federal Deposit Insurance Act 

FDIC Federal Deposit Insurance Corporation 

FDICIA Federal Deposit Insurance Corporation Improvement Act of 

 1991 

IG inspector general 

OCC Office of the Comptroller of the Currency 

OTS Office of Thrift Supervision 

PCA prompt corrective action 

Y2K Year 2000 

Page ii GAO-07-242 Deposit Insurance
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Page iii GAO-07-242 Deposit Insurance
United States Government Accountability Office

Washington, DC 20548 

February 15, 2007 

The Honorable Christopher J. Dodd 

Chairman 

The Honorable Richard C. Shelby 

Ranking Member 

Committee on Banking, Housing, and Urban Affairs 

United States Senate 

The Honorable Barney Frank 

Chairman 

The Honorable Spencer Bachus 

Ranking Member 

Committee on Financial Services 

House of Representatives 

With the failure of more than 2,900 federally insured banks and thrifts in 

the 1980s and early 1990s, federal regulators were criticized for failing to 

take timely and forceful action to address the causes of these failures and 

prevent losses to the deposit insurance fund and taxpayers.1

 In response to 

the federal banking regulators’ failure to take appropriate action, Congress 

passed the Federal Deposit Insurance Corporation Improvement Act of 

1991 (FDICIA), implementing significant changes to the way banking 

regulators supervise the nation’s depository institutions.2

 FDICIA created 

two new sections in the Federal Deposit Insurance Act (FDIA)—sections 

38 and 39—that required the federal banking regulators to create a twopart framework to supplement their existing supervisory authority to 

address capital deficiencies and unsafe or unsound conduct, practices, or 

conditions.3 The addition of sections 38 and 39 to FDIA were intended to 

improve the ability of regulators to identify and promptly address 

deficiencies at an institution to better safeguard the deposit insurance 

 1

Under the Federal Deposit Insurance Reform Act of 2005, title II, subtitle B of Pub. L. No. 

109-171, 120 Stat. 4, 9-21 (2006), the Bank Insurance Fund and the Savings Association 

Insurance Fund, which insured deposits in banks and thrifts, respectively, were merged

into a combined Deposit Insurance Fund effective March 31, 2006. Throughout this report 

we use “deposit insurance fund” to refer to both funds individually and collectively. 

2

Pub. L. No. 102-242, 105 Stat. 2236 (1991). 

3

Act of September 21, 1950, ch. 967, 64 Stat. 873 (1950). 

Page 1 GAO-07-242 Deposit Insurance
fund. Specifically, section 38 requires regulators to classify depository 

institutions into one of five capital categories based on their level of 

capital—well capitalized, adequately capitalized, undercapitalized, 

significantly undercapitalized, and critically undercapitalized—and take 

increasingly severe actions, known as prompt corrective action (PCA), as 

an institution’s capital deteriorates.4

 Section 38 primarily focuses on 

capital as an indicator of trouble, thus the supervisory actions authorized 

under it are almost exclusively designed to address an institution’s 

deteriorating capital level (for example, requiring undercapitalized 

institutions to implement capital restoration plans). However, section 38

also authorizes noncapital supervisory actions (for example, removing 

officers and directors or downgrading an institution’s capital level).5

Section 39 required the banking regulators to prescribe safety and 

soundness standards related to noncapital criteria, including operations 

and management; compensation; and asset quality, earnings, and stock 

valuation, and allows the regulators to take action if an institution fails to 

meet one or more of these standards.6 Since the passage of FDICIA, banks 

and thrifts have benefited from a strong economy, but this has not 

diminished the importance of the need for regulators to take early and

forceful action to address capital and noncapital deficiencies.

FDICIA also granted the Federal Deposit Insurance Corporation (FDIC) 

the authority to establish and maintain a system—the deposit insurance 

system—to assess the relative risk of federally insured banks and thrifts 

and charge them premiums based on that risk. In February 2006, Congress 

granted FDIC the authority to make substantive changes to the deposit 

insurance system, including the way the regulator assesses risk and 

assigns premiums.

7

 FDIC issued its final rule implementing changes in 

November 2006. 

 4

12 U.S.C. § 1831o. 

5

Although section 38 authorizes several noncapital supervisory actions (such as restricting 

operational activities a regulator determines pose excessive risk to an institution), the 

discussion of noncapital supervisory actions in this report is limited to actions to dismiss 

officers and directors under section 38(f)(2)(F) and to reclassify an institution’s capital 

category under section 38(g). 

6

12 U.S.C. § 1831p-1. 

7

Federal Deposit Insurance Reform Act of 2005, Pub. L. No. 109-171, 120 Stat. 9 (2006); 

Federal Deposit Insurance Conforming Amendments Act of 2005, Pub. L. No. 109-173, 119

Stat. 3601 (2006). 

Page 2 GAO-07-242 Deposit Insurance
This report responds to the mandate contained in section 6 of the Federal 

Deposit Insurance Reform Conforming Amendments Act of 2005 requiring 

the Comptroller General to report on issues relating to the federal banking

regulators’ administration of the PCA program under section 38 of FDIA as 

well as various aspects of FDIC’s deposit insurance system.8

 Because the 

banking regulators also monitor the safety and soundness of depository 

institutions using criteria other than capital levels, this report also includes 

a review of the federal banking regulators’ use of safety and soundness 

standards under section 39. Specifically, this report (1) describes trends in 

the financial condition of banks and thrifts and federal regulators’ 

oversight of these institutions since the passage of FDICIA, (2) evaluates 

how federal regulators have used PCA to resolve capital adequacy issues 

at the institutions they regulate, (3) evaluates the extent to which federal

regulators have used the noncapital supervisory actions of sections 

38 and 39 to address weaknesses at the institutions they regulate, and 

(4) describes FDIC’s deposit insurance system and how recent changes to 

the system affect the determination of institutions’ risk and insurance 

premiums. 

To address these objectives, we reviewed relevant laws, regulations, and 

regulators’ policies and procedures and interviewed officials from the four 

federal banking regulators—FDIC, the Board of Governors of the Federal 

Reserve System (Federal Reserve), the Office of the Comptroller of the 

Currency (OCC), and the Office of Thrift Supervision (OTS)—as well as 

industry officials and academics. We also reviewed our previous reports 

on PCA.9

 To describe trends in the financial condition of banks and thrifts 

and regulators’ oversight of these institutions since the passage of FDICIA, 

we reviewed relevant industry reports and analyses. We also analyzed 

regulator and industry data to determine, among other things, the number 

of well-capitalized, adequately capitalized, and undercapitalized 

institutions and the number of institutions appearing on the problem 

institutions list since 1992, the year regulators implemented FDICIA.10 To 

 8

Pub. L. No. 109-173, 119 Stat. 3601 (2006). 

9

GAO, Bank Supervision: Prompt and Forceful Regulatory Actions Needed, 

GAO/GGD-91-69 (Washington, D.C.: Apr. 16, 1991), and Bank and Thrift Regulation: 

Implementation of FDICIA’s Prompt Regulatory Action Provisions, GAO/GGD-97-18 

(Washington, D.C.: Nov. 21, 1996). 

10Problem institutions typically have severe asset quality, liquidity, and earnings problems

that make them potential candidates for failure. FDIC reports the number of problem

institutions on its problem institutions list on a quarterly basis.

Page 3 GAO-07-242 Deposit Insurance
assess how federal regulators have used PCA to resolve capital adequacy

issues at the institutions they regulate, we reviewed section 38 and its 

implementing regulations, as well as regulators’ policies and procedures. 

We also examined reports of examination, informal and formal 

enforcement actions, and institution-regulator correspondence for a 

nonprobability sample of 24 institutions from a population of 157 

institutions that fell below one of the three lowest PCA capital thresholds 

at least once from 2001 through 2005. We chose this period for review 

based on the availability of examination- and enforcement-related 

documents and to reflect the most current policies and procedures used 

by the regulators. The sample reflects a mix of institutions regulated by

each of the four regulators as well as a mix of the three lowest PCA capital

categories. In 6 of these 24 cases, regulators did not implement PCA 

because they determined that it was not warranted.11 In addition, we 

reviewed the material loss reviews of all banks and thrifts that failed from

1992 through 2005 and in which the primary regulator implemented PCA to 

address capital adequacy issues.12 To determine the extent to which 

federal regulators have used the noncapital supervisory actions of sections 

38 and 39 to address weaknesses at the institutions they regulate, we 

reviewed regulators’ policies and procedures related to sections 

38(f)(2)(F) and 38(g) (the provisions for dismissal of officers and directors 

and reclassification of a capital category, respectively) and section 39, as 

well as data on the number of times and for what purposes they used these 

noncapital authorities. To provide context on the extent of regulators’ use 

of these noncapital provisions, we also obtained data on the number of 

times regulators used their authority under section 8(e) of FDIA to remove 

officers and directors from office and section 8(b) to enforce compliance 

 11In these six cases, regulators did not use PCA for reasons including the following: the

institution suffering a onetime drop in reported capital information, the institution 

misreporting capital information, or the institution failing to meet one or more of the PCA 

capital ratios by a fraction of a percent. 

12Section 38(k) of FDIA requires the inspector general of the applicable federal regulator to 

issue reports on any depository institution whose failure results in a “material loss”—

generally losses that exceed $25 million or 2 percent of the institution’s assets, whichever is 

greater—to the deposit insurance fund. These material loss reports must assess why the 

institution’s failure resulted in a material loss and make recommendations for preventing

such losses in the future. 12 U.S.C. § 1831o(k). 

Page 4 GAO-07-242 Deposit Insurance
with safety and soundness standards.13 Finally, to describe how changes in

FDIC’s deposit insurance system affect the determination of institutions’ 

risk and insurance premiums, we reviewed FDIC’s notice of proposed rule 

making on deposit insurance assessments, selected comments to the 

proposed rule, and FDIC’s final rule on deposit insurance assessments.14

We also interviewed representatives of five depository institutions (three 

large and two small) and two trade groups representing large and small 

institutions and two academics to obtain their views on the impact of 

FDIC’s changes to the system. Appendix I contains a more detailed 

description of our scope and methodology. We conducted our work in 

Washington, D.C., and Chicago from March 2006 through January 2007 in 

accordance with generally accepted government auditing standards. 

Since the enactment of FDICIA, the financial condition of federally insured 

depository institutions generally has been strong and regulators have 

increased their presence at banks and thrifts. Net income and total assets 

exceeded $133 billion and $10 trillion, respectively, in 2005, and the 

industry’s two primary indicators of profitability—returns on assets and 

equity—remained near highs at the end of 2005. In this strong economic 

environment, the percentage of well-capitalized institutions steadily has 

increased from 94 percent in 1992, the year regulators implemented 

FDICIA, to just over 99 percent in 2005, while the percentage of wellcapitalized institutions with capital in excess of the well-capitalized 

minimum increased from 84 percent in 1992 to 94 percent in 2005. Over the 

period, the number of institutions in undercapitalized and lower capital 

categories experienced a corresponding decline from 1,235 in 1992 to 14 in 

2005, and the number of failed institutions also fell dramatically. In 

addition to requiring regulators to take prompt corrective action against 

institutions that fail to meet minimum capital requirements, FDICIA also 

required examiners to conduct annual, on-site examinations at all federally 

Results in Brief 

 13Section 8(e) (codified at 12 U.S.C. § 1818(e)) gives regulators authority to permanently 

ban certain institution-affiliated individuals (including officers, directors, and shareholders 

of an institution) from participating in the conduct of the affairs of any federally regulated

institution under certain circumstances involving egregious conduct on the part of the

individuals. Section 8(b) (codified at 12 U.S.C. 1818(b)) of FDIA gives regulators authority

to order an institution to cease and desist from certain practices or violations. 

14Federal Deposit Insurance Corporation—Assessments, 71 Fed. Reg. 41910 (2006) 

(proposed rule). Comments to the proposed rule making were due on September 22, 2006.

Federal Deposit Insurance Corporation—Assessments, 71 Fed. Reg. 69282 (2006) (final rule 

codified at 12 C.F.R. § 327.9, 327.10 and Appendixes A, B, and C of Subpart A). 

Page 5 GAO-07-242 Deposit Insurance
insured banks and thrifts to improve their ability to identify and address 

problems in a more timely manner. Although we did not evaluate the 

regulators’ timeliness in conducting examinations, regulatory data show 

that the average time between examinations fell from a high of 609 days in

1986 to 373 in 1992. Based on information we obtained from all four 

regulators, the average interval between examinations for all institutions 

generally has remained from 12 to 18 months since 1993 (the year after 

FDICIA requirements were implemented) and in many instances, has been 

even shorter, especially for problem institutions (those with composite 

CAMELS ratings of 4 or 5).15

For the sample of 18 banks and thrifts that were subject to PCA, we found 

that regulators generally implemented PCA in accordance with section 38, 

consistent with findings in our 1996 report.16 For example, regulators 

identified when each of the institutions failed to meet minimum capital 

requirements, required these institutions to implement capital restoration 

plans or corrective actions outlined in enforcement orders, and took steps 

to close or require the sale or merger of those institutions that were unable 

to adequately recapitalize. Fifteen of the 18 institutions in our sample 

remain open or were merged into other institutions or closed without 

causing losses to the deposit insurance fund, and 3 failed causing losses, 

one of which was a material loss (that is, a loss exceeding $25 million or 

2 percent of an institution’s assets, whichever is greater). Although 

regulators appeared to have used PCA appropriately, capital is a lagging

indicator and thus not necessarily a timely predictor of problems at banks 

and thrifts. All four regulators generally agreed that by design, PCA is not a 

tool that can be used upon early recognition of a bank or thrift’s troubled 

status. In most cases we reviewed, regulators had responded to safety and 

soundness problems in advance of a bank or thrift’s decline in PCA capital

category. For example, each of the 18 institutions subject to PCA appeared 

on one or more regulatory watch lists prior to or concurrent with 

experiencing a decline in its capital category, and a majority of the 18

institutions had at least one enforcement action in place prior to becoming 

undercapitalized. Finally, the inspectors general (IG) of the federal 

 15At each examination, examiners assign a supervisory CAMELS rating, which assesses six 

components of an institution’s financial health: capital, asset quality, management, 

earnings, liquidity, and sensitivity to market risk. An institution’s CAMELS rating is known 

directly only by the institution’s senior management and appropriate regulatory staff. 

Regulators never publicly release CAMELS ratings, even on a lagged basis.

16GAO/GGD-97-18. 

Page 6 GAO-07-242 Deposit Insurance
banking agencies found that in 12 of 14 cases where regulators used PCA 

to resolve capital problems at an institution that failed with material 

losses, the regulators’ use of PCA was appropriate. In two cases, the IG 

found that the regulator could have used PCA sooner than it did. 

Regulators have made limited use of noncapital supervisory actions under 

sections 38 and 39, which allow them to reclassify institutions’ capital 

categories, dismiss officers and directors from deteriorating banks and 

thrifts, and require institutions to implement plans to address deficiencies

in their compliance with regulatory safety and soundness standards. For 

example, since the implementation of FDICIA, only OCC has used the 

authority granted under section 38 to reclassify an institution’s capital 

category. According to the regulators, section 38’s reclassification 

provision is of limited use because they can use other enforcement actions

to address deficiencies, including capital and noncapital deficiencies (such 

as deficiencies in asset quality, risk management, and the quality of bank

management). These other enforcement actions can be used even when an

institution is well capitalized or adequately capitalized by PCA standards. 

Similarly, since the implementation of FDICIA, regulators made limited 

use of section 38’s dismissal authority—FDIC has made the most frequent 

use of the authority (six times), while OCC used it once and the Federal

Reserve and OTS have never used it. Regulators told us that they often rely

on moral suasion to encourage problem officers and directors to resign 

from institutions, or when an individual’s misconduct is severe, they may 

use their authority under section 8(e) of FDIA to remove that individual 

from an institution and prohibit him or her from further employment in the 

industry. FDIC, OCC, and OTS also used section 39 authority in limited 

circumstances to address safety and soundness deficiencies at the 

institutions they regulate. However, amendments to section 39 in 1994 

increased regulator flexibility over when and how to use the authority and 

regulators maintain considerable discretion to choose how and when to 

address safety and soundness weaknesses, as demonstrated by their 

varied use of noncapital supervisory actions under sections 38 and 39 and

other informal and formal enforcement actions. Regulators have used 

section 39 predominantly to address noncompliance with certain laws or 

requirements or when management was willing and able to implement 

required corrective actions, but may not have been responsive to prior 

informal regulatory criticisms. Regulators told us that they prefer to use 

formal enforcement actions, such as section 8(b) cease-and-desist orders, 

to address complex or multiple deficiencies at an institution or in cases 

where management was not willing or able to quickly implement the 

required corrective actions. 

Page 7 GAO-07-242 Deposit Insurance
Recent changes to FDIC’s deposit insurance system tie the premiums a 

bank or thrift pays into the deposit insurance fund more directly to an 

estimation of the risk that the institution poses to the fund than under the 

previous system. To do so, FDIC created a system that generally 

(1) differentiates between larger institutions with current credit agency 

ratings and $10 billion or more in assets and all other, smaller institutions; 

(2) for institutions without credit agency ratings, forecasts the likelihood

of a decline in financial health; (3) for institutions with credit agency 

ratings, uses financial market information to evaluate institutional risk; 

and (4) requires all institutions to pay premiums based on their individual 

risk.17 However, FDIC did not completely follow risk-based pricing tenets 

to set the premiums. Rather, FDIC has chosen to set the base rate 

premium for the riskiest banks and thrifts at 40 basis points, or 60 percent 

below the indicated premium of 100, the amount needed to cover expected 

losses in the event of failure. In doing so, FDIC officials told us they sought

to address long-standing concerns of the industry, regulators, and others 

that premiums should not be set so high as to prevent an institution that is

troubled and seeking to rebuild its health from doing so. Most bankers, 

industry groups, and academics with whom we spoke and many of those 

organizations that submitted comment letters to FDIC on its new system 

generally supported FDIC’s efforts to make the system more risk based, 

but many also expressed concerns about certain elements and questioned 

whether the new system might produce unintended consequences. For 

example, some were concerned that what they said should be an objective 

calculation of premiums now will give attention to such subjective factors 

as the quality of bank management. Others noted that because a bank or 

thrift receiving a lower CAMELS rating can now expect an increase in 

premiums, this could create disincentives for bank and thrift management 

to be cooperative or forthcoming during examinations. FDIC officials said

that FDIC, along with the other federal regulators, plans to monitor the 

new system for adverse effects. 

We provided a draft of this report to FDIC, the Federal Reserve, OCC, and 

OTS for their review and comment. In written comments, the Federal 

Reserve concurred with our findings relating to PCA (see app. II). In 

addition, FDIC, the Federal Reserve, and OCC provided technical 

comments, which we incorporated as appropriate. 

 17Credit rating agencies, such as Moody’s Investors Services, Standard & Poor’s, and Fitch 

Ratings, evaluate an institution’s ability to repay debt and then publish a rating reflecting 

their opinion on that institution’s likelihood of default. 

Page 8 GAO-07-242 Deposit Insurance
Four federal banking regulators—FDIC, the Federal Reserve, OCC, and 

OTS—oversee the nation’s banks and thrifts to ensure they are operating 

in a safe and sound manner. The failure of more than 2,900 depository 

institutions during the 1980s and early 1990s led to the passage of FDICIA, 

which amended FDIA to require regulators to take action against 

institutions that failed to meet minimum capital levels and granted 

regulators several authorities to address noncapital deficiencies at the 

institutions they regulate. FDICIA also required FDIC to establish a system 

to assess the risk of depository institutions insured by the deposit 

insurance fund. 

FDIC insures the deposits of all federally insured depository institutions, 

generally up to $100,000 per depositor, and monitors their risk to the 

deposit insurance fund. In addition, FDIC is the primary regulator for 

state-chartered nonmember banks (that is, state-chartered banks that are 

not members of the Federal Reserve System), the Federal Reserve is the 

primary regulator for state-chartered member banks (state-chartered 

banks that are members of the Federal Reserve System) and bank holding

companies, OCC is the primary regulator of federally chartered banks, and

OTS is the primary regulator of federally and state-chartered thrifts and 

thrift holding companies.

18

Background 

Federal Regulation of 

Banks and Thrifts 

Federal regulators have defined several categories of risk to which 

depository institutions are exposed—credit risk, compliance risk, legal 

 18This report only addresses the extent to which regulators used sections 38 and 39 to

address problems at banks and thrifts. Bank and thrift holding companies are excluded

from all discussion and data. Under the dual federal and state banking system, statechartered banks are supervised jointly by their state chartering authority and either FDIC 

or the Federal Reserve. OCC and OTS are operating bureaus under the Department of the

Treasury. 

Page 9 GAO-07-242 Deposit Insurance
risk, liquidity risk, market risk, operational risk, reputational risk, and 

strategic risk (see table 1).19

Table 1: Definitions of Risk

Risk Definition

Compliance The risk arising from violations of or nonconformance with laws, rules, 

regulations, prescribed practices, or ethical standards. 

Credit The risk that a borrower or counterparty to a transaction will default on an 

obligation. 

Legal The risk that potential unenforceable contracts, lawsuits, or adverse legal

judgments could negatively affect the operations or condition of an 

institution. 

Liquidity The risk arising from an institution’s inability to meet its obligations when 

they come due because of an inability to liquidate assets or obtain 

adequate funding. 

Market The risk arising from adverse movement in market rates or prices, such 

as interest rates, foreign exchange rates, or equity prices. 

Operational The risk that inadequate information systems, operational problems, 

breaches in internal controls, fraud, or unforeseen catastrophes will result 

in losses. 

Reputational The risk that potential negative publicity regarding an institution’s 

business practices could cause a decline in the customer base, costly 

litigation, or revenue reductions. 

Strategic The risk arising from adverse business decisions or improper

implementation of those decisions, improper business planning, or 

inadequate responses to changes in the industry. 

Source: GAO.

Banks and thrifts, in conjunction with regulators, must continually manage 

risks to ensure their safe and sound operation and protect the well-being 

of depositors—those individuals and organizations that act as creditors by 

“loaning” their funds in the form of deposits to institutions to engage in 

 19Within these categories, we and others have identified and reported on several specific 

risks currently facing the industry, including the growth in alternative mortgage products 

and increasing concentrations of commercial real estate holdings among certain 

institutions. See GAO, Alternative Mortgage Products: Impact on Defaults Remains 

Unclear, but Disclosure of Risks to Borrowers Could Be Improved, GAO-06-1021 

(Washington, D.C.: Sept. 19, 2006); Office of the Comptroller of the Currency, Board of

Governors of the Federal Reserve System, and Federal Deposit Insurance Corporation, 

Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices, 

71 Fed. Reg. 74585 (2006) (joint final guidance); and Office of Thrift Supervision, 

Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices, 

71 Fed. Reg. 75298 (2006) (final guidance). 

Page 10 GAO-07-242 Deposit Insurance
lending and other activities. Regulators are responsible for supervising the 

activities of banks and thrifts and taking corrective action when these 

activities and their overall performance present supervisory concerns or 

have the potential to result in financial losses to the insurance fund or 

violations of law. Losses to the insurance fund may occur when an 

institution does not have sufficient assets to reimburse customers’ insured 

deposits and FDIC’s administrative expenses in the event of closure or 

merger. 

Regulators assess the condition of banks and thrifts through off-site 

monitoring and on-site examinations. Examiners use Reports of Condition 

and Income (Call Report) and Thrift Financial Report data to remotely 

assess the financial condition of banks and thrifts, respectively, and to

plan the scope of on-site examinations.20 As part of on-site examinations, 

regulators more closely assess institutions’ exposure to risk and assign 

institutions ratings, known as CAMELS ratings, that reflect their condition 

in six areas: capital, asset quality, management, earnings, liquidity, and 

sensitivity to market risk.21 Each component is rated on a scale of 1 to 5,

with 1 the best and 5 the worst. The component ratings then are used to 

develop a composite rating also ranging from 1 to 5. Institutions with 

composite ratings of 1 or 2 are considered to be in satisfactory condition,

while institutions with composite ratings of 3, 4, or 5 exhibit varying levels 

of safety and soundness problems. Also as part of the examination and 

general supervision process, regulators may direct an institution to 

address issues or deficiencies within specified time frames. 

When regulators determine that a bank or thrift’s condition is

unsatisfactory, they may take a variety of supervisory actions, including 

informal and formal enforcement actions, to address identified 

deficiencies and have some discretion in deciding which actions to take. 

Regulators typically take progressively stricter actions against more 

serious weaknesses. Informal actions generally are used to address less 

severe deficiencies or when the regulator has confidence that the 

institution is willing and able to implement changes. Informal actions 

include, for example, commitment letters detailing an institution’s 

 20All banks that FDIC insures must submit quarterly Call Reports, which contain a variety 

of financial information, including capital ratios, that show a bank’s condition and income. 

Thrifts file similar reports, called Thrift Financial Reports.

21Effective January 1, 1997, the Federal Financial Institutions Examination Council added

the “S” component of the CAMELS rating; prior to 1997, the rating was known as CAMEL.

Page 11 GAO-07-242 Deposit Insurance
commitment to undertake specific remedial measures, board resolutions 

adopted by the institution’s board of directors at the request of its 

regulator, and memorandums of understanding. Informal actions are not 

public agreements (meaning, regulators do not make them public through 

their Web sites or other channels) and are not enforceable by the 

imposition of sanctions.22 In comparison, formal enforcement actions are 

publicly disclosed by regulators and enforceable and are used to address 

more severe deficiencies or when the regulator has limited confidence in

an institution’s ability to implement changes. Formal enforcement actions 

include, for example, PCA directives, cease-and-desist orders under 

section 8(b) of FDIA, removal and prohibition orders under section 8(e) of

FDIA, civil money penalties, and termination of an institution’s deposit 

insurance.23

All four regulators have policies and procedures that describe for 

examiners the circumstances under which they should recommend the use 

of informal and formal enforcement actions to address identified 

deficiencies. Each federal banking regulator also has established a means

through which senior management of the applicable federal regulator 

reviews all enforcement recommendations to ensure that the proposed 

actions are the best and most efficient means to bring an institution back 

into compliance with applicable laws, regulations, and best practices. 

Capital and Noncapital 

Actions of FDIA 

Section 38 of FDIA requires regulators to categorize depository 

institutions into five categories on the basis of their capital levels. 

Regulators use three different capital measures to determine an

institution’s capital category: (1) a total risk-based capital measure, (2) a 

tier 1 risk-based capital measure, and (3) a leverage (or non-risk-based) 

capital measure (see table 2). To be considered well capitalized or 

adequately capitalized, an institution must meet or exceed all three ratios 

for the applicable capital category. Institutions are considered

undercapitalized or worse if they fail to meet just one of the ratios 

 22Noncompliance with an informal enforcement action can be addressed by a formal action 

under section 8 of FDIA. 

23PCA directives are formal actions that regulators issue to institutions that fail to meet 

minimum capital requirements. Directives require institutions to take one or more specified 

actions to return to required minimum capital standards. Regulators typically use directives

to specify corrective actions for significantly and critically undercapitalized institutions, as

the restrictions and requirements specified in section 38 for undercapitalized institutions 

are automatic. 

Page 12 GAO-07-242 Deposit Insurance
necessary to be considered at least adequately capitalized. For example, 

an institution with 9 percent total risk-based capital and 6 percent tier 1

risk-based capital but only 3.5 percent leverage capital would be 

undercapitalized for PCA purposes. 

Table 2: PCA Capital Categories

Capital category Total risk-based capitalaTier 1 risk-based capital Leverage capitalb

Well capitalizedc10% or more and 6% or more and 5% or more 

Adequately capitalized 8% or more and 4% or more and 4% or mored

Undercapitalized Less than 8% or Less than 4% or Less than 4%

Significantly undercapitalized Less than 6% or Less than 3% or Less than 3%

Critically undercapitalized An institution is critically undercapitalized if its tangible equity is 2% or less regardless of its 

other capital ratios.e

Sources: Capital measures and capital category definitions: FDIC—12 C.F.R. § 325.103 (2006), Federal Reserve—12 C.F.R. § 208.43

(2006), OCC—12 C.F.R. § 6.4 (2006), and OTS—12 C.F.R. § 565.4 (2006). 

a

The total risk-based capital ratio consists of the sum of tier 1 and tier 2 capital divided by riskweighted assets. Tier 1 capital consists primarily of tangible equity. Tier 2 capital includes 

subordinated debt, loan loss reserves, and certain other instruments. 

b

Leverage capital is tier 1 capital divided by average total assets. 

c

An institution that satisfies the capital measures for a well-capitalized institution but is subject to a 

formal enforcement action that requires it to meet and maintain a specific capital level is considered 

to be adequately capitalized for purposes of PCA. 

d

CAMELS 1-rated institutions not experiencing or anticipating significant growth need only have 3 

percent leverage capital to be considered adequately capitalized. 

e

Tangible equity is equal to the amount of core capital elements plus outstanding perpetual preferred 

stock minus all intangible assets not previously deducted, except certain purchased mortgageservicing rights. 

Under section 38, regulators must take increasingly severe supervisory 

actions as an institution’s capital level deteriorates. For example, all 

undercapitalized institutions are required to implement capital restoration 

plans to restore capital to at least the adequately capitalized level, and 

regulators are generally required to close critically undercapitalized 

institutions within a 90-day period. Section 38 allows an exception to the 

90-day closure rule if both the primary regulator and FDIC concur and 

document why some other action would better achieve the purpose of 

section 38—resolving the problems of institutions at the least possible 

long-term cost to the deposit insurance fund. 

Resolving failed or failing institutions is one of FDIC’s primary 

responsibilities under PCA. In selecting the least costly resolution 

alternative, FDIC’s process is to compare the estimated cost of 

Page 13 GAO-07-242 Deposit Insurance
liquidation—basically, the amount of insured deposits paid out minus the 

net realizable value of an institution’s assets—with the amounts that 

potential acquirers bid for the institution’s assets and deposits. FDIC 

has resolved failed or failing institutions using three basic methods: 

(1) directly paying depositors the insured amount of their deposits and 

disposing of the failed institution’s assets (depositor payoff and asset 

liquidation); (2) selling only the institution’s insured deposits and certain 

other liabilities, with some of its assets, to an acquirer (insured deposit 

transfer); and (3) selling some or all of the failed institution’s deposits, 

certain other liabilities, and some or all of its assets to an acquirer 

(purchase and assumption). Within this third category, many variations 

exist based on specific assets that are offered for sale. For example, some 

purchase and assumption resolutions also have included loss-sharing 

agreements—an arrangement whereby FDIC, in order to sell certain assets 

with the intent of limiting losses to the deposit insurance fund, agrees to 

share with the acquirer the losses on those assets. 

Section 38 also authorizes several non-capital-based supervisory actions 

designed to allow regulators some flexibility in achieving the purpose of 

section 38. Specifically, under section 38(g) regulators are permitted to 

reclassify or downgrade an institution’s capital category to apply more 

stringent operating restrictions or requirements if they determine, after 

notice and opportunity for a hearing, that an institution is in an unsafe and

unsound condition or engaging in an unsafe or unsound practice. Under

section 38(f)(2)(F) regulators can require an institution to make 

improvements in management, for example, by dismissing officers and 

directors who are not able to materially strengthen an institution’s ability 

to become adequately capitalized.24

Section 39 directs regulatory attention to noncapital areas of an

institution’s operations and activities in three main safety and soundness 

areas: operations and management; compensation; and asset quality,

earnings, and stock valuation. As originally enacted under FDICIA, section 

39 required regulators to develop and implement standards in these three 

areas, as well as develop quantitative standards for asset quality and 

earnings. However, in response to concerns about the potential regulatory 

burden of section 39 on banks and thrifts, section 318 of the Riegle 

Community Development and Regulatory Improvement Act of 1994

 24Under section 38(f)(2)(F), regulators also may order a new election for an institution’s 

board of directors or require the institution to employ qualified senior executive officers. 

Page 14 GAO-07-242 Deposit Insurance
amended section 39 to allow the standards to be issued either by 

regulation (as originally specified in FDICIA) or by guideline and 

eliminated the requirement to establish quantitative standards for asset 

quality and earnings.25 The regulators chose to prescribe the standards 

through guideline rather than regulation, essentially providing them with 

flexibility in how and when they would take action against institutions that 

failed to meet the standards.26 Under section 39, if a regulator determines 

that an institution has failed to meet a prescribed standard, the regulator 

may require that the institution file a safety and soundness plan specifying 

the steps it will take to correct the deficiency.27 If the institution fails to 

submit an acceptable plan or fails to materially implement or adhere to an

approved plan, the regulator must require the institution, through the 

issuance of a public order, to correct identified deficiencies and may take

other enforcement actions pending the correction of the deficiency. 

Deposit Insurance System In addition to adding sections 38 and 39 to FDIA to address capital 

inadequacy and safety and soundness problems at depository institutions, 

FDICIA also required FDIC to establish a system—the deposit insurance 

system—to assess the risk of federally insured depository institutions and 

charge premiums to finance a deposit insurance fund meant to protect 

depositors in the event of future bank and thrift failures. 

At the urging of FDIC, in February 2006 Congress enacted legislation 

granting the regulator authority to make substantive changes to the 

deposit insurance system, including the way it assesses the risk of 

institutions and determines their premiums. In July 2006, FDIC issued its 

proposed rule outlining proposed changes to the deposit insurance system 

and opened a public comment period. FDIC adopted a final rule in 

November 2006. Recalculated premiums and other changes reflected in the 

final rule were effective January 1, 2007. As of September 30, 2006, FDIC 

insured over 60 percent of all domestic deposits, totaling more than 

$4 trillion. 

 25Pub. L. No. 103-325, 18 Stat. 2160, 2223-2224 (1994). 

26Interagency Guidelines Establishing Standards for Safety and Soundness, 60 Fed. Reg.

35680 (1995) (codified as amended as follows: FDIC—Appendix A to 12 C.F.R. pt. 364 

(2006); Federal Reserve—Appendix D-1 to 12 C.F.R. pt. 208 (2006); OCC—Appendix A to 12

C.F.R. pt. 30 (2006); and OTS—Appendix A to 12 C.F.R. pt. 570 (2006)). 

2712 U.S.C. § 1831p-1(e). 

Page 15 GAO-07-242 Deposit Insurance
The nation’s banks and thrifts have benefited from a strong economy since 

1992—as demonstrated by steady increases in several of the industry’s 

primary performance indicators and growing numbers of institutions 

meeting or exceeding minimum capital levels. For example, in 2005, the 

industry reported record total assets ($10 trillion in 2005) and net income 

($133 billion in 2005) (see fig. 1). Similarly, the industry’s two primary 

indicators of profitability—returns on assets and equity—have improved 

since 1992 and remain near record highs. 

Since the Enactment 

of FDICIA, the 

Financial Condition of 

Depository 

Institutions Has Been 

Strong and 

Regulators’ On-site 

Monitoring Has Been 

More Frequent 

Page 16 GAO-07-242 Deposit Insurance
Figure 1: Total Assets, Total Net Income, Return on Assets, and Return on Equity for Federally Insured Commercial Banks 

and Savings Institutions, 1992-2005 

2005 constant dollars in trillions

2005 constant dollars in billions

Percentage

Percentage

Assets

Net income

Return on assets

Return on equity

Source: GAO analysis of FDIC data.

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

0

5

10

15

20

25

30

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Banks

Thrifts

0

2

4

6

8

10

0

20

40

60

80

100

120

140

.0

.5

1.0

1.5

2.0

As a result of institutions’ overall strong financial performance, few have 

failed to meet minimum capital requirements since 1992, the year 

regulators implemented PCA. The percentage of well-capitalized 

Page 17 GAO-07-242 Deposit Insurance
institutions has increased from 93.99 percent in 1992 to 99.71 percent in 

2005, while the percentage of undercapitalized and lower-rated institutions 

generally has declined (see fig. 2). For example, the percentage of 

significantly undercapitalized institutions declined from 2.74 percent (394 

institutions) to 0.06 percent (5 institutions) in this period, while the 

percentage of critically undercapitalized institutions fell from 1.64 percent 

to 0.01 percent (236 to 1).

28

Figure 2: Number and Percentage of Institutions in PCA Capital Categories, 1992-2005 

 

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

1992

2005

13,741

13,136

12,448

11,971

11,499

10,973

10,594

10,319

9,931

9,598

9,406

9,217

14,399

9,077

Reporting

Year institutions

Percentage and number of reporting institutions by capitalization category

Undercapitalized

57

24

18

11

14

10

12

6

15

14

13

5

236

1

.41

.18

.14

.09

.12

.09

.11

.06

.15

.15

.14

.05

1.64

.01

%

Critically

undercapitalized

Well

capitalized

13,445

12,971

12,350

11,886

11,408

10,886

10,498

10,230

9,853

9,540

9,378

9,192

13,534

9,051

97.85

98.74

99.21

99.29

99.21

99.21

99.09

99.14

99.21

99.40

99.70

99.73

93.99

99.71

%

Adequately

capitalized

698

461

369

381

424

438

454

456

420

367

247

212

1,596

172

5.08

3.51

2.96

3.18

3.69

3.99

4.29

4.42

4.23

3.82

2.63

2.30

11.08

1.89

%

196

89

63

49

37

60

38

28

40

35

19

8

605

8

1.43

.68

.51

.41

.32

.55

.36

.27

.40

.36

.20

.09

4.20

.09

%

Significantly

undercapitalized

139

59

32

21

26

21

22

17

17

16

14

7

394

5

1.01

.45

.26

.18

.23

.19

.21

.16

.17

.17

.15

.08

2.74

.06

%

Source: GAO analysis of Call and Thrift Financial Report data.

28We counted the institutions in each PCA capital category by quarter because institutions 

are required to report capital ratio information in quarterly Call and Thrift Financial 

Reports. As a result, the number of institutions in each category per year is more than the 

number of institutions reporting in each year because an institution could appear in more 

than one capital category in a year. Thus, the percentage of institutions in all five capital 

categories in a given year is more than 100 percent. 

Page 18 GAO-07-242 Deposit Insurance
Further, the percentage of institutions carrying capital in excess of the 

well-capitalized leverage capital minimum (that is, 5 percent or more of 

leverage capital) also increased from 84 percent of all reporting

institutions in 1992 to 94 percent in 2005.29 The percentage of institutions 

carrying at least two times as much capital (200 percent or more of the 

well-capitalized leverage capital minimum) increased from 25 percent to

41 percent over the period. 

According to regulators, the improved financial condition of banks and 

thrifts may have contributed to the sharp decline in the number of 

problem institutions (those with composite CAMELS ratings of 4 or 5), 

from 1,063 in 1992 to 74 in 2005 (see fig. 3). 

 29To determine those institutions that held capital in excess of the well-capitalized 

minimum, we first determined the number of institutions that were well capitalized for all 

four quarters of each calendar year, 1992 through 2005, and then calculated the average

amount of leverage capital each of the institutions held during each calendar year. 

Page 19 GAO-07-242 Deposit Insurance
Figure 3: Number of Problem Institutions and Total Assets, 1992-2005

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Problem institutions

Problem institutions

Yearly cumulative assets for problem institutions

Dollars in billions

Source: GAO analysis of FDIC data.

0

200

400

600

800

1,000

1,200

0

100

200

300

400

500

600

Fiscal year

Similarly, regulators said that institutions’ improved financial condition 

may have also contributed to the significant decline in the number of 

failures and losses to the insurance fund since 1992 (see fig. 4). From 

1992 through 2004, the number of failed banks and thrifts fell from 180 

(with estimated losses to the insurance fund of $7.3 million) to 4 (with 

no estimated losses). No bank or thrift failed from June 2004 through 

January 2007. 30

 30Metropolitan Savings Bank, Pittsburgh, Pennsylvania, failed on February 2, 2007; 

however, because this failure occurred after we completed our audit work, we did not

include this bank in our discussion of failed institutions. 

Page 20 GAO-07-242 Deposit Insurance
Figure 4: Failed Banks and Thrifts and Their Estimated Losses, 1992-2005 

Year Year

Source: GAO analysis of FDIC data.

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

0

1

2

3

4

5

6

7

8

0

100

200

300

400

500

600

700

800

’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05

Banks and thrifts Dollars in billions

Dollars in millions

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

0

25

50

75

100

125

150

175

200

Failed banks and thrifts Estimated losses

In addition, regulators’ on-site presence at banks and thrifts increased 

beginning in the early 1990s, in part as a result of reforms enacted as a part

of FDICIA that required regulators to conduct full-scope, on-site 

examinations for most federally insured institutions at least annually to 

help contain losses to the deposit insurance fund.31 Historical data show 

that the interval between full-scope, on-site examinations for all 

institutions peaked in 1986 when it reached 609 days. Subsequent to the 

enactment of FDICIA in December 1991, the average interval between 

 31Pub. L. No. 102-242 § 111(a), 105 Stat. 2236, 2240 (1991) (codified as amended at 12 U.S.C. 

§ 1820(d)). Section 605 of the Financial Services Regulatory Relief Act of 2006, Pub. L. No. 

109-351, 120 Stat. 1966, 1981 (2006) amended section 10(d)(4)(A) of FDIA (codified at 12

U.S.C. § 1820(d)(4)(A)) to provide that for well-capitalized, well-managed institutions with 

total assets of less than $500 million that are not subject to an enforcement action or any 

change in control during the 12-month period in which a full-scope, on-site examination 

would be required, regulators are only required to conduct an on-site examination every 18

months. 

Page 21 GAO-07-242 Deposit Insurance
examinations for all institutions declined to 373 days in 1992.32 Based on 

information we obtained from all four regulators, the average interval 

between examinations for all institutions generally has remained from 12 

to 18 months since 1993 (the year after FDICIA requirements were 

implemented) and in many instances has been even shorter, especially for

problem institutions. 

For the sample of banks and thrifts we reviewed, we found that regulators 

generally implemented PCA in accordance with section 38. For example, 

when institutions failed to meet minimum capital requirements, regulators 

required them to submit capital restoration plans or imposed restrictions 

through PCA directives or other enforcement actions. Regulators generally 

agreed that capital is a lagging indicator of poor performance and 

therefore other measures are often used to address deficiencies upon 

recognition of an institution’s troubled status. This contention was 

supported by the fact that in a majority of the cases we reviewed, 

institutions had one or more informal or formal enforcement actions in 

place prior to becoming undercapitalized. Most of the material loss 

reviews conducted by IGs also found that regulators appropriately used 

PCA provisions in most cases, although in two reviews they found that 

regulators could have used PCA sooner. 

Based on a sample of cases, we found that regulators generally acted 

appropriately to address problems at institutions that failed to meet 

minimum capital requirements by taking increasingly severe enforcement 

actions as these institutions’ capital deteriorated, as required by section 

38. 

Regulators Used PCA 

Appropriately in

Cases We Reviewed 

and Other 

Enforcement Actions 

Generally Preceded 

Declines in These 

Institutions’ PCA 

Capital Categories 

Regulators Used PCA 

Appropriately to Resolve 

Capital Problems at Banks 

and Thrifts We Reviewed 

 32Federal Deposit Insurance Corporation, History of the Eighties—Lessons for the Future 

(Washington, D.C.: 1997). FDIC data include only those institutions that FDIC, the Federal 

Reserve, and OCC supervise. According to OTS data, the average number of days between 

examinations was 461 in 1989, the year OTS was formed, and down to 309 days by 1992. 

Page 22 GAO-07-242 Deposit Insurance
Institutions that fail to meet minimum capital levels face several 

mandatory restrictions or requirements under section 38 (see fig. 5).33

Specifically, section 38 requires an undercapitalized institution to submit a 

capital restoration plan detailing how it is going to become adequately 

capitalized. When an institution becomes significantly undercapitalized,

regulators are required to take more forceful corrective measures, 

including requiring the sale of equity or debt, or under certain

circumstances requiring an institution to be acquired by or merged with 

another institution; restricting otherwise allowable transactions with 

affiliates; and restricting the interest rates paid on deposits. In addition to 

these actions, regulators also may impose other discretionary restrictions 

or requirements outlined in section 38 that they deem appropriate. After 

an institution becomes critically undercapitalized, regulators have 90 days

to either place the institution into receivership or conservatorship (that is, 

close the institution) or to take other actions that would better prevent or 

reduce long-term losses to the insurance fund.34 Regulators also have some

discretion in how they enforce PCA restrictions and requirements—they 

may issue a PCA directive (a formal action that requires an institution to 

take one or more specified actions to return to required minimum capital 

standards) or delineate the restrictions and requirements in a new or 

modified enforcement order, such as a section 8(b) cease-and-desist order. 

PCA Requires Regulators to 

Take Specific Actions When 

Capital Declines 

 33With one exception, section 38 does not place restrictions on institutions that are well 

capitalized or adequately capitalized. Namely, all institutions, regardless of their capital 

level, are prohibited from paying dividends or management fees that would drop them into 

the undercapitalized category. Further, section 301 of FDICIA amended section 29 of FDIA

(codified at 12 U.S.C. § 1831f) to allow adequately capitalized institutions to accept or 

renew brokered deposits only if they receive waivers from FDIC. (Brokered deposits are 

large-denomination deposits that a broker divides into smaller pieces to sell to multiple 

depository institutions on behalf of its customers.) Section 301 also imposes certain 

interest rate restrictions for brokered deposits accepted by institutions that are not well 

capitalized. 

34Any determination to take other action in lieu of receivership or conservatorship for a 

critically undercapitalized institution is effective for no more than 90 days. After the 90-day

period, the regulator must place the institution in receivership or conservatorship or make

a new determination to take other action. Each new determination is subject to the same 

90-day restriction. If the institution is critically undercapitalized, on average, during the

calendar quarter beginning 270 days after the date on which the institution first became 

critically undercapitalized, the regulator is required to appoint a receiver for the institution.

Section 38 contains an exception to this requirement, if, among other things, the regulator 

and chair of the FDIC Board of Directors both certify that the institution is viable and not

expected to fail.

Page 23 GAO-07-242 Deposit Insurance
Figure 5: Section 38 Mandatory and Discretionary Requirements 

Submit a capital restoration plan 

detailing, among other things, 

how the institution is going to 

become adequately capitalized.

Restrict asset growth during any 

quarter so that average total 

assets for the quarter do not 

exceed the preceding quarter’s

average total assets, unless

certain conditions are met. 

Receive prior regulatory 

approval for acquisitions, 

branching, and new lines of 

business.

Regulators are required to 

closely monitor the institution’s

condition and its compliance 

with section 38’s requirements.

Receive prior regulatory 

approval to pay bonuses or 

raises to senior executive 

officers of the institution.

Sell sufficient equity or debt to 

restore the institution’s capital to 

at least the minimum acceptable 

capital level or, under certain circumstances, be acquired by or 

merged with another institution. 

Restrict otherwise allowable 

transactions with affiliates.

Restrict the interest rates paid 

on deposits by the institution.

After an institution becomes

critically undercapitalized, the

regulator has a 90-day period in 

which it must either place the 

institution into receivership or, 

with FDIC’s consent, 

conservatorship. Alternatively, 

the regulator may take any other 

action that would better prevent 

or minimize long-term losses to 

the insurance fund provided 

FDIC concurs with its actions.

Receive approval from FDIC 

before making any payment of 

principal or interest on the 

institution’s subordinated debt 

beginning 60 days after it 

became critically 

undercapitalized.

Receive written approval from FDIC prior to any of the following:

• entering into any material transaction (such as investments, 

 expansions, acquisitions, and asset sales), other than in the usual 

 course of business;

• extending credit for any highly leveraged transaction;

• amending the institution’s charter or bylaws, except to the extent 

 necessary to carry out any other requirement of any law, regulation, 

 or order;

• making any material change in accounting methods;

• engaging in any covered transaction;

• paying excessive compensation or bonuses; or

• paying interest on new or renewed liabilities at a rate that would 

 increase the institution’s weighted average cost of funds to a level 

significantly exceeding the prevailing rates of interest on insured 

 deposits in the institution’s normal market area.

Undercapitalized

Significantly

undercapitalized

Critically

undercapitalized

Requirements

The regulator must impose one or more of the following actions on a significantly undercapitalized institution:

• Imposing more stringent asset growth limitations than required for undercapitalized institutions or requiring the institution to reduce its total 

assets.

• Requiring the institution, or its subsidiaries, to alter, reduce, or terminate an activity that the regulator determines poses excessive risk to the 

institution. 

• Improving management by (1) ordering a new election for the institution’s board of directors, (2) requiring the dismissal of directors or senior 

executive officers, and/or (3) requiring an institution to employ qualified senior executive officers.

• Prohibiting the acceptance, including renewal and rollover, of deposits from correspondent banks.

• Requiring prior Federal Reserve approval for capital distributions from any bank holding company having control of the institution.

• Requiring divestiture by (1) the institution of any subsidiary that the regulator determines poses a significant risk to the institution, (2) the 

parent company of any nondepository affiliate the parent company regulator determines poses a significant risk to the institution, and/or 

(3) any controlling company of the institution if the controlling company’s regulator determines that divestiture would improve the institution’s

financial condition and future prospects. 

• Requiring the institution to take any other action the regulator determines would better carry out the purposes of section 38.

Institution status

Mandatory for institutions Requirements for regulators Discretionary actions

Source: 12 C.F.R. Parts 308 and 325, September 29, 1992.

In addition to these requirements, a regulator may also impose any other discretionary action specific to significantly undercapitalized institutions to an 

undercapitalized institution.

Each of these steps is mandatory unless the regulator determines that taking such steps would not further the purpose of section 38 (that is, to resolve 

the problems of institutions at the least possible long-term loss to the insurance fund).

Page 24 GAO-07-242 Deposit Insurance
For the cases we reviewed, consistent with our 1996 report, we found that 

regulators generally implemented PCA in accordance with section 38, the 

implementing regulations, and their policies and procedures.35 Regulators 

used PCA to address capital problems at 18 of 24 institutions we sampled 

from among those that fell below one of the three lowest PCA capital 

thresholds (that is, undercapitalized, significantly undercapitalized, or 

critically undercapitalized based on Call or Thrift Financial Report data). 

(See table 3.) 

Regulators Used PCA 

Appropriately at the Banks and 

Thrifts We Reviewed 

Table 3: Sampled Institutions with PCA Taken to Address Capital Deficiencies 

Institution name Primary regulator PCA capital categorya

Pulaski Savings Bank FDIC Critically undercapitalized

Rock Hill Bank and Trust FDIC Critically undercapitalized

FDIC Open Bank 1 FDIC Significantly undercapitalized 

FDIC Open Bank 2 FDIC Significantly undercapitalized 

CIB Bank FDIC Undercapitalized 

Southern Pacific Bank FDIC Undercapitalized 

Deuel County State Bank Federal Reserve Critically undercapitalized

New Century Bank Federal Reserve Critically undercapitalized

Federal Reserve Open Bank 1 Federal Reserve Significantly undercapitalized 

Federal Reserve Open Bank 2 Federal Reserve Significantly undercapitalized 

Bank of Greenville Federal Reserve Undercapitalized 

Harbor Bank OCC Critically undercapitalized

Compubank OCC Significantly undercapitalized

First National Bank (Lubbock) OCC Undercapitalized 

Georgia Community Bank OTS Critically undercapitalized

OTS Open Thrift 1 OTS Significantly undercapitalized 

First Heights Bank FSB OTS Significantly undercapitalized 

Enterprise FSB OTS Undercapitalized 

Source: GAO analysis of Call and Thrift Financial Report data. 

 35GAO/GGD-97-18. Our 1996 report on the implementation of PCA found that regulators 

generally took prescribed enforcement actions under section 38, including obtaining and

reviewing capital restoration plans from undercapitalized institutions and closing critically 

undercapitalized institutions within the required 90-day time frame. 

Page 25 GAO-07-242 Deposit Insurance
a

We do not name institutions that are still active, but refer to them by regulator and number. We 

selected institutions for our sample randomly by regulator and by capital category (based on Call and 

Thrift Financial Report data) so that the numbers of institutions regulated by each of the regulators 

and numbers of institutions in each of the capital categories generally were equal. An institution’s 

capital category as listed in this table does not necessarily reflect the only capital category in which it 

appeared, based on Call or Thrift Financial Report data, during the period of our review (2001-2005); 

rather it represents the capital category from which it was selected for the sample. 

In each of the 18 cases in which regulators used PCA to address capital 

deficiencies, the relevant regulator identified the institution as having

fallen below one of the three lowest PCA capital thresholds and in most 

cases required the institution to address deficiencies through a capital 

restoration plan or a PCA directive or other enforcement order. 

Regulators’ use of PCA is illustrated by the following examples: 

• From the end of March 2002 to the end of June 2002, Rock Hill Bank and 

Trust’s capital level declined from well capitalized to critically

undercapitalized. In response, FDIC issued a notice informing the bank of

the restrictions applicable to critically undercapitalized institutions under 

section 38. Within approximately 2 months of first becoming critically

undercapitalized, the bank entered into a purchase and assumption 

agreement with another institution. 

• Federal Reserve examiners required Federal Reserve Open Bank 2 to 

submit a capital restoration plan more than a year and a half prior to the 

bank’s failure to meet minimum capital requirements. Federal Reserve 

examiners, prepared to issue a PCA directive when the bank’s capital fell

to significantly undercapitalized in March 2005, noted in a June 2005 

report of examination that the bank had taken steps to raise its capital 

level to undercapitalized, and then issued a PCA directive requiring the 

bank to submit a capital restoration plan. By September 2005, the bank

was well capitalized by PCA standards. 

• OCC examiners notified First National Bank (Lubbock) of its critically 

undercapitalized status shortly after the closing date of the bank’s June 30, 

2003, Call Report filing. In November 2003, the bank was sold to a bank

holding company and recapitalized. Concurrent with the bank’s June 30, 

2004, Call Report filing date, OCC conducted a full-scope examination and 

found the bank to be critically undercapitalized and directed it to file a 

capital restoration plan. The bank merged into an affiliate in early 2005, in

accordance with its capital restoration plan. 

• After Enterprise FSB’s capital level declined to undercapitalized in 

September 2001, OTS issued a PCA directive that required the institution 

to submit a capital restoration plan and make arrangements to sell or 

Page 26 GAO-07-242 Deposit Insurance
merge with another institution. On several occasions, OTS modified its 

original PCA directive to allow additional time to process the institution’s 

merger application. With the exception of one quarter in which Enterprise 

FSB’s capital level increased to well capitalized, the institution remained 

undercapitalized until the merger was completed in early 2003. 

Regulators said that PCA was most effective when it was used to close or

require the sale or merger of institutions as a means of minimizing or 

preventing losses to the insurance fund. Fifteen of the 18 institutions we 

reviewed were able to recapitalize or merged or closed without losses to 

the insurance fund. The remaining three institutions failed with losses to 

the insurance fund: Pulaski Savings Bank ($1 million), New Century Bank 

($5 million), and Southern Pacific Bank ($93 million). The failure of 

Southern Pacific Bank resulted in material losses to the insurance fund. In

its material loss review for the bank, the FDIC IG noted that even though

FDIC examiners applied PCA in accordance with regulatory guidelines, 

other factors, including the bank’s failure to abide by FDIC 

recommendations related to the administration of its loan program, 

resulted in an overstatement of both net income and capital and limited 

PCA’s effectiveness in minimizing losses to the insurance fund. In our 

review of FDIC’s reports of examination and other information for the 

bank, we found that FDIC examiners continually informed the bank of its

capital status and made repeated requests to management to recapitalize.

However, the bank’s reported capital level never fell to critically 

undercapitalized—the point at which FDIC has the authority to close an 

institution under section 38. 

In 6 of the 24 sampled cases we reviewed, we determined that use of PCA 

was not required to address declines in capital reported on quarterly Call

and Thrift Financial Reports (see table 4). 

Page 27 GAO-07-242 Deposit Insurance
Table 4: Sampled Institutions Where Use of PCA Was Not Required

Institution name Primary regulator Reason regulator did not use PCA to address decline in capital category 

First Bank of Texas FDIC First Bank of Texas was in the process of merging into another institution when it 

became undercapitalized for one quarter. The bank did not present any capital or 

supervisory concerns prior to its merger. 

Madison Bank Federal Reserve Madison Bank experienced an operating loss as a result of a pending merger, 

which caused it to become undercapitalized for one quarter. The loss and impact 

on capital were reported after the institution merged, thus Federal Reserve

examiners did not apply PCA. 

First National Bank of 

Springdale 

OCC First National Bank of Springdale became critically undercapitalized for one 

quarter that coincided with its merger into another institution. The bank presented 

no supervisory concerns at that time. 

Household Bank of 

Nevada

OCC Household Bank of Nevada was significantly undercapitalized on two occasions 

because it miscalculated capital ratio information. OCC officials told us that during 

this period, the bank had other safety and soundness weaknesses rather than 

capital problems. Therefore, OCC, in conjunction with FDIC and OTS, took steps 

to consolidate Household Bank and other subsidiaries of the bank’s parent 

company so that they could be acquired by another institution. 

Century Bank OCC Century Bank failed to meet the total risk-based capital requirement for only one 

quarter and only by a fraction of a percent (0.01 percent). The bank was 

otherwise well capitalized and did not have any other indicators that it was a 

troubled institution during this period. 

OTS Open Thrift 2 OTS OTS Open Thrift 2 was undergoing a reorganization that involved the issuance of 

stock. The issuance was oversubscribed, causing the thrift’s tier 1 leverage

capital to fall below the required minimum and appear as undercapitalized for one 

quarter. The thrift did not present any capital or supervisory concerns before or 

after the stock issuance. 

Source: GAO analysis of regulatory data. 

Regulators Used Other 

Enforcement Actions to 

Address Deficiencies in 

Sampled Institutions Prior 

to Declines in Their PCA 

Capital Categories 

Although PCA requires regulators to take regulatory action when an 

institution fails to meet established minimum capital requirements, capital 

is a lagging indicator and thus not necessarily a timely predictor of 

problems at banks and thrifts. Although capital is an essential and 

accepted measure of an institution’s financial health, it does not typically

begin to decline until an institution has experienced substantial 

deterioration in other areas, such as asset quality and the quality of bank 

management. As a result, regulatory actions focused solely on capital may 

have limited effects because of the extent of deterioration that may have

already occurred in other areas. All four regulators generally agreed that

by design, PCA is not a tool that can be used upon early recognition of an

institution’s troubled status—in all of the cases we examined, regulators

took steps, in addition to PCA, to address institutions’ troubled conditions. 

Page 28 GAO-07-242 Deposit Insurance
For example, 12 of the 18 banks and thrifts subject to PCA that we 

examined experienced a decline in their CAMELS ratings to composite 

ratings of 4 or 5 prior to or generally concurrent with becoming 

undercapitalized. CAMELS ratings measure an institution’s performance in 

six areas—capital, asset quality, management, earnings, liquidity, and 

sensitivity to market risk. These ratings are a key product of regulators’ 

on-site monitoring of institutions, providing information on the condition

and performance of banks and thrifts, and can be useful in predicting their 

failure. The FDIC IG found a similar trend among the banks it examined as

part of an evaluation of FDIC’s implementation of PCA.36

All of the 18 institutions we examined also appeared on at least one of 

three regulator watch lists—the FDIC problem institutions list, the FDIC 

resolution cases list, and the FDIC projected failure list—prior to or 

concurrent with becoming undercapitalized (see fig. 6).37 Regulators use 

these and their own watch lists to monitor the status of troubled 

institutions and, in some cases, ensure their timely resolution (that is, 

facilitating the merger or closure of institutions to prevent losses to the 

insurance fund); the lists were another means through which regulators 

monitored and addressed problems or potential problems at the 18 

institutions prior to declines in PCA capital categories. 

 36Federal Deposit Insurance Corporation Office of the Inspector General, The Role of 

Prompt Corrective Action as Part of the Enforcement Process, Audit Report No. 03-038

(Washington, D.C.: Sept. 12, 2003). 

37Institutions with CAMELS composite ratings of 4 or 5 are placed on the problem 

institutions list. When FDIC’s Division of Resolution and Receivership becomes involved in 

the resolution of any institution, it places that institution on the resolution cases list.

Institutions that are deemed likely to fail within 1 year are placed on the projected failure 

list. FDIC is responsible for maintaining each of the lists. Regulators also may maintain 

their own watch lists; however, we did not determine whether any of the institutions in our 

sample appeared on any of these lists. 

Page 29 GAO-07-242 Deposit Insurance
Figure 6: Institutions on Regulator Watch Lists

Source: GAO analysis of regulatory data.

FDIC

resolution cases list

FDIC problem

institutions list

FDIC projected

failure list

Pulaski Savings Bank

Rock Hill Bank and Trust

CIB Bank

Southern Pacific Bank

Deuel County State Bank

New Century Bank

Federal Reserve Open Bank 1

Federal Reserve Open Bank 2

First National Bank (Lubbock)

Georgia Community Bank

OTS Open Thrift 1

Compubank

Bank of Greenville

FDIC Open Bank 1

FDIC Open Bank 2

Harbor Bank

First Heights Bank

Consistent with banks and thrifts exhibiting declining CAMELS ratings and 

appearing on one or more watch lists prior to or concurrent with 

becoming undercapitalized, at least 15 of the 18 banks and thrifts that we 

reviewed had informal or formal enforcement actions in place prior to 

becoming undercapitalized.38 Although we did not examine the 

effectiveness of these prior actions in addressing deficiencies, the 

following examples illustrate the types and numbers of enforcement 

actions regulators took at some of the institutions in our sample.39

Although FDIC Open Bank 1 and FDIC examiners disagreed over the 

bank’s capital status, FDIC required the bank’s board of directors to 

execute a board resolution to address certain safety and soundness 

deficiencies identified as part of an examination (see fig. 7). When the 

 38Because we only examined enforcement-related documents for the four quarters prior to

when these institutions became undercapitalized or worse by PCA standards, the number 

of institutions with prior enforcement action actually may be greater than 15. 

39The enforcement actions detailed in the following examples may not represent all the

enforcement actions regulators took against these institutions because we only reviewed 

documents for the four quarters prior to the institutions becoming undercapitalized or 

worse. 

Page 30 GAO-07-242 Deposit Insurance
Page 31 GAO-07-242 Deposit Insurance 

bank failed to adequately address the identified deficiencies, FDIC issued 

a cease-and-desist order. 

Figure 7: Timeline of Enforcement Actions, FDIC Open Bank 1 

When New Century Bank opened in July 1999, the Federal Reserve, the 

state regulator, and FDIC all required the bank to maintain capital in 

excess of the PCA well-capitalized minimums to obtain a state charter and 

FDIC insurance (see fig. 8). Throughout its existence, the bank not only 

failed to maintain these capital levels, but also failed to remain adequately 

capitalized by PCA standards. The Federal Reserve attempted to address 

these capital and other safety and soundness deficiencies through PCA 

directives and other formal enforcement orders. When the bank proved 

incapable of maintaining minimum capital levels, the state regulator closed 

it and appointed FDIC as receiver. 

+ 2002

1/17/02: Board executes a board resolution to address deficiencies identified in 

3/31/2001 report of examination; FDIC cites concerns over the bank’s 

reporting and valuation of assets and determines that the bank is 

significantly undercapitalized 

3/2/02: Bank submits a capital restoration plan to FDIC

3/15/02: FDIC issues a notice of intent to issue a PCA directive and notifies the 

bank of intent to issue a cease-and-desist order addressing the bank’s 

unsafe and unsound practices 

3/18/02: Bank sends response to FDIC’s notice of intent to issue a PCA 

directive—response disputes FDIC’s assessment that the bank is 

significantly undercapitalized and appeals the issuance of a PCA 

directive

5/31/02: FDIC accepts the bank’s capital restoration plan

6/26/02: FDIC issues a notice of withdrawal of notice of intent to issue a PCA 

 directive based on the bank’s appeal and adequately capitalized status

1/17/02

6/26/02

+

Source: GAO analysis of regulatory data.

Bank significantly undercapitalized

Bank adequately capitalized
Figure 8: Timeline of Enforcement Actions, New Century Bank

1999

2000

2002

2001

7/1/99: Bank opened; state charter and FDIC deposit insurance are made 

contingent on the maintenance of specified capital levels

2/12/02: Federal Reserve rejects the bank’s proposed capital restoration plan

12/31/01: Federal Reserve sends the bank a notice of (PCA) capital category 

requiring the submission of a (new) capital restoration plan

3/6/02: Federal Reserve issues a second PCA directive

3/18/02: Bank appeals the issuance and terms of the PCA directive in federal 

court

3/28/02: State closes the bank and appoints FDIC as receiver

2/10/00: Federal Reserve issues first PCA directive 

7/13/00: Bank and Federal Reserve enter into a safety and soundness 

 written agreement containing safety and soundness and 

 maintenance of capital provisions

12/31/99

6/30/00

9/30/01

12/31/01

1/10/02

3/31/00

3/1/00 $

8/30/00 $

11/14/01

$

$

Source: GAO analysis of regulatory data.

Bank significantly undercapitalized

Bank critically undercapitalized

Capital injection

Bank undercapitalized

$

OCC examiners identified Compubank as posing serious safety and 

soundness concerns related to earnings when the bank was well 

capitalized by PCA standards (see fig. 9). The bank had high operating 

losses because of high overhead expenses caused by expanding operations

Page 32 GAO-07-242 Deposit Insurance
in anticipation of high growth. As a result, OCC required the bank to enter 

into a written agreement, which stipulated that the bank implement a 

capital restoration plan and develop a contingency plan to sell, merge, or 

liquidate. Five months later, the bank reported that it was critically 

undercapitalized by PCA standards. The bank began the self-liquidation 

process and closed in June 2002. 

Figure 9: Timeline of Enforcement Actions, Compubank

1/24/01: Bank and OCC enter into a formal agreement requiring the bank to 

 implement a capital restoration plan and a contingency plan to sell, 

 merge, or liquidate

2/22/01: OCC and FDIC officials meet with the bank’s board of directors to 

discuss resolution process

6/29/02: Bank self-liquidates and closes

6/30/01

9/30/01

12/31/01

12/31/00 +

3/31/01 +

+

Source: GAO analysis of regulatory data.

Bank critically undercapitalized

Bank well capitalized

2000

2001

2002

Approximately 5 months before Georgia Community Bank became 

undercapitalized, OTS and the institution entered into a supervisory 

agreement in response to regulator concerns about the institution’s asset 

quality and management (see fig. 10). When the institution reported it was 

significantly undercapitalized, OTS issued a PCA directive; however, the 

institution was unable to recapitalize and as a result, it merged into 

another institution in July 2005. 

Page 33 GAO-07-242 Deposit Insurance
Figure 10: Timeline of Enforcement Actions, Georgia Community Bank

2004

2005

4/26/04: Institution and OTS enter into a supervisory agreement to address

asset quality and management deficiencies and OTS requires the 

submission of a (new) capital restoration plan

9/30/04: OTS sends the institution a notice of (PCA) capital category requiring 

the submission of a capital restoration plan and imposing additional 

requirements

2/17/05: OTS issues a notice of intent to issue a PCA directive; the notice 

acknowledges that OTS and the institution have agreed that the only 

solution to the institution’s ongoing problem is for it to be acquired by 

or merged into another institution

3/1/05: OTS issues a PCA directive

4/4/05: OTS issues a notice of (PCA) capital category

7/1/05: Institution merges into another institution

9/30/04

6/30/05

12/31/04

3/31/05

Source: GAO analysis of regulatory data.

Institution significantly undercapitalized

Institution critically undercapitalized

Page 34 GAO-07-242 Deposit Insurance
We also reviewed material loss reviews of all institutions that failed with 

material losses to the insurance fund—losses that exceed $25 million or 2 

percent of an institution’s assets, whichever is greater—from 1992 through

2005 and in which regulators used PCA to address capital problems (see 

table 5).40 In 12 of these 14 cases, the relevant IG found that PCA was 

applied appropriately—meaning that when institutions failed to meet 

minimum capital requirements, regulators required that they submit 

capital restoration plans and adhere to restrictions and requirements in 

PCA directives or other enforcement orders. 

Most Material Loss 

Reviews Also Found 

Appropriate Use of PCA, 

but Some Reviews Found 

Regulators Could Have 

Used PCA Sooner 

Table 5: Institutions with Material Losses and PCA to Address Capital Adequacy, 

1992-2005 

Institution Regulator Year of failure 

Appropriate

use of PCA 

Bank of Harford FDIC 1994 Yes 

The Bank of San Pedro FDIC 1994 Yes 

Bank of Newport FDIC 1994 Yes 

First Trust Bank FDIC 1995 Yes 

Pacific Heritage Bank FDIC 1995 Yes 

BestBank FDIC 1998 Yes

Pacific Thrift and Loan Company FDIC 1999 Yes 

Connecticut Bank of Commerce FDIC 2002 Yes 

Pioneer Bank FRB 1994 Yes 

Mechanics National Bank OCC 1995 Yes 

First National Bank of Keystone OCC 1999 No 

Hamilton Bank OCC 2002 Yes 

NextBank OCC 2002 Yes

Superior Bank OTS 2001 No 

Source: GAO analysis of regulatory data. 

Regulators appropriate use of PCA in institutions that failed with material 

losses are demonstrated by the following examples: 

 40Since 1992, 19 banks and thrifts failed with material losses. We excluded 4 of these 

institutions from our review because they either did not suffer from capital deficiencies 

that required the use of PCA or because their capital deficiencies predated the 

implementation of FDICIA. In one case (Southern Pacific Bank), the bank was selected as 

part of our sample of 24 institutions. 

Page 35 GAO-07-242 Deposit Insurance
• According to the FDIC IG’s material loss review on Connecticut Bank of 

Commerce, FDIC used enforcement actions other than PCA directives to

address the bank’s capital and other problems. Connecticut Bank of 

Commerce experienced capital deficiencies from 1991 through 1996 as a 

result of its poor asset quality. The bank operated under several cease-anddesist orders (1991, 1993, and 2001) and a memorandum of understanding, 

each of which contained requirements that the bank hold capital in excess 

of the required PCA minimums. Upon the detection of fraud in April 2002,

the bank’s capital was immediately exhausted and it became critically

undercapitalized. On June 25, 2002, FDIC issued a PCA directive ordering 

the dismissal of the bank’s chairman and president. On June 26, 2002, the

Banking Commissioner for the State of Connecticut declared Connecticut

Bank of Commerce insolvent, ordered it closed, and appointed FDIC as 

receiver. 

• Prior to the implementation of legislation implementing PCA, Federal 

Reserve examiners attempted to restore Pioneer Bank to a safe and sound 

operating condition through written agreements entered into in 1986 and 

1991. Despite these enforcement actions, the bank’s condition continued 

to deteriorate and in June 1994, the Federal Reserve issued a PCA 

directive requiring Pioneer Bank to become adequately capitalized though 

the sale of stock or to be acquired by or merge into another institution. 

When the bank was unable to comply with the terms of the PCA directive, 

the California State Banking Department issued a capital impairment order 

on July 6, 1994, and closed the bank on July 8, 1994. In its material loss 

review of Pioneer Bank, the Federal Reserve IG concluded that the level of 

supervisory actions taken by the Federal Reserve was within the range of 

acceptable actions for the problems the bank experienced. 

• In October 2001, NextBank’s capital level dropped from well capitalized to

significantly undercapitalized based on findings from an examination 

conducted by OCC’s Special Supervision and Fraud Division. The 

Department of the Treasury (Treasury) IG noted in its material loss review 

that the bank was at that point automatically subject to restrictions under 

PCA. In November 2001, OCC issued a PCA directive requiring the bank,

among other things, to develop a capital restoration plan; file amended 

Call Reports; restrict new credit card account originations to prime 

lenders; and restrict asset growth, management fees, and brokered 

deposits. By December 2001, NextBank advised OCC that it would not be 

able to address its capital deficiency. In January 2002, NextBank and its 

parent company took steps to liquidate the bank. OCC appointed FDIC as 

receiver on February 7, 2002. While the Treasury IG did not find fault with 

OCC’s use of PCA to address NextBank’s capital deficiencies, it found that 

PCA’s effectiveness in NextBank’s situation was difficult to assess given 

Page 36 GAO-07-242 Deposit Insurance
the short amount of time that passed between when the bank’s capital 

declined below PCA minimum requirements and when the bank failed. 

In two cases, the relevant IG determined that the regulator’s use of PCA 

was not appropriate—First National Bank of Keystone (Keystone) and 

Superior Bank, regulated by OCC and OTS, respectively. In both cases, the 

Treasury IG found that the regulator failed to identify the institution’s true 

financial condition in a timely manner and thus could not apply PCA’s 

capital-based restrictions because the institution’s reported capital levels 

met or exceeded the minimum required levels. Because PCA was not 

implemented timely in these cases, it was not effective in containing losses 

to the deposit insurance fund.41

• According to the Treasury IG, Keystone’s operating strategy entailed 

growth into the high-risk areas of subprime lending and selling loans for 

securitization.42 The bank’s growth in these areas occurred without 

adequate management systems and controls, and inaccurate financial 

records masked the bank’s true financial condition. At the time of the 

bank’s failure, allegations of fraud were under investigation. In its material 

loss review of the bank, the IG noted that if OCC had reclassified the 

bank’s capital category from well capitalized to adequately capitalized 

following an examination in late 1997, OCC could have restricted the 

bank’s use of brokered deposits and applied certain interest-rate 

restrictions in an effort to curb the bank’s growth 6 months before its 

capital levels showed serious signs of decline. Instead, these restrictions 

were not put in place until June 1998 when OCC required the bank to 

adjust its reported capital based on examination findings—this adjustment 

resulted in a downgrade in the bank’s capital category from well 

capitalized to undercapitalized and trigged PCA restrictions. Despite this 

finding, the IG noted that it was unclear whether reclassification would 

have actually had its desired effect—after the restrictions were trigged in 

June 1998, the bank continued to intentionally violate them. 

 41The FDIC IG made similar findings in its report on the effectiveness of PCA in preventing

losses to the deposit insurance fund. See Federal Deposit Insurance Corporation Office of 

the Inspector General, The Effectiveness of Prompt Corrective Action Provisions in

Preventing or Reducing Losses to the Deposit Insurance Funds, Audit Report No. 02-013

(Washington, D.C.: Mar. 26, 2002). 

42Typically, subprime loans are for persons with poor or limited credit histories and carry a 

higher rate of interest than prime loans to compensate for increased credit risk. 

Securitization is the process of selling to investors (public or private) asset-backed 

securities that represent an interest in the cash flow generated by the loans.

Page 37 GAO-07-242 Deposit Insurance
• The Treasury IG’s material loss report on Superior Bank notes that while 

the immediate causes of the bank’s insolvency in 2001 appeared to be 

improper accounting and inflated valuations of residual assets, the causes

could be attributed to a confluence of factors going back as early as 1993, 

including asset concentration, rapid growth into a new high-risk activity,

deficient risk management systems, liberal underwriting of subprime 

loans, unreliable loan loss provisioning, economic factors affecting asset 

valuation, and lack of management response to supervisory concerns.43

Our 2002 testimony on the failure of Superior Bank and the IG’s material 

loss review suggested that had OTS acknowledged problems at Superior 

Bank when examiners became aware of them in 1993, PCA would have

been triggered sooner and might have slowed the bank’s growth and 

contained its losses to the deposit insurance fund.44 The IG further noted 

that OTS’s delayed detection of so many critical problems suggests that 

the advantage of PCA as an early intervention tool depends as much on 

timely supervisory detection of actual, if not developing, problems as it 

does on capital. 

Under section 38 regulators have the ability to reclassify an institution’s 

capital category and dismiss officers and directors from deteriorating 

banks and thrifts. However, regulators have made limited use of these 

authorities, preferring instead to use moral suasion (as part of or separate 

from the examination process) or other enforcement actions to address 

deficiencies. Under section 39, regulators can require institutions to 

implement plans to address deficiencies in their compliance with 

regulatory safety and soundness standards. Regulators have used section 

39 with varying frequency to address noncapital deficiencies; however, 

those that use the provision use it to address targeted deficiencies, such as 

noncompliance with certain laws or requirements, and when an 

institution’s management generally is willing and able to comply with 

required corrective actions. 

Regulators Have 

Made Limited and 

Targeted Use of the 

Noncapital 

Supervisory Actions 

Available under 

Sections 38 and 39 

 43Residual assets are assets remaining after sufficient assets are dedicated to meet all 

senior debtholders’ claims in full.

44GAO, Bank Regulation: Analysis of the Failure of Superior Bank, FSB, Hinsdale, 

Illinois, GAO-02-419T (Washington, D.C.: Feb. 7, 2002). 

Page 38 GAO-07-242 Deposit Insurance
In addition to their authority under PCA to reclassify an institution’s PCA 

capital category or require improvements in management at significantly 

undercapitalized institutions, regulators also can use other means—such 

as moral suasion or more formal enforcement actions—to address 

deficiencies or effect change at an institution. Under section 38(g), 

regulators have the authority to reclassify or downgrade an institution’s 

PCA capital category to apply PCA restrictions and requirements in 

advance of a decline (or further decline) in capital if the regulator 

determines that the institution is operating in an unsafe or unsound 

manner or engaging in an unsafe or unsound practice.45 Regulators also 

may treat an undercapitalized institution as if it were significantly 

undercapitalized if they determine that doing so is “necessary to carry out 

the purpose” of PCA. In practice, this means that regulators may, in certain 

circumstances, treat a well-capitalized institution as if it were adequately 

capitalized, an adequately capitalized institution as if it were 

undercapitalized, and an undercapitalized institution as if it were 

significantly undercapitalized. Regulators are prohibited from reclassifying 

or downgrading an institution more than one capital category and cannot 

downgrade a significantly undercapitalized institution to critically 

undercapitalized. Regulators also may require improvements in the 

management of a significantly undercapitalized institution—for example, 

through the dismissal of officers and directors. This provision can be used 

alone or in conjunction with the reclassification provision. In the latter 

case, a regulator can require the dismissal of officers and directors from 

an undercapitalized institution. 

All four regulators said that they generally prefer other means of 

addressing problems to PCA. According to the regulators, the authority to 

reclassify an institution’s capital category is of limited use on its own 

because regulators’ ability to address both noncapital (such as 

management) and capital deficiencies through other informal and formal 

enforcement actions prior to a decline in capital effectively negates the 

need to reclassify an institution to apply operating restrictions or 

requirements. Regulators’ use of section 38’s reclassification authority is 

consistent with their views on it—since 1992, FDIC, the Federal Reserve,

Regulators Prefer to Use 

Other Informal and Formal 

Enforcement Powers over 

PCA’s Reclassification and 

Dismissal Authorities 

 45FDIA does not define unsafe and unsound practice or condition—such determinations are 

to be made by the appropriate regulator based on the facts and circumstances of each case. 

For purposes of the cease-and-desist authority under section 8(b)(8) of FDIA, an institution 

with a less-than-satisfactory rating (CAMELS 3, 4, or 5) for asset quality, management, 

earnings, or liquidity may be deemed by the appropriate federal regulator to be engaging in 

an unsafe and unsound practice. 

Page 39 GAO-07-242 Deposit Insurance
and OTS have never reclassified an institution’s capital category. OCC has 

used the authority twice.

All four regulators said that section 38’s dismissal authority under section

38(f)(2)(F) is valuable as a deterrent and a potential tool, despite their 

infrequent use of it—FDIC has used the authority six times since 1992 and 

OCC once; the Federal Reserve and OTS have never used the authority. 

They said that the PCA authority occupies the middle ground between 

moral suasion and the removal and prohibition authority under section 

8(e) of FDIA. According to the regulators, the first step in confronting 

problem officers and directors is moral suasion—that is, reminding the 

board of directors that it has an obligation to ensure that the institution is 

competently managed. In many cases, we were told that this reminder 

often is enough to force the resignations of problem individuals.46

Dismissal under section 38 represents a “middle of the road” option—it 

results in a ban from serving as an officer or director in the institution in 

question. In order to be reinstated, the dismissed individual must 

demonstrate that he or she has the capacity to materially strengthen the

institution’s ability to become adequately capitalized or correct unsafe or 

unsound conditions or practices. Regulators also have a more severe 

option—removal under section 8(e), which results in an industrywide 

prohibition and consequently, requires proof of a high degree of 

misconduct or malfeasance.47 Data show that regulators have used section

8(e) with some regularity (see fig. 11). The regulators said that if an 

individual’s misconduct rises to the level required to support removal and 

 46Data were not available on the frequency with which regulators were able to informally 

persuade individuals to resign from institutions. 

47Under section 8(e) of FDIA, regulators must make three determinations to institute an 

action for removal or prohibition: misconduct, the effect of the misconduct, and the

individual’s culpability for the misconduct. Misconduct includes (1) violation of any law,

regulation, or final section 8(b) order; (2) violation of any condition imposed in writing by

the appropriate federal agency in connection with the grant of any application or other 

request by the institution; (3) violation of any written agreement between the institution 

and the appropriate federal agency; (4) engagement or participation in any unsafe or 

unsound practice; or (5) engagement in any act, omission, or practice that constitutes a 

breach of fiduciary duty. The regulator then must demonstrate that as a result of the

individual’s misconduct any of the following occurred: (1) the institution suffered or 

probably will suffer financial loss or other damage, (2) the interests of the institution’s 

depositors have been or could be prejudiced, or (3) the individual in question received 

financial gain or other benefit as a result of his or her conduct. To assess culpability,

regulators must determine whether the individual’s conduct involved personal dishonesty 

or demonstrated a willful or continuing disregard for the safety and soundness of the 

institution.

Page 40 GAO-07-242 Deposit Insurance
prohibition under section 8(e), use of that authority generally is preferable

to dismissal under section 38. 

Figure 11: Regulators Use of Section 8(e), 1992-2005 

The regulators also noted that moral suasion and section 8(e) are not 

necessarily capital based, meaning that both can be used at times when 

PCA cannot. The regulators acknowledged that section 38 permits them to 

reclassify an institution’s capital category to dismiss an officer or director; 

however, they said that because section 38 only allows them to dismiss 

individuals from institutions that are undercapitalized or worse by PCA 

standards, the tool generally is not available to them in these good 

economic times when all or most of the institutions they regulate are well 

capitalized. OCC was of the view that section 38’s dismissal authority 

could be more useful if it were uncoupled from capital and instead 

triggered by less-than-satisfactory ratings in the management component 

of the CAMELS rating. In particular, OCC officials said that linking the 

authority to the CAMELS rating could provide regulators with the 

authority to dismiss individuals who did not meet the criteria for removal 

and prohibition under section 8(e) and from institutions with boards that 

were unresponsive to regulators’ moral suasion. 

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Total

50

74

56

54

71

48

22

33

24

14

19

35

62

79

641

92

81

96

55

42

48

11

4

27

14

9

8

20

19

526

8

1

7

5

6

2

4

2

4

0

1

1

1

6

48

38

38

47

14

30

42

16

33

36

25

28

43

38

35

463

FDIC OTS OCC Federal Reserve

Source: GAO analysis of regulatory data.

Page 41 GAO-07-242 Deposit Insurance
Changes to section 39 in 1994 gave regulators considerable flexibility over 

how and when to use their authority under the section to address safety 

and soundness deficiencies at the institutions they regulate.48 Like section 

38’s dismissal authority, section 39 represents a “middle of the road” 

option between informal enforcement actions (such as a commitment 

letter) and formal enforcement actions (such as a cease-and-desist order). 

In varying degrees, they have used section 39 to address deficiencies in the 

three broad categories defined under the section: operations and 

management; compensation; and asset quality, earnings, and stock 

valuation (see fig. 12). Finally, regulators said that they prefer to use 

section 39 when regulators are certain that management is willing and able

to address identified deficiencies, even if management has not been 

responsive to informal regulatory criticisms in the past. For example, 

FDIC, OCC, and OTS have all used section 39 to require institutions to 

achieve compliance with Year 2000 (Y2K) or Bank Secrecy Act (BSA) 

requirements (both of which relate to institutions’ operations). 

Regulators Use Section 39 

to Address Targeted Safety 

and Soundness 

Deficiencies 

 48The Federal Reserve has established safety and soundness standards under section 39,

but has not used the enforcement mechanisms under the section to address deficiencies in 

favor of using other supervisory authorities. The following discussion about regulators use 

of section 39 is therefore limited to FDIC, OCC, and OTS. 

Page 42 GAO-07-242 Deposit Insurance
Figure 12: Regulators Use of Section 39, 1995-2005 

1

18

40

Total actions: 59

68%

31%

3% 2%

50

64

Total actions: 117

55%

43%

3

103

368

Total actions: 471

78%

22%

FDIC OCC OTS

Purpose not specified/other

Related to Y2K or BSA

Related to operations and management; compensation; or asset quality, earnings, or stock valuation

Source: GAO analysis of regulatory data.

Officials from the Federal Reserve told us that they use memorandums of 

understanding in the same way that the other three regulators use section 

39—that is, to address targeted deficiencies at institutions that are willing 

and able to make required changes.

According to the regulators, formal enforcement actions, such as section 

8(b) cease-and-desist orders or written agreements, are better reserved for 

institutions that have multiple or complex problems and in cases where 

management is unable to define what steps must be taken to address 

problems independent of the regulator or is unwilling to take action. Since 

1995 (the year regulators issued the section 39 guidelines), regulators have 

made frequent use of section 8(b) of FDIA to address problems associated 

with operations and management; compensation; and asset quality, 

earnings, and stock valuation. From 1995 through 2005, FDIC and the 

Federal Reserve issued 288 and 98 cease-and-desist orders or written 

Page 43 GAO-07-242 Deposit Insurance
agreements, respectively, to address deficiencies in these three areas. OTS

issued 47 cease-and-desist orders related to deficiencies in operations.49

Under authority provided by the Federal Deposit Insurance Reform Act of 

2005, FDIC now prices its deposit insurance more closely to the risk FDIC 

officials judge an individual bank or thrift presents to the insurance fund. 

To do this, FDIC has created a system in which it evaluates a number of 

financial and regulatory factors specific to an individual bank or thrift. 

This replaces a system that was also risk based, but which differentiated 

risk less finely. Industry officials and academics to whom we spoke and 

selected organizations that submitted comment letters to FDIC generally

supported the concept of the new system. However, several voiced

concern about what they saw as the new system’s subjectivity and 

complexity and questioned whether the new system might produce 

unintended consequences, including upsetting relations between bankers 

and their regulators. 

FDIC’s recent changes to the deposit insurance system more closely tie an

individual bank or thrift’s deposit insurance premium to the risk it 

presents to the insurance fund. In general, FDIC does this by considering 

three sets of factors—supervisory (CAMELS) ratings and financial ratios 

or credit agency ratings—while also distinguishing between large 

institutions with credit agency ratings and all other institutions. However, 

the system stops short of completely risk-based pricing. 

FDIC’s previous method for determining premiums relied on two factors—

capital levels and supervisory ratings—to determine institutions’ risk and 

premiums.50 FDIC established three capital groups—termed 1, 2, and 3 for 

well-capitalized, adequately capitalized, and undercapitalized institutions, 

FDIC Has More 

Tightly Linked 

Deposit Insurance 

Premiums to 

Institutional Risk, but 

Some Expressed 

Concerns about 

Certain Aspects of the 

New System 

Changes to FDIC’s Deposit 

Insurance System More 

Closely Tie Premiums to 

the Risk Institutions 

Present to the Deposit 

Insurance Fund, but Stop 

Short of Completely RiskBased Pricing 

Old System Relied on Two 

Factors to Determine Risk and 

Premiums 

 49OCC was unable to segregate orders covering operations and management;

compensation; and asset quality, earnings, and stock valuation from all cease-and-desist

orders issued over the period. According to data obtained from OCC’s Web site, the 

regulator issued 240 cease-and-desist orders from 1995 through 2005.

50See Assessments, 71 Fed. Reg. 69282, 69283-84 (2006). 

Page 44 GAO-07-242 Deposit Insurance
respectively—based on leverage ratios and risk-based capital ratios.51

Three supervisory groups—termed A, B, and C—reflected, respectively, 

financially sound institutions with only a few minor weaknesses; 

institutions with weaknesses, which if not corrected could result in 

significant deterioration and increased risk of loss to the insurance fund; 

and institutions that pose a substantial probability of loss to the insurance 

fund unless effective corrective action is taken. Based on its capital levels 

and supervisory ratings, an institution fell into one of nine risk categories 

(see table 6). However, the vast majority of institutions—95 percent at 

year-end 2005—fell into category 1A, even though, according to FDIC 

officials, there were significant differences among individual institutions’ 

risk profiles within the category. 

Table 6: Distribution of Institutions among Risk Categories in FDIC’s Previous

Deposit Insurance System, as of December 31, 2005 

Supervisory category

Capital group A B C

1: Well capitalized 1A

(8,358)

1B

(373)

1C

(50)

2: Adequately capitalized 2A

(54)

2B

(7)

2C

(1)

3: Undercapitalized 3A

(0)

3B

(0)

3C

(2)

Source: FDIC. 

Further, according to FDIC, in 2005, 95 percent of institutions did not pay 

premiums into the insurance fund because the agency was barred from 

charging premiums to well-managed and well-capitalized institutions when 

the deposit insurance fund was at or above its designated reserve ratio, 

and was expected to remain there.52 Because nearly all institutions paid 

 51These capital categories are different from the PCA capital categories discussed 

elsewhere in this report. Where PCA divides institutions into five capital categories, the

previous insurance system used three. 

52Deposit Insurance Funds Act of 1996, title II, subtitle G of Pub. L. No. 104-208, § 2708(c),

110 Stat. 3009, 3009-497 (1996) (codified at 12 U.S.C. § 1817(b)(2)(A)(v)). The repeal of 

section 1817(b)(2)(A)(v) was effective on January 1, 2007, the date that FDIC’s final 

regulations under Section 2109(a)(5) of the Federal Deposit Insurance Reform Act of 2005 

took effect. See Federal Deposit Insurance Reform Act of 2005, supra note 1, § 2104(e). The 

designated reserve ratio is the insurance fund’s reserve level, expressed as a fraction of 

total estimated insured deposits. 

Page 45 GAO-07-242 Deposit Insurance
the same rate under the old system, lower-risk institutions effectively 

subsidized higher-risk institutions.53

To tie institutions’ insurance premiums more directly to the risk each 

presents to the insurance fund, FDIC created a system that generally 

(1) differentiates between large and small institutions, specifically 

between institutions with current credit agency ratings and $10 billion or

more in assets and all other institutions; (2) for institutions without credit 

agency ratings, forecasts the likelihood of a decline in financial health

(referred to throughout this report as the general method); (3) for 

institutions with credit agency ratings, uses those ratings, plus potentially 

other financial market information, to evaluate institutional risk (referred 

to throughout this report as the large-institution method); and (4) requires 

all institutions to pay premiums based on their individual risk.

54

The New System Links Risk 

and Premiums More Closely 

Premiums under the general method and the large-institution method are 

calculated differently, based on the availability of relevant information for 

institutions in each category. The general method uses two sources of 

information as inputs to a statistical model designed to predict the 

probability of a downgrade in an institution’s CAMELS rating: (1) financial 

ratios (such as an institution’s capital, past-due loans, and income) and 

(2) CAMELS ratings. According to FDIC officials, little other information is 

readily available to assess risk for these institutions. However, FDIC data 

show that the higher on the CAMELS scale institutions are rated, the 

higher the rate of failure—the 5-year failure rate is 0.39 percent for 

CAMELS 1-rated banks, 3.84 percent for 3-rated banks, and 46.92 percent

for 5-rated banks—thus making CAMELS ratings and financial ratios a 

reasonable basis for assessing risk.55

The large-institution method also uses CAMELS ratings. But rather than 

employ financial ratios, it incorporates market-based information—credit

agency ratings of an institution’s debt offerings. FDIC officials told us that 

 53According to FDIC officials, although most institutions paid no premiums in recent years,

lower-risk institutions implicitly subsidized the premiums of higher-risk institutions—even 

when the premium rate charged to most institutions was zero, the activities of higher-risk 

institutions raised the chances of insurance fund losses and thus higher premiums for all 

institutions. 

54FDIC officials refer to the general method as the financial ratio method and the largeinstitution method as the debt rating method.

55These data are only for banks and do not include thrifts. Also excluded are failures in 

which fraud was determined to be a primary contributing factor. 

Page 46 GAO-07-242 Deposit Insurance
incorporating debt ratings provides a fuller, market-based picture of an 

institution’s condition than do financial ratios. For example, some large 

institutions concentrate in certain activities, such as transactions 

processing or credit cards, while others provide more general services. 

According to FDIC officials, financial ratios may not adequately 

distinguish among such different activities. Also, credit ratings determine 

how much institutions must pay to obtain funds in capital markets—wellrated banks and thrifts will pay less, while institutions the market judges 

as riskier will pay more. Thus, according to FDIC officials, it makes sense 

to align premiums with these market-based funding costs. In addition to its 

ability to use the CAMELS and credit ratings, FDIC also has the flexibility 

to adjust premiums for large institutions up to 0.5 basis points up or down 

based on other relevant information (such as market analyst reports, 

rating-agency watch lists, and rates paid on subordinated debt) as well as 

stress considerations (such as how an institution would be expected to 

react to a sudden and significant change in interest rates).56 If a large 

institution does not have an available credit agency rating, its premium is 

calculated according to the general method.57

The new insurance system places banks and thrifts into one of four risk 

categories, each of which has a corresponding premium or range of 

premiums. These “base rate” premiums range from 2 to 4 basis points for 

banks and thrifts in the best-rated category, risk category I, to 40 basis 

points for institutions in the bottom category, risk category IV (see table 

7).58 Thus, for example, under the base rate schedule the riskiest 

institutions (risk category IV) pay a premium rate 20 times greater than the 

best-rated banks and thrifts (minimum rate, risk category I). Even within 

the best category, riskier institutions pay twice the rate paid by the safest 

banks and thrifts, reducing the tendency for subsidies under the old 

 56Subordinated debt is repayable only after other debts with higher claim priority have been

satisfied. 

57According to FDIC, approximately 10 to 15 percent of the 120 institutions with assets of at 

least $10 billion do not have available credit agency ratings. As with large institutions with 

credit agency ratings, FDIC may use other financial market information to evaluate these 

institutions’ risk. 

58With some minor adjustments, premiums are assessed on total domestic deposits. 

Page 47 GAO-07-242 Deposit Insurance
system.59 The same premium schedule applies to all institutions, regardless 

of their premium assessment method. 

Table 7: Base Rate Premiums by Risk Category under FDIC’s New Deposit 

Insurance System 

Risk category

I II III IV

Annual base rate (premiums in basis points) Minimum – 2 

Maximum – 4 

7 25 40

Source: FDIC. 

Under the new system, FDIC has limited authority, without resorting to 

new rule making, to vary premiums from the base rates as necessary and 

appropriate. For assessments beginning in 2007, FDIC has used this 

flexibility to increase premiums by 3 basis points over the base rates. 

Thus, the current rate for risk category I is 5 to 7 basis points, rather than 2 

to 4 basis points; for risk category II, the premium is 10 basis points; for 

risk category III, the premium is 28 basis points; and for risk category IV, 

the premium is 43 basis points. According to FDIC, the increase in 

premiums for 2007 was necessary because of strong growth in insured 

deposits and the availability of premium credits to many institutions under 

the terms of the Federal Deposit Insurance Reform Act of 2005. 

In general, to set the premium rates for each of the four risk categories, 

FDIC officials told us they considered both what the differences should be

in premiums among risk categories and, taking those differences into 

account, the level at which the premiums should be established. 

Considering the two together, the goal was to create a schedule of rates 

with the best chance of maintaining the insurance fund with a designated

reserve ratio from 1.15 percent to 1.35 percent of insured deposits, with 

 59Section 2107(a) of the Federal Deposit Insurance Reform Act of 2005 amended section 

7(e)(3) of FDIA (codified at 12 U.S.C. § 1817(e)(3)) to require that FDIC’s Board provide by

regulation a onetime premium credit to eligible banks and thrifts to offset future premiums

based on certain previous payments into the deposit insurance fund. The aggregate amount

of funds available for such onetime credits is capped at the amount FDIC could have 

collected if it had imposed an assessment of 10.5 basis points on the combined assessment 

base of the Bank Insurance Fund and the Savings Association Insurance Fund as of 

December 31, 2001. FDIC has calculated this amount to be approximately $4.7 billion. See

One-Time Assessment Credit, 71 Fed. Reg. 61374, 61375 (2006) (final rule). While their 

credits are drawn down, some institutions will pay lower premiums; however, when the 

credits are exhausted, all institutions will be assessed full premiums.

Page 48 GAO-07-242 Deposit Insurance
Page 49 GAO-07-242 Deposit Insurance 

the former representing the required minimum under the Federal Deposit 

Insurance Reform Act of 2005, and the latter being the level at which 

mandated rebates of premiums to banks and thrifts must begin.60 FDIC 

officials told us they established the level of premiums based on four 

factors: (1) historical data on insurance losses, (2) FDIC operating 

expenses, (3) projected interest rates and their effect on FDIC investment 

portfolio income, and (4) expected growth of insured deposits.61

Although the new system ties premiums more specifically to the risk an 

individual institution presents to the insurance fund, it does not represent 

completely risk-based pricing. As a result, some degree of cross-subsidy 

still exists in the new system. In particular, as estimated by FDIC, 

institutions in risk category IV would need to pay premiums of about 100 

basis points to cover the expected losses of the group. However, FDIC has 

chosen to set the base rate premium for these banks and thrifts at 40 basis 

points, or 60 percent below the indicated premium. In doing so, FDIC 

officials told us they sought to address long-standing concerns of the 

industry, regulators, and others that premiums should not be set so high as 

to prevent an institution that is troubled and seeking to rebuild its health 

from doing so. In contrast, some have suggested that capping premiums to 

address such concerns ultimately may cost the insurance fund more in the 

long run—lower premiums for riskier institutions may allow them to 

remain open longer, resulting in greater losses if and when they eventually 

fail. FDIC officials said that the number of institutions in category IV is 

small and thus the trade-off between lower premiums for troubled 

institutions and potentially larger losses later is not significant. Further, 

they said that the 40 basis point base rate applicable to the highest risk 

institutions represents a sizable increase over the assessment rate for 

these institutions under the previous system. 

 60Federal Deposit Insurance Reform Act of 2005, §§ 2105 and 2107, 120 Stat. 14 and 16 

(2006). Section 2105 of the act amended section 7(b)(3) of FDIA to require FDIC to 

establish by regulation the insurance fund’s reserve level, known as the designated reserve 

ratio, within a range of 1.15 to 1.50 percent of insured deposits. If the reserve ratio exceeds 

1.35 percent, but is not more than 1.50 percent, FDIC generally must rebate to institutions 

half of any amount above 1.35 percent. If the reserve ratio exceeds 1.50 percent, FDIC must 

rebate all amounts in the fund above the 1.50 percent level. 

61FDIC omitted from design of its new system data on institutions insured by the former 

Federal Savings and Loan Insurance Corporation. FDIC officials told us they did so 

because the information was unavailable or deemed unreliable or unrepresentative. 

While Focusing More on Risk, 

the New System Stops Short of 

Completely Risk-Based Pricing 
Another way FDIC’s new premium pricing system stops short of being 

completely risk based is that it does not take into account “systemic risk.” 

In a fully risk-based system, premiums would be set to reflect two major 

components: expected losses plus a premium for systemwide risk of 

failure or default. According to academics we spoke to, FDIC’s new 

system reflects the first component, but not the second. Incorporating the 

notion of systemic risk into the premium calculation would acknowledge 

that failure of some banks could have repercussions to the financial 

system as a whole and that such failures are more likely during economic

downturns. FDIC officials told us that the new system does not reflect 

systemic risk for several reasons. First, there is an alternative mechanism 

for capturing what is effectively a systemic risk premium.62 Second, FDIC 

officials said that charging an up-front premium for systemic risk could 

prevent institutions from getting the best premium rate on the basis of 

their size, which is not permitted under the 2005 Federal Deposit 

Insurance Reform Act.63 And finally, FDIC officials said that FDIC has 

other sources of financing available to address losses resulting from largescale failures, including borrowing from the industry, a $30 billion line of 

credit with Treasury, and the ability to borrow from the Federal Financing 

Bank and the Federal Home Loan Bank system. 

 62Section 13 of FDIA (codified at 12 U.S.C. § 1823) authorizes FDIC to undertake various 

actions or provide assistance to a failing institution. FDIC is obligated to pursue a course of 

resolution that is the least costly to the insurance fund, except in cases involving systemic 

risk. 12 U.S.C. § 1823(c)(4). Under the “systemic risk” exception, if upon recommendation 

of FDIC’s Board of Directors and the Board of Governors of the Federal Reserve System (in 

each case by a two-thirds vote of the members of the boards), the Secretary of the 

Treasury, in consultation with the President, determines that pursuing the least costly 

alternative would have serious adverse effects on economic conditions or financial 

stability, then FDIC may take any action or provide any assistance authorized under

section 13 that would avoid or mitigate such adverse effects. In such cases, the loss to the 

insurance fund arising from such action or assistance is recaptured by special assessment 

on all insured institutions. This assessment effectively amounts to a systemic risk premium.

Because the assessment is not levied on insured deposits, but rather on nonsubordinated 

liabilities, the effect is to shift the burden to larger institutions—the institutions that pose 

the greatest systemic risks. 

63Section 2104(a)(2) of the Federal Deposit Insurance Reform Act (codified at 12 U.S.C. § 

1817(b)(2)(D)) specifically prohibits barring an institution from obtaining the lowest 

premium solely because of size. Pub. L. No. 109-171, 120 Stat. 12. Large institutions 

generally pose the greatest systemic risk, so according to FDIC officials, charging a 

systemic risk premium could effectively amount to a surcharge based on size, improperly 

disqualifying them from the lowest rate. 

Page 50 GAO-07-242 Deposit Insurance
In our review of selected comments to FDIC’s proposed rule and 

interviews with bankers, industry trade groups, and academics, we found 

that the industry generally supported the concept of a more risk-based 

insurance premium system.

64 However, several of those to whom we spoke 

and many organizations that submitted comments to FDIC raised several 

concerns about the new system. First, many said that the new system 

places too much weight on subjective factors, which could result in 

incorrect assessments of institutions’ actual risk. Specifically, officials 

from two trade associations and one small bank who we interviewed 

questioned the inclusion of, or the weight given to, the management 

component of the CAMELS ratings.65 One considered this component to be 

the most subjective of the CAMELS component areas. Six additional 

organizations noted in comment letters their concern with FDIC’s plan to 

assign different weights to the CAMELS components, noting in at least one 

case that FDIC had provided no evidence to support using a weighted 

rating in place of the composite rating. FDIC officials said that the weights 

were set in consultation with the other federal banking regulators and 

represent the relative importance of each component as it pertains to the 

risk an institution presents to the insurance fund. Specifically, FDIC 

officials said that asset quality, management, and capital are often key 

factors in an institution’s failure and any subsequent losses to the 

insurance fund, and thus warrant more consideration than other factors in 

the calculation of risk. 

Industry Officials and 

Academics Generally 

Support the New System, 

but Have Voiced Concerns 

about Certain Aspects 

Similarly, in comment letters to FDIC, five large banks, three trade groups,

and one financial services company expressed concern with the part of the 

rule that gives FDIC flexibility to adjust large institutions’ premiums up or 

down based on other information, including other market information and 

 64A majority of comments submitted to FDIC in response to its initial proposal for the new

insurance system addressed two issues: (1) the automatic assessment of de novo 

institutions at the ceiling rate (4 basis points under the base rate schedule) in Risk 

Category I and (2) the possible treatment of Federal Home Loan Bank advances as volatile 

liabilities. FDIC’s final rule relaxed treatment of de novo institutions and dropped volatile 

liabilities as a factor in the determination of premiums. Thirty-two organizations and 

individuals, including 6 we interviewed, provided comments to FDIC on issues and 

concerns with other aspects of FDIC’s deposit insurance system. The comments of these 

institutions are reflected in our discussion. 

65According to FDIC, CAMELS ratings capture information on an institution’s risk

management practices that is not otherwise reflected in premium calculations. Under the 

new system, FDIC generally will consider an institution’s ratings in each of the CAMELS 

components in determining risk. Each component will receive the following weight: C, 25 

percent; A, 20 percent; M, 25 percent; and E, L, and S, 10 percent each. 

Page 51 GAO-07-242 Deposit Insurance
financial performance and conditions measures (such as market analyst 

reports, assessments of the severity of potential losses, and stress factors). 

All of these organizations cautioned that to do so would undermine the 

assessments of institutions’ primary regulators regarding their 

performance and health (as expressed in CAMELS ratings, a primary 

component of FDIC’s system). According to FDIC, this authority to adjust 

ratings in consultation with other federal regulators is necessary to ensure 

consistency, fairness, and the consideration of all available information. 

FDIC officials said that the agency plans to clarify its processes for making 

any adjustments to ensure transparency and plans to propose and seek 

comments on additional guidelines for evaluating whether premium 

adjustments are warranted and the size of the adjustments. 

Related to these concerns, officials from one large bank, one small bank, 

and one trade association and one of the academics with whom we spoke 

said that FDIC’s new system is overly complicated and that it might not be 

readily apparent to bank or thrift management how activities at their 

respective institutions could affect the calculation of their insurance 

premiums. Seven others expressed similar concerns in comment letters to 

FDIC. In its final rule, FDIC stated that while the pricing method is 

complex, its application is straightforward. For example, if an institution’s 

capital declines, its premium will likely increase. Further, FDIC officials 

said that the FDIC Web site contains a rate calculator that allows an 

institution to determine its premium and to simulate how a change in the 

value of debt ratings, supervisory ratings, or financial ratios would affect

its premium.

Officials we interviewed from all three of the large banks said that the 

level and range of premiums for top-rated institutions generally was too 

high, given the actual risk they believe their institutions pose to the 

insurance fund. Officials from one large bank and one trade association 

we spoke with said that the best-rated banks and thrifts should pay no 

premiums, or that the base rate range of premiums should be reduced

from 2 to 4 to 1 to 3 basis points. An additional nine organizations 

supported similar changes in their comment letters. Risk category I, the 

top-rated premium category, accounts for the majority of total deposits, 

meaning that even small changes in premium assessment rates could 

produce a significant difference in revenue to the insurance fund, and 

hence assessments to the industry. FDIC officials said that the 2 to 4 basis 

point spread is more likely to satisfy the insurance fund’s long-term 

revenue needs than a 1 to 3 basis point spread. FDIC officials also said that 

FDIC could, based on authority in the final rule, reduce rates below the 

Page 52 GAO-07-242 Deposit Insurance
current base rate “floor” of 2 to 4 basis points if the agency determined 

that such a reduction was warranted. 

Further, one bank official we spoke to said that the new system was 

incorrectly based in the idea of institutions failing, rather than on the more 

nuanced notion of actual losses expected to be suffered by the deposit 

insurance fund if failures occurred. As a result, he said, FDIC failed to give 

appropriate credit to how large banks handle risk. Three organizations 

that submitted comments on FDIC’s new system supported this notion, 

saying that FDIC should not assess premiums on all domestic deposits 

because losses suffered by uninsured depositors should impose no burden 

on the insurance fund—the magnitude of any loss would be lessened to 

the extent that depositors in foreign branches, other uninsured depositors, 

general creditors, and holders of subordinated debt absorbed such losses.66

FDIC officials, citing research the agency has done on failures and losses, 

said that the differences in rates and categories were empirically based, 

and thus adequately reflected all institutions’ risk. Further, FDIC officials 

said that loss severity is one of the many factors the agency is permitted to 

consider as part of its assessment of the risk of large institutions. 

Officials from the two small banks, one large bank, and both industry 

trade groups and the academics with whom we spoke questioned FDIC’s 

choice on initial placement of institutions into risk categories. Because 

most institutions are now healthy, FDIC placed them into the best-rated 

premium category, risk category I, for which base rate premium charges 

range from 2 to 4 basis points. Within this top-rated category, FDIC 

initially assigned approximately 45 percent of institutions to receive the 

minimum rate of 2 basis points, and 5 percent of institutions to receive the 

highest rate of 4 basis points. The remainder fell in the middle of the range. 

These officials and academics generally agreed that FDIC should establish 

risk criteria, and then assign institutions to appropriate groups based on 

those criteria, rather than start with a predetermined distribution in mind. 

Three additional organizations expressed similar concerns in comment 

letters to FDIC. Further, officials from the other two large banks with 

whom we spoke said that given the economic good times and institutional 

good health, the 45 percent of institutions with the lowest rate was too 

small a grouping and, as a result, healthy institutions arbitrarily would be 

bumped into higher premiums. FDIC officials said that based on the 

 66FDIC officials said that such changes were not within the scope of this redesign of the

deposit insurance system. 

Page 53 GAO-07-242 Deposit Insurance
agency’s experience, a range of 40 to 50 percent appeared to be a natural

breaking point in the distribution of institutions by risk, and that over 

time, the percentage of institutions assigned the lowest premium in the 

top-rated category may vary. 

Some also thought the new system had the potential to create tension or 

discourage cooperative relations between bank management and federal

examiners. Under the old system, there was no difference in premiums for 

well-capitalized, 1-rated institutions and well-capitalized 2-rated 

institutions. However, under the new system, such a difference could lead 

to higher premiums because CAMELS ratings are factored into premium 

calculations. As a result, according to officials we interviewed from one 

trade group, management might be less willing to discuss with examiners 

issues or problems that could prompt a lower rating, although raising and 

resolving such problems ultimately might be good for both the institution 

and the insurance fund. FDIC officials acknowledged the concern, and 

said that FDIC and the other federal regulators plan to monitor the new 

system for adverse effects. However, they said that it was important to 

include CAMELS ratings in the assessment of risk because the ratings 

provide valuable information about institutions’ financial and operational 

health. 

Finally, officials from one trade association and one of the large banks 

with whom we spoke also expressed concern that regional or smaller 

institutions could be disadvantaged under the new system. Officials from 

two credit rating agencies echoed this view, saying that larger, more 

diverse institutions (by virtue of factors such as revenue, geography, or 

range of activities) typically have steadier income, which increases 

security and decreases risk. In contrast, regional or smaller institutions 

can have geographic or line-of-business concentrations in their lending 

portfolios that could hurt supervisory or credit ratings, leading to higher 

deposit insurance premiums. FDIC said that while size or geography could 

affect an institution’s risk profile, management could offset that risk by 

maintaining superior earnings or capital reserves, requiring higher 

collateral requirements on loans, or using hedging vehicles. 

FDIC officials told us that the agency plans to monitor the new deposit 

insurance system to ensure its proper functioning and the fair treatment of 

the institutions that pay premiums into the deposit insurance fund. For 

example, in addition to assessing whether the new system creates friction

between examiners and bank and thrift management, as discussed above, 

FDIC officials also said that the agency will, among other things, assess 

over time whether the percentage of institutions paying the lowest rate in 

Page 54 GAO-07-242 Deposit Insurance
risk category I—those receiving the best premium rate—should be 

increased and whether different financial ratios should be considered in 

the calculation of premiums. 

We provided FDIC, the Federal Reserve, OCC, and OTS with a draft of this

report for their review and comment. In written comments, the Federal 

Reserve concurred with our findings related to PCA. These comments are 

reprinted in appendix II. The Federal Reserve noted that PCA has 

substantively enhanced the agency’s authority to resolve serious problems 

expeditiously and that PCA has generally worked effectively in the 

problem situations where its use became applicable. In addition, FDIC, the 

Federal Reserve, and OCC provided technical comments, which we 

incorporated as appropriate. 

We are sending copies of this report to the Chairmen of the Federal 

Deposit Insurance Corporation and the Board of Governors of the Federal

Reserve System, the Comptroller of the Currency, the Director of the 

Office of Thrift Supervision, and interested congressional committees. We

will also make copies available to others upon request. In addition, the 

report will be available at no charge on the GAO Web site at 

http://www.gao.gov. 

Agency Comments 

If you or your staff have any questions concerning this report, please 

contact me at (202) 512-8678 or at jonesy@gao.gov. Contact points for our 

Offices of Congressional Relations and Public Affairs may be found on the 

last page of this report. Key contributors to this report are listed in 

appendix III. 

Yvonne D. Jones 

Director, Financial Markets 

 and Community Investment 

Page 55 GAO-07-242 Deposit Insurance
Appendix I: Objectives, Scope, and Appendix I: Objectives, Scope, and Methodology 

Methodology 

The objectives of this report were to (1) describe trends in the financial 

condition of banks and thrifts and federal regulators’ oversight of these 

institutions since the passage of the Federal Deposit Insurance 

Corporation Improvement Act of 1991 (FDICIA), (2) evaluate how federal 

regulators used the capital or prompt corrective action (PCA) provisions 

of FDICIA to resolve capital adequacy issues at the institutions they 

regulate, (3) evaluate the extent to which federal regulators use the 

noncapital provisions of FDICIA to identify and address weaknesses at the 

institutions they regulate, and (4) describe the Federal Deposit Insurance 

Corporation’s (FDIC) deposit insurance system and how recent changes to 

the system affect the determination of depository institutions’ risk and 

insurance premiums. Our review focused on FDIC, the Board of 

Governors of the Federal Reserve System (Federal Reserve), the Office of 

the Comptroller of the Currency (OCC), and the Office of Thrift 

Supervision (OTS) and was limited to depository institutions. 

To describe trends in the financial condition of banks and thrifts, we 

summarized financial data (including total assets, net income, returns on 

assets, returns on equity, the number of problem institutions, and the 

number of bank and thrift failures) from 1992, the year FDICIA was 

implemented, through 2005. We obtained this information from FDIC 

Quarterly Banking Reports, which publish industry statistics derived from

Reports on Condition and Income (Call Report) and Thrift Financial 

Reports. All banks and thrifts must file Call Reports and Thrift Financial

Reports, respectively, with FDIC every quarter. We also analyzed Call and 

Thrift Financial Report data for 1992 through 2005 that FDIC provided to 

determine (1) the number of well-capitalized, adequately capitalized, 

undercapitalized, significantly capitalized, and critically undercapitalized 

depository institutions from 1992 through 2005 and (2) the amount of 

capital well-capitalized banks and thrifts carried in excess of the wellcapitalized leverage capital minimum for each year from 1992 through 

2005.

1

 We chose to use Call and Thrift Financial Report data because the 

data are designed to provide information on all federally insured 

depository institutions’ financial condition, and FDIC collects and reports 

the data in a standardized format. We have tested the reliability of FDIC’s 

Call and Thrift Financial Report databases as part of previous studies and 

 1

Leverage capital is tier 1 capital computed without risk weights and in most cases closely 

matches an institution’s reported tangible equity. If an institution’s tangible equity is 2 

percent or less, it is considered critically undercapitalized for PCA purposes. 

Page 56 GAO-07-242 Deposit Insurance
Appendix I: Objectives, Scope, and 

Methodology 

found the data to be reliable.2 In addition, we performed various electronic 

tests of the specific data extraction we obtained from FDIC and 

interviewed FDIC officials responsible for providing the data to us. Based 

on the results of these tests and the information we obtained from FDIC 

officials, we found these data to be sufficiently reliable for purposes of this 

report. 

To describe federal regulators’ oversight of banks and thrifts since the 

passage of FDICIA, we reviewed the provisions of the Federal Deposit 

Insurance Act (FDIA) requiring regulators to conduct annual, on-site, fullscope examinations of depository institutions as well as several GAO and 

industry reports discussing the federal regulators’ oversight of depository 

institutions prior to the failures of the 1980s and early 1990s and after the

enactment of FDICIA, including their use of PCA to address capital 

deficiencies.3

 We also obtained data from each of the four federal 

regulators on the interval between examinations for each year, from 1992 

through 2005. We interviewed officials from FDIC, the Federal Reserve, 

OCC, and OTS to assess the reliability of these data. Based on their 

responses to our questions, we determined these data to be reliable for 

purposes of this report. 

To determine how federal regulators used PCA to address capital 

adequacy issues at the institutions they regulate, we reviewed section 38 of

FDIA, related regulations, regulators’ policies and procedures, and past 

GAO reports on PCA to determine the actions regulators are required to 

take when institutions fail to meet minimum capital requirements.4

 We 

then analyzed Call and Thrift Financial Report data to identify all banks 

 2

For example, see GAO, Industrial Loan Corporations: Recent Asset Growth and 

Commercial Interest Highlight Differences in Regulatory Authority, GAO-05-621 

(Washington, D.C.: Sept. 15, 2005), 87. In addition, we confirmed that no significant 

changes occurred to the way in which banks and thrifts report information on their 

financial condition and how FDIC maintains the data since the release of this report. 

3

Pub. L. No. 102-242 § 111(a), 105 Stat. 2236, 2240 (1991) (codified as amended at 12 U.S.C. 

§ 1820(d)). GAO, Bank Supervision: Prompt and Forceful Regulatory Actions Needed, 

GAO/GGD-91-69 (Washington, D.C.: Apr. 16, 1991); GAO, Bank and Thrift Regulation: 

Implementation of FDICIA’s Prompt Regulatory Action Provisions, GAO/GGD-97-18 

(Washington, D.C.: Nov. 21, 1996); Federal Deposit Insurance Corporation Office of the

Inspector General, The Role of Prompt Corrective Action as Part of the Enforcement 

Process, Audit Report No. 03-038 (Washington, D.C.: Sept. 12, 2003); and Federal Deposit 

Insurance Corporation, History of the Eighties—Lessons for the Future (Washington,

D.C.: 1997). 

4

GAO/GGD-91-69 and GAO/GGD-97-18. 

Page 57 GAO-07-242 Deposit Insurance
Appendix I: Objectives, Scope, and 

Methodology 

and thrifts that were undercapitalized, significantly undercapitalized, or 

critically undercapitalized (the three lowest PCA capital categories) during 

at least one quarter from 2001 through 2005. We chose this period for 

review based on the availability of examination- and enforcement-related 

documents and to reflect the regulators’ most current policies and 

procedures. From the 157 institutions we identified as being 

undercapitalized or lower from 2001 to 2005, we selected a nonprobablity 

sample of 24 institutions, reflecting a mix of institutions supervised by 

each of the four regulators and institutions in each of the three lowest PCA 

capital categories. We reviewed their reports of examination, informal and 

formal enforcement actions, and institution-regulator correspondence for 

a period covering four quarters prior to and four quarters following the 

first and last quarters in which each institution failed to meet minimum 

capital requirements to determine how regulators used PCA to address 

their capital deficiencies. As discussed above, we have tested the 

reliability of Call and Thrift Financial Report data and found the data to be 

reliable. To supplement our sample, we also reviewed material loss 

reviews from 14 banks and thrifts that failed with material losses from

1992 through 2005 and in which regulators used PCA to address capital 

deficiencies.5

 Because of the limited nature of our sample, we were unable

to generalize our findings to all institutions that were or should have been 

subject to PCA since 1992. 

To determine the extent to which federal regulators have used the 

noncapital supervisory actions of sections 38 and 39 of FDIA to address 

weaknesses at the institutions they regulate, we reviewed regulators’ 

policies and procedures related to sections 38(f)(2)(F) and 38(g)—the 

provisions for dismissal of officers and directors and reclassification of a 

capital category, respectively—and section 39, which gives regulators 

authority to address safety and soundness deficiencies. We analyzed 

regulator data on the number of times and for what purposes the 

regulators used these noncapital authorities. To provide context on the 

extent of regulators’ use of these noncapital provisions, we also obtained 

data on the number of times regulators used their authority under section 

8(e) of FDIA to remove officers and directors from office and section 8(b)

 5

Section 38(k) of FDIA requires the federal regulators’ respective inspectors general to 

issue reports on each depository institution whose failure results in a “material loss”—

losses that exceed $25 million or 2 percent of an institution’s assets, whichever is greater—

to the insurance fund. These material loss reports must assess why the institution’s failure

resulted in a material loss and make recommendations for preventing such losses in the 

future. 

Page 58 GAO-07-242 Deposit Insurance
Appendix I: Objectives, Scope, and 

Methodology 

of FDIA to enforce compliance with safety and soundness standards. 

Based on regulators’ responses to our questions related to these data, we 

determined the data to be reliable for purposes of this report. 

Finally, to describe how changes in FDIC’s deposit insurance system affect

the determination of institutions’ risk and insurance premiums, we 

reviewed FDIC’s notice of proposed rule making on deposit insurance 

assessments, selected comments to the proposed rule, and FDIC’s final 

rule on deposit insurance assessments.6

 We also interviewed 

representatives of three large institutions, two small institutions, and two 

trade groups representing large and small institutions and two academics 

to obtain their views on the impact of FDIC’s changes to the system. We 

selected the large institutions based on geographic location and size and 

the small institutions based on input from the Independent Community 

Bankers Association on which of its member organizations were familiar 

with FDIC’s proposed changes to the deposit insurance system. We also 

interviewed officials from two credit rating agencies on the factors—

financial, management, and operational—they consider when rating 

institutions’ debt offerings. 

We conducted our work in Washington, D.C., and Chicago from March 

2006 through January 2007 in accordance with generally accepted 

government auditing standards. 

 6

Federal Deposit Insurance Corporation—Assessments, 71 Fed. Reg. 41910 (2006) 

(proposed rule). Comments to the proposed rule making were due on September 22, 2006.

Federal Deposit Insurance Corporation—Assessments, 71 Fed. Reg. 69282 (2006) (final rule 

codified at 12 C.F.R. pt. 327.9, 327.10 and Appendixes A, B, and C of Subpart A). 

Page 59 GAO-07-242 Deposit Insurance
Appendix II: Comments from the Board of Governors of the Federal Reserve System

Page 60 GAO-07-242

Appendix II: Comments from the Board of 

Governors of the Federal Reserve System 

Deposit Insurance
Appendix II: Comments from the Board of Governors of the Federal Reserve System

Page 61 GAO-07-242 Deposit Insurance
Appendix III: GAO

A

 Contact and Staff 

cknowledgments 

Page 62 GAO-07-242

Appendix III: GAO Contact and Staff 

Acknowledgments 

Yvonne D. Jones, (202) 512-8678 or jonesy@gao.gov

In addition to the contact named above, Kay Kuhlman, Assistant Director; 

Gloria Hernandez-Saunders; Wil Holloway; Tiffani Humble; Bettye 

Massenburg; Marc Molino; Carl Ramirez; Omyra Ramsingh; Barbara 

Roesmann; Cory Roman; and Christopher Schmitt made key contributions 

to this report. 

Deposit Insurance

GAO Contact 

Acknowledgments 

(250289) 
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