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S. HRG. 112–172 

ENHANCING SAFETY AND SOUNDNESS: LESSONS 

LEARNED AND OPPORTUNITIES FOR CONTINUED IMPROVEMENT 

HEARING 

BEFORE THE

SUBCOMMITTEE ON 

FINANCIAL INSTITUTIONS AND CONSUMER 

PROTECTION 

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED TWELFTH CONGRESS 

FIRST SESSION 

ON 

EXAMINING OPPORTUNITIES FOR CONTINUED IMPROVEMENT IN THE 

SAFETY AND SOUNDNESS OF OUR BANKING SYSTEM 

JUNE 15, 2011 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: http://www.fdsys.gov/ 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

TIM JOHNSON, South Dakota, Chairman 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

KAY HAGAN, North Carolina 

RICHARD C. SHELBY, Alabama 

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

ROGER F. WICKER, Mississippi 

DWIGHT FETTIG, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director 

DAWN RATLIFF, Chief Clerk 

LEVON BAGRAMIAN, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND CONSUMER PROTECTION

SHERROD BROWN, Ohio, Chairman 

BOB CORKER, Tennessee, Ranking Republican Member 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

JEFF MERKLEY, Oregon 

KAY HAGAN, North Carolina 

JERRY MORAN, Kansas 

MIKE CRAPO, Idaho 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

GRAHAM STEELE, Subcommittee Staff Director 

MICHAEL BRIGHT, Republican Subcommittee Staff Director 

(II)

C O N T E N T S 

WEDNESDAY, JUNE 15, 2011 

Page 

Opening statement of Chairman Brown ................................................................ 1 

Opening statements, comments, or prepared statements of: 

Senator Corker .................................................................................................. 2 

WITNESSES 

Michael R. Foley, Senior Associate Director, Division of Banking Supervision 

and Regulation, Board of Governors of the Federal Reserve System .............. 4 

Prepared statement .......................................................................................... 31 

Responses to written questions of: 

Senator Reed .............................................................................................. 59 

Senator Merkley ........................................................................................ 59 

Christopher J. Spoth, Senior Deputy Director, Division of Risk Management 

Supervision, Federal Deposit Insurance Corporation ....................................... 6 

Prepared statement .......................................................................................... 34 

David K. Wilson, Deputy Comptroller, Credit and Market Risk, Office of 

the Comptroller of the Currency ......................................................................... 8 

Prepared statement .......................................................................................... 39 

Responses to written questions of: 

Chairman Brown ....................................................................................... 61 

Senator Reed .............................................................................................. 63 

Senator Merkley ........................................................................................ 64 

Salvatore Marranca, Director, President, and Chief Executive Officer, 

Cattraugus County Bank, Little Valley, New York .......................................... 19 

Prepared statement .......................................................................................... 52 

Frank A. Suellentrop, Chairman and President, Legacy Bank, Colwich, 

Kansas ................................................................................................................... 21 

Prepared statement .......................................................................................... 56 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Statement submitted by the American Bankers Association ............................... 68 

(III)

(1) 

ENHANCING SAFETY AND SOUNDNESS: LESSONS LEARNED AND OPPORTUNITIES FOR 

CONTINUED IMPROVEMENT 

WEDNESDAY, JUNE 15, 2011 

U.S. SENATE, 

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND

CONSUMER PROTECTION, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Subcommittee met at 10:04 a.m., in room SD–538, Dirksen 

Senate Office Building, Hon. Sherrod Brown, Chairman of the Subcommittee, presiding. 

OPENING STATEMENT OF CHAIRMAN SHERROD BROWN 

Chairman BROWN. The Subcommittee on Financial Institutions 

and Consumer Protection will come to order. I will do a brief opening statement, call on the Ranking Member, Senator Corker from 

Tennessee, and then I think Senator Reed and I believe Senator 

Moran will be here for opening statements, and Senator Moran 

wants to introduce somebody in the second panel. 

From 1999 to 2007, Wall Street in many ways was a big party 

without adult supervision. Mortgage originators, investors, and investment banks all made money. Large megabanks made lots and 

lots of money. Citigroup’s CEO, Chuck Prince, famously asked 

Treasury Secretary Hank Paulson, ‘‘Isn’t there something you can 

do to order us not to take all of these risks?’’ The answer was, ‘‘Yes, 

but no one did.’’ And so Prince concluded, ‘‘As long as the music 

is playing, you have got to get up and dance.’’ 

As a former Fed Chairman once said, ‘‘The Fed’s job is to take 

away the punch bowl just as the party gets going.’’ So where were 

the regulators? One Fed supervisor told the Financial Crisis Inquiry Commission, ‘‘Citigroup was earning $4 to $5 billion a quarter. When that kind of money is flowing out quarter after quarter, 

it is very hard to challenge.’’ 

While the securitization machine was in full swing, Wall Street 

basically wrote its own rules. Banking regulators relied on Wall 

Street’s own internal risk models and allowed the banks to hold no 

capital buffer against their subprime securities while these securities were rubber-stamped as AAA by the rating agencies. The 

OCC’s head of large bank supervision has acknowledged that they 

did not have enough information about market risk and failed to 

intervene before the crisis. 

2 

According to a 2009 evaluation, the New York Fed’s supervision 

of Citigroup ‘‘lacked a disciplined and proactive approach in assessing and validating actions taken by the firm to address supervisory 

issues.’’ 

The former head of the Office of Thrift Supervision compared its 

ability to regulate AIG to that of a gnat on an elephant. With supervision like this, the party was sure to end in financial disaster. 

Now there is a constant drumbeat on Wall Street and in Washington that focusing on safe and sound financial practices will hold 

back our economic recovery. Wall Street and my conservative colleagues in Washington have a bad case of amnesia. They have forgotten that poor safety and soundness oversight helped push us toward a fiscal crisis and a disaster in our economy. The Congressional Budget Office projects the financial crisis will increase Federal debt held by the private sector by 40 percent of GDP. Standard 

& Poor’s estimates that another financial sector bailout could have 

up-front costs as high as $5 trillion. 

These are not the only costs. We know home prices have fallen 

by more than they did during the Depression; 28 percent of homeowners are currently underwater, owing more on their house than 

their house is worth. Reports of foreclosure fraud and mortgagebacked security failures are all too commonplace. 

Lax supervision also makes it harder to hold wrongdoers accountable because law enforcement agencies rely only on referrals 

too often only from bank regulators. As the New York Times noted 

in April, the Office of Thrift Supervision has not referred a single 

case to the Justice Department since 2000 and the OCC has referred only three. When laws can be ignored, then property can be 

taken from its rightful owners, homeowners and investors, and 

given to servicers and originators. A safe and sound banking system should attract capital from investors and provide it to borrowers to finance productive economic activity. 

Guided by clear-cut, sensible rules, our banking system for over 

five decades has been a model of safety and security for the world, 

yet it is clear that we forgot the lessons learned in prior bank crises at home and abroad that an unsafe and unsound banking system destroys wealth and drains resources from the rest of the economy. I am afraid that American families and investors, simply put, 

have lost faith in our financial system. 

So my question to the witnesses is: What are you doing—and 

those questions will be more specific from all of us after statements 

from us and you. What are you doing to restore Main Street’s confidence? What have you learned about sound bank regulation? How 

has your approach changed? And what is being done right now before all the provisions of Dodd-Frank take effect to prevent another 

collapse of our banking system? 

Senator Corker. 

STATEMENT OF SENATOR BOB CORKER 

Senator CORKER. Thank you, Mr. Chairman. That was quite a 

statement. 

I want to thank each of you for coming and thank you for what 

you do. I will say that there is no question that I think people on 

both sides of the aisle would agree that we have to figure out a way 

3 

to keep regulation from being procyclical where, when things are 

really good, people loosen up, and when things are really bad, we 

create a self-fulfilling prophecy by overregulating. And I think 

probably everybody would agree that that is a problem that we 

have got to keep from happening. 

But I have to tell you, I think I am amazed. Congress certainly 

was part of the party and was pouring some of the alcohol in the 

punch bowl, and, you know, I look at Dodd-Frank as an incredible 

exercise of laziness by Congress where basically Congress punted 

all the tough decisions to regulators, trying to act like it had done 

something great. And I think the Financial Times had the best 

summary of it about a week after they had an analysis, and it said, 

‘‘So many pages, so little content.’’ And I find it hilarious—it would 

be hilarious except for the damage that it is doing to our country 

right now. 

You know, Dodd-Frank was basically put in place and rushed the 

way that it was to create clarity in the markets, and anything but 

that has happened. The fact is that, you know, Congress punted all 

tough decisions to regulators, did not give the clarity. Then I find 

it, again, hilarious except for the damage that is being done that 

we now have Senators on both sides of the aisle acting as 

supplicants to regulators, begging them not to do certain things because we have turned over all of the power as it relates to these 

financial institutions to regulators without really giving the type of 

direction that we should have given. 

So I think over time historically, looking at Dodd-Frank, people 

are going to look at it as a minor disaster as it relates to our economy. I do wish we had taken more time to do the work we needed 

to do to understand the issues instead of just, as Congress typically 

does, acting like we did something great but basically have asked 

the regulators to make hundreds and hundreds of rules in a short 

amount of time. I mean, that alone we all know is going to lead 

to all kinds of unintended consequences. 

So as we are pointing fingers, I certainly hope fingers will be 

pointed, as they should be, at the U.S. Senate and Congress for not 

doing the oversight that it should have done while the party was 

going on, for basically fueling it with much of the housing policies, 

and then now basically punting much of our responsibilities to regulators, creating a tremendous lack of clarity out there. And I do 

hope while the regulators, in my opinion, have made some bad decisions over the course of the last couple months, several months, 

this last year, the fact is that we are all in this together, and I 

think we all do want a sound financial system with appropriate reserves and all of those types of things. 

So I think the pendulum has swung too far. I think Congress, 

just like regulators do, on a procyclical basis, the regulators overregulate during the bad times. We are seeing it throughout our 

country, especially with community banks. I think Congress has 

done the same thing, and instead of surgically looking at the problems and prescriptively trying to deal with those, we wrote this 

massive, massive, massive bill that has given the regulators tremendous powers, many of which the regulators do not want. 

You know, we complain about regulatory overreach, and in the 

case of Dodd-Frank, I think the regulators are saying, ‘‘Please, do 

4 

not ask us to do all these things in the short amount of time that 

you have given us.’’ 

So, with that, I look forward to your testimony, and I do that 

with a smile, and I thank you for being here. 

Chairman BROWN. Senator Reed. 

Senator REED. Thank you, Mr. Chairman, for convening this 

hearing. 

Chairman BROWN. Good statement. Thank you. 

Michael Foley is a Senior Associate Director of the Federal Reserve Board with responsibility for large bank supervision. In that 

role he cochairs a system-wide multidisciplinary committee that is 

responsible for implementing a coordinated, comprehensive supervisory program for large complex banking organizations overseeing 

horizontal examinations and evaluating the findings from key supervisory activities. He has served in that capacity since the formation of this group in mid-2010. Previously, he was senior adviser 

to the Director of Banking Supervision and Regulation beginning 

in late 2008. 

Christopher Spoth is Senior Deputy Director of the FDIC’s Division of Risk Management Supervision. His responsibilities include 

oversight of the FDIC’s supervisory programs for safety and soundness and bank secrecy, antimoney laundering. Prior to his current 

appointment, Mr. Spoth was regional director of the FDIC’s New 

York Region. Welcome. 

David Wilson was appointed Deputy Comptroller for Credit and 

Market Risk at the Office of the Comptroller of the Currency in 

June 2010. In this role Mr. Wilson is a key adviser to OCC’s senior 

management on evaluating credit risk. He also provides expertise 

on other major policy matters affecting national bank lending activities. Mr. Wilson cochairs OCC’s National Risk Committee and 

supplies executive direction in analyzing emerging risks to the financial banking system and establishing bank supervisory policy. 

Mr. Foley, if you would begin. 

STATEMENT OF MICHAEL R. FOLEY, SENIOR ASSOCIATE DIRECTOR, DIVISION OF BANKING SUPERVISION AND REGULATION, BOARD OF GOVERNORS OF THE FEDERAL RESERVE 

SYSTEM 

Mr. FOLEY. Thank you, Chairman Brown, Ranking Member 

Corker, and other Members of the Subcommittee. I appreciate the 

opportunity to testify today regarding the Federal Reserve Board’s 

supervision of financial institutions and, in particular, changes that 

we have made and are in the process of making to enhance our supervisory opportunities over these firms. As you mentioned, I am 

a Senior Associate Director at the Federal Reserve. I am responsible for the largest banking institutions. 

The financial crisis revealed a number of vulnerabilities in the 

financial system and in the regulatory framework in the United 

States. Many of those have been addressed by the Dodd-Frank Act, 

but in addition, the Federal Reserve has taken a number of steps 

to strengthen our oversight of the largest, most complex financial 

institutions and to broaden our perspective to include a more 

macroprudential approach to supervision. 

5 

To that end, as you mentioned, we have established a new governance structure for large bank supervision. This was led by a 

number of senior officials from across the Federal Reserve System 

with expertise in a number of areas—macroeconomics, capital markets, payment systems—in addition to bank supervisors. 

This committee is responsible for helping us to identify potential 

threats both to individual firms and to the system more broadly, 

to set supervisory priorities and strategies for the largest institutions, and to review the findings and the work of the examiners onsite at these institutions. 

The Supervisory Capital Assessment Program, which was led by 

the Federal Reserve in early 2009, helped to stabilize the U.S. financial system, but also demonstrated the feasibility and the benefits of employing an across-firm macroprudential approach to the 

supervision of the largest firms. As a result, our examiners are 

making greater use of these horizontal assessments. The most recent example of this is the Comprehensive Capital Analysis and 

Review, or the CCAR, which we completed earlier this year in cooperation with our colleagues from the OCC and the FDIC. 

The CCAR also, very importantly, represented a substantial 

strengthening of previous approaches by supervisors to ensure that 

large firms themselves have robust internal processes for managing 

their capital resources, that resulted in a forward-looking assessment of capital adequacy, both for individual firms and also for a 

majority of the assets of the U.S. banking system. 

We also are strengthening our firm-specific supervisory techniques. We are using more detailed data, more frequent and more 

granular collection of data, and improved quantitative methods and 

models in analyzing that data. 

I would like to add that while many of our recent actions have 

been focused on enhancing the supervision for the largest institutions, we also have been making adjustments to our oversight for 

community and regional banks. As liquidity strains developed during the course of the crisis, we adjusted our focus to place greater 

emphasis on evaluating liquidity contingency funding plans at 

those organizations. And as commercial real estate began to deteriorate and affected the performance of those firms, we conducted 

reviews of the implementation of the 2006 interagency guidance addressing commercial real estate concentrations. And as a result of 

those reviews, we identified a number of issues for which examiners and bankers needed clarification. That contributed to the 

2009 interagency guidance aimed at facilitating prudent workouts 

of commercial real estate loans and prudent modifications of those 

loans. 

So while the crisis made it clear that tightening of supervisory 

expectations and our processes was needed and appropriate, we are 

also mindful of the importance of maintaining banks’ ability and 

willingness to lend to creditworthy small businesses and consumers. Consequently, we have worked hard to ensure that our examiners employ a balanced approach when they are reviewing 

banks’ underwriting and when they are reviewing banks’ risk management and mitigation practices. We expect our examiners to 

strive for consistency in the examination process throughout the 

business cycle. 

6 

I would add that credit markets have been recovering slowly 

since the financial crisis. Recent measures of aggregate credit outstanding that have shown some signs of improvement. But, clearly, 

the residential and commercial real estate lending sectors remain 

lagging. They are going to continue to present challenges for banks 

and supervisors for quite some time to come. With housing values 

flat or deteriorating in many markets, there are renewed concerns 

about the health of the mortgage market in general, and home equity loans and the activities of firms in that regard. 

So with residential and commercial property values still under 

strain, heightened reserve levels at banks remain appropriate. We 

expect that banks will continue to incur higher-than-historical 

losses in these sectors for some time to come, certainly through the 

remainder of this year and beyond. In conclusion, the Federal Reserve has made significant enhancements to our supervisory process, and those enhancements, coupled with the Dodd-Frank Act, 

support enhanced regulation and supervision of large complex 

firms, but we have also enhanced our supervision of regional and 

community banks, placing greater emphasis on sound risk management practices. In so doing, we have been mindful of the need to 

ensure that bank supervision is scaled to the size and the complexity of the supervised firm, and that bank management and examiners take a balanced approach to ensuring the safety and 

soundness of the banking system and also serving the credit needs 

of their communities. 

Thank you for inviting me to appear before the Committee today 

on these important issues. I would be pleased to take any questions 

that you may have. 

Chairman BROWN. Thank you, Mr. Foley. 

Mr. Spoth. 

STATEMENT OF CHRISTOPHER J. SPOTH, SENIOR DEPUTY DIRECTOR, DIVISION OF RISK MANAGEMENT SUPERVISION, 

FEDERAL DEPOSIT INSURANCE CORPORATION 

Mr. SPOTH. Chairman Brown, Ranking Member Corker, Members of the Committee, thank you for the opportunity to testify on 

behalf of the FDIC about our supervisory process. As Senior Deputy Director, Division of Risk Management, I oversee our nationwide safety and soundness examination program. 

As the primary Federal supervisor of most community banks, the 

FDIC seeks to maintain a balanced approach to bank supervision, 

regardless of economic conditions. In our unique role as deposit insurer, we have a vital interest in assessing risks to the Deposit Insurance Fund posed by all FDIC-insured institutions. 

Overall, we are cautiously optimistic regarding the current condition and trends in banking. The number of institutions on the 

FDIC Problem List is leveling off, and the number of failed insured 

financial institutions appear to have peaked in 2010. However, the 

number of problem institutions remains high at 12 percent of all 

insured institutions, indicating that a portion of the industry continues to struggle with lingering credit quality issues. These issues 

limit the ability of some institutions to grow their lending activity. 

We identify four broad factors that led to the financial crisis: excessive leverage, misaligned incentives, regulatory gaps, and weak 

7 

market discipline. Much of the risk centered on poorly underwritten mortgage loans originated for securitization in the so called 

shadow banking system. Structured financial activities that generated the greatest losses were undertaken at the intersection of 

the lightly regulated shadow banking system and the more heavily 

regulated traditional banking system. This experience motivated 

legislative reforms and supervisory improvements. 

The establishment of the Financial Stability Oversight Council, 

the designation of systemically important financial institutions, or 

SIFIs, and the heightened supervision of systemic institutions 

along with other regulatory changes will help restore market discipline to our financial system. At the FDIC we established the Office of Complex Financial Institutions to continuously monitor and, 

potentially, resolve SIFIs. Among other requirements the office will 

review SIFI resolution plans which must demonstrate that the firm 

is resolvable under the Bankruptcy Code. 

With respect to community banks, they were generally not involved in the mortgage-related issues that were at the center of the 

financial crisis, but they were impacted in the fallout. Hit first was 

construction and development lending. Credit losses subsequently 

spread across all loan types. Further, home prices continued to fall 

because of several factors, including the foreclosure inventory. 

Growth in well-underwritten loans is essential for bank revenue 

growth and for our economy to grow. However, recent independent 

surveys and some bankers indicate that borrower demand remains 

sluggish. Despite the challenges, community banks continue their 

vital role as lenders. In fact, they have increased their loan balances since the second quarter of 2008. 

To address the significant challenges faced by banks and their 

borrowers, we continue our active engagement with banks. For example, 2 years ago the FDIC established its Advisory Committee 

on Community Banking. The committee provides the FDIC with 

advice on a broad range of policies. In addition, bank CEOs received a letter reiterating various channels, including confidential 

ones, for bankers to raise any concern about an examination. 

The FDIC continues to work on eliminating unnecessary burdens 

on community banks whose structure and business lines are relatively noncomplex. As noted in my written testimony and appropriate for the causes of the crisis, much of the Dodd-Frank Act 

should not directly impact community banks, and certain provisions of the act provide some benefits. 

We will continue to pursue methods to streamline our supervisory process using technology and other means to reduce disruption associated with examinations. We strive to be efficient in our 

work while also conducting effective examinations. Having our office locations in numerous communities across the country helps 

our examiners be knowledgeable about community banks in their 

areas and about local conditions. 

The FDIC has been incorporating lessons learned into our examination program. We are encouraging banks to make loans to creditworthy borrowers, and we recognize their important role in the 

economy. 

Thank you. I would be pleased to take your questions. 

Chairman BROWN. Thank you, Mr. Spoth. 

8 

Mr. Wilson. 

STATEMENT OF DAVID K. WILSON, DEPUTY COMPTROLLER, 

CREDIT AND MARKET RISK, OFFICE OF THE COMPTROLLER 

OF THE CURRENCY 

Mr. WILSON. Chairman Brown, Ranking Member Corker, and 

Members of the Subcommittee, I appreciate the opportunity to discuss the OCC’s perspectives on lessons learned from the financial 

crisis and our ensuing approach to bank supervision. While not covered in my remarks, pursuant to the Subcommittee’s request, my 

written statement does provide an update on the current state of 

small business and real estate lending, mortgage servicing, and 

trading lines of business. 

The financial crisis underscored the importance of prudent underwriting practices, adequate loan loss reserves, strong capital 

cushions, and it also highlighted the need for supervisors to develop better tools to evaluate and address emerging risks across 

the system. The OCC has taken action to strengthen our supervision and practices of the banks we supervise in each of these 

areas. 

The primary driver of the financial crisis was the progressive 

slippage in underwriting practices that occurred as banks responded to competitive pressures from the shadow banking system. 

We closely monitor national bank underwriting and have directed 

our banks not to compromise their underwriting standards due to 

competitive or other pressures, and as well, we have strengthened 

our analytical tools to help monitor for slippage in loan quality so 

we can intervene at an earlier stage. This includes granular loanlevel data on major credit portfolios that we are collecting from the 

largest national banks that allow us to conduct forward-looking 

analysis under varying economic scenarios. 

The financial crisis also highlighted that risk management is and 

must be much more than simply a collection of policies, procedures, 

limits, and models. Effective risk management requires a strong 

corporate culture and corporate risk governance. This culture must 

be set, embraced, and enforced by the bank’s board of directors and 

its senior management, and it must permeate through all the 

bank’s activities. This is a point of emphasis in all of our meetings 

with senior management teams, directors, and senior management 

at large, midsized, and community banks. 

We have also updated our risk assessment system that we use 

as a part of our examinations at each national bank to reflect and 

incorporate lessons learned from the financial crisis and have directed examiners to be more forward-looking when they assess and 

assign these risk assessments. Given the importance and role of 

large national banks and the importance they play in the financial 

stability of the U.S., we have made it clear that these firms should 

not operate without strong risk management and audit functions. 

Anything less would not be sufficient. 

Further, we are directing large banks to incorporate robust, enterprise-wide stress testing as a part of their ongoing risk management. We are also working with smaller banks to improve their 

ability to assess potential concentrations in key portfolios, most noVerDate Nov 24 2008 07:49 Mar 06, 2012 Jkt 048080 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 L:\HEARINGS 2011\06-15B DISTILLER\61511.TXT JASON
9 

tably commercial real estate, so they can address potential problems before they occur. 

To improve our ability to identify emerging systemic risks, we 

have established a financial markets group to monitor and gather 

market intelligence, and we developed a system of early indicators 

that signal a buildup of risk within the system. Under this system 

warning signals across a number of measures will trigger a more 

formal review and assessment of the risk and the need for a supervisory response. 

The OCC has worked with supervisors across the globe to enhance and strengthen capital and liquidity standards. These efforts 

culminated in Basel III. These reforms tighten the definition of 

what counts as regulatory capital, expand the type of risk captured 

within the regulatory capital framework, increase overall capital 

requirements, establish an international leverage ratio, and introduce global minimum liquidity standards for large banks. 

The OCC has also been a vocal advocate with the accounting 

standard setters to revise the current accounting model for loan 

loss reserves to make them more forward-looking. 

In closing, the financial crisis exposed fundamental weaknesses 

in risk management and supervisory practices across the financial 

industry and the supervisory community. The OCC has taken numerous steps to enhance its supervision programs. As we implement these changes and those mandated by the Dodd-Frank Act, 

we are cognizant of the need to tailor our expectations to the scope 

and complexity of each bank’s activities. We must also avoid wringing all risk out of the banking system. Banks’ fundamental role is 

risk intermediation, and financial innovation and expansion of 

credit are important drivers of our economy. Banks must be able 

to respond to customer and investor demand for new and innovative products and services, and in this respect our overarching goal 

and mission remain the same: to assure banks conduct their activities with integrity and in a safe and sound manner, and that our 

supervision remains balanced and fair. 

Thank you, and I would be happy to take questions. 

Chairman BROWN. Thank you, Mr. Wilson. I do not think anybody wants, to your last comment, wring all the risk out of the financial system. I do not think that is where anybody is going in 

this. 

Last week the Treasury Department—and this question will be 

for you, Mr. Wilson, but anybody can weigh in—announced it was 

withholding payments from three servicers due to poor performance in the HAMP program. We do not always in these hearings 

and in our deliberations think about human beings and the consequences of all of these actions. 

I want to tell a quick story about Frank Vance from Medina 

County, an exurban county just south of Cleveland. He worked at 

the Arcelor Mittal Steel Plant as a railroad engineer. He and his 

wife bought their dream house in Chatham, Ohio, with a Countrywide mortgage. The financial crisis hit. The plant closed. The plant 

laid him off in 2009. He went to his lender, now Bank of America, 

entered into a trial modification that lowered his monthly payment 

by extending the loan 12 years. When a paper bill came in the mail 

showing the old payment amount, Frank called his bank. They told 

10 

him not to worry, to keep making his payments, that no negative 

reports were being made to the credit bureaus. The bank did not 

approve a permanent modification until August 2010 when his payments increased by $200 a month. He later discovered that all his 

payments for a period of 13 months were sitting in an escrow account, and his credit report made it appear as if he was not making 

any payments over that year. In addition to placing his home in 

jeopardy, it is now more expensive for him to make the second biggest purchase in his life—his car. 

My question for the regulator is: What is the OCC doing to scrutinize these loans? What are you doing to help the Frank Vances 

of the world? 

Mr. WILSON. Yes, Senator, HAMP is a Treasury program, but 

these problems are indicative of our findings of the reviews that we 

did late last year. They are the subject of the consent orders that 

we issued in April. Those consent orders get to the heart of, you 

know, where consumers were harmed because of foreclosure management practices. The consent orders specifically talk about dualtrack processing and things like that. It is, unfortunately, not 

something that can be corrected overnight. But one of the reasons 

that the OCC and my colleague agencies moved forward with consent orders is to get them corrected as quickly as possible. 

Chairman BROWN. Anyone else want to weigh in? 

[No response.] 

Chairman BROWN. Let me go somewhere else. National City 

Bank in Cleveland was a huge regional bank founded in Cleveland 

in 1845. As recently as 2007, it was the ninth largest U.S. commercial bank with $140 billion in assets. It was sold to PNC a year 

later during this terrible crisis. It is a case study in regulatory failure. 

After buying subprime lender First Franklin in 1999, the bank’s 

mortgage annual profits grew 20-fold in 4 years from $50 million 

to $1 billion. These volatile, unpredictable mortgages eventually 

did in National City. National City executives started talking about 

selling First Franklin in early 2005. It took until late 2006 for 

them to sell it. They were forced to retain $10 billion of the riskiest 

loans, half of the loans that ultimately brought National City down. 

In the summer of 2006, their chief economist wrote a research report arguing that the housing market was headed for collapse. 

That report was ignored by the bank’s own executives. A few 

months later, the bank spent 42 billion buying two Florida banks, 

a market that has been crushed by declining property values and 

foreclosures. 

In early 2007 the bank bought back $3 billion of its own stock. 

A year later it was forced to raise a very expensive $7 billion from 

private investors. National City wound up losing $6 billion in 2008 

and was bought by PNC for only $2.23 a share. The company and 

its regulators—the Fed and the OCC had known for almost a year 

the bank was in trouble. 

What have we learned from this? What would you do differently? 

What are you doing now to prevent failures such as National City? 

And understanding that bank still exists as part of PNC, they still 

have a lot of employees in my State, but they have significantly 

11 

fewer employees, and a whole lot of stockholders in National City 

lost a lot of money. 

Mr. WILSON. I will refer back to some of the comments about 

when do you take away the punch bowl. That is one of the most 

difficult things that regulators and supervisors have. And I referred to it in my testimony. We have developed a number of tools 

and indicators that really indicate when times are too good. For example, the best loans are often made during the worst of times and 

vice versa. So the worst loans are made during the best of times. 

Being able to identify that and flag it early and take early action 

I think is the key to preventing your description of National City. 

Chairman BROWN. And you are capable of that, and the other 

regulators are now capable of that? 

Mr. WILSON. We have a renewed emphasis, and we are going to 

do the best we can. 

Chairman BROWN. Mr. Foley. 

Mr. FOLEY. From our perspective the first step is to go back and 

consider the lessons learned in the crisis. The very situation you 

talked about really describes a collective failure of imagination by 

the banks and by the regulators themselves. Of course, this is in 

the context of very strong economic growth, a long benign economic 

environment, strong profitability from firms, and exceptionally low 

losses on mortgage lending. 

But against that backdrop, bankers and supervisors did not consider the potential for a significant decline in house prices. We did 

not consider the potential that what were assumed to be stable 

sources of funding could go away in that type of environment. The 

result was that these firms were undercapitalized, and they were 

not prepared for the liquidity strains that they saw in the crisis. 

One of the appropriate responses, we think, is that bankers 

themselves need to have stronger risk management in place and 

supervisors have to have better tools to assess the potential for low 

profitability, but high-impact stress events. Stress testing is one effective way to do that. That is required under the Dodd-Frank Act. 

That is reflective of the activities undertaken in the SCAP and the 

CCAR process. But one important element of this is the need for 

a forward-looking assessment of the potential risks of the firms. We 

need to consider more extreme economic events and idiosyncratic 

risks that can affect individual firms and relate that back to potential future losses, the ability to earn and supplement their capital 

base, and evaluate their need for capital and liquidity under those 

types of adverse circumstances. 

Mr. SPOTH. Senator, I would only add, the one thing FDIC has 

done with the other regulators is reframe our back-up examination 

activities to protect the insurance fund wherein we adopted a new 

memorandum of understanding to engage in back-up activities 

where necessary. 

Chairman BROWN. OK. Thank you. Senator Corker, before you 

begin, in light of your opening statement, I hope there are some 

statutory issues that maybe with Dodd-Frank we can work together on to help us with that. Thank you. 

Senator CORKER. I appreciate that. As a matter of fact, I think 

there are, and I think that a lot of us are seeing a lot of unintended 

12 

consequences and I think a lot of folks wanted to see appropriate 

financial regulation, so I hope we can do that. 

As I go through our State, people from all kinds of backgrounds 

and persuasions politically that are in community banking come up 

to me and say, ‘‘You know, Corker, I am beginning to think that 

the Federal Government just really does not want community 

banks in the number that they have today, that they really want 

to force consolidation, that they really are doing everything they 

can to keep us from being successful.’’ 

And I guess my question to each of you, without being too elaborate with your answers, is what is happening right now throughout 

community banks, the banking system? Is it a result of 

procyclicality, where, in essence, we are clamping down more than 

we should at a time when the economy is slow and creating a selffulfilling prophecy? Is it that Dodd-Frank is forcing you to do 

things that you were not doing before? Or is it some other answer? 

But I really do believe that amongst community bankers in our 

country, there is a belief that the Federal Government really has 

stacked the deck in a way that makes it very difficult for them to 

compete. 

Mr. SPOTH. I might touch on that first, Senator, as principally we 

are the regulator for most of the community banks. I think with 

respect to Dodd-Frank, the burden falls, as it should, on the largest 

financial institutions and we should work in that regard for implementation. 

I hear the same things that you do when I am talking with bankers about burden. I am optimistic that the community bank franchise is a strong one and a valuable one and will continue to be 

so for our country. Looking at the numbers, I know that of all the 

7,500 insured banks in this country, 90 percent of them are community banks serving their communities well. They have under a 

billion dollars in assets each, but they have a disproportionately 

large share of the commercial loans in their markets. 

Mr. WILSON. At the OCC, we respect and support the role of community banks and have no intention of trying to reduce the number 

of community banks or anything like that. In addition to what 

Chris said, community banks are under a lot of pressure right now 

because they tended to be overly concentrated in commercial real 

estate, and commercial real estate, particularly income-producing 

commercial real estate, has lagged the recovery. A lot of banks are 

continuing to struggle with those concentrations and working 

through those concentrations. We are doing the best we can, and 

I know my colleagues are, as well, to make sure that we are fair 

and balanced in allowing the banks to work through those. But in 

some cases, it is just not possible. 

Senator CORKER. Yes. We kind of forced them out of residential 

into commercial due to our policies here, and that is one of the 

problems that we, Congress, helped create. 

The one thing I would say, Mr. Spoth, I know you mentioned 

that, somehow or other, this is tilted toward the large institutions. 

The fact is, that is not the case. I mean, the big just get bigger 

when we regulate the way that we have, and what has happened 

is with the community banks, their back offices now are much, 

much, much larger and are getting larger just to deal with all the 

13 

things that are in Dodd-Frank. So I would just say your statement 

is just categorically untrue, because larger institutions have the 

ability to absorb regulations in a much more efficient way. They 

can spread it over a larger mass than community banks do. So that 

is just categorically an incorrect statement. And you can go talk to 

any community bank in our country and they will tell you that the 

burden per asset base that they have is much larger on a community bank than it is on something that is much larger. 

Let me ask another question. The risk retention piece, I thought, 

was ridiculous, and I think it is going to have tremendous effects 

on our securitization market. So, again, Congress punted and basically said, oh, well, we do not really want to get—we do not know 

how this works, really, so set up a Qualified Residential Mortgage. 

You guys have, in your wisdom, come up with a 20 percent downpayment and now Congress, being the supplicants that we now are 

in this process—everybody is writing letters to say, well, we really—oh, gosh, we wish you had not done that. Would you all like 

to respond to the Qualified Residential Mortgage and just the 

whole risk retention piece and how you guys, in your wisdom, have 

come up with a 20 percent downpayment that now Senators who 

punted their responsibilities are trying to keep you from doing. 

Mr. WILSON. Of course, Senator. That rule is out for comment 

and we have invited comments on that very issue, especially the 

20 percent downpayment. I think the policy makers looked at the 

rule as primarily a risk retention rule. The intent of the rule is 

that the securitizer would retain risk. It did allow, as you mentioned, the option of designing a very, very high quality asset that 

would be exempt from that risk retention rule. So the design of it 

was very conservative, not only in residential real estate, but in the 

other asset classes that are mentioned in the proposed rule. And, 

again, the intent of the law was risk retention, and so the exceptions to risk retention should be narrow. 

Senator CORKER. So, basically, this is—for those out in the real 

estate world that are slightly upset, if you can imagine, about a 20 

percent downpayment, what you would say is that is exactly what 

the U.S. Senate told you to do. 

Mr. WILSON. We believe that there are many, many good mortgages, we would hope, that would still be made that are outside of 

QRM if you include—— 

Senator CORKER. But the institutions would have to hold risk 

against those. 

Mr. WILSON. But they would have to hold—— 

Senator CORKER. And so that means that no community bank— 

let me just go back to the other statement—no community bank 

could possibly, possibly be in that world. It means that, now, home 

mortgages will be concentrated in the JPMorgans and the 

Citibanks and the Bank of Americas because nobody else has the 

ability to hold risk on their balance sheet, is that correct? 

Mr. WILSON. We have tried to design the rule to not have that 

happen. The risk retention is the primary responsibility of the 

securitizer, not the originator. So under the current model where 

you have a community bank that will originate a handful of loans 

and then sell them to a securitizer, the community bank does not 

14 

have to retain the risk. It is the securitizer that has to retain that 

risk. 

Senator CORKER. But will it not concentrate that market when 

you have to have a large balance sheet like that to hold the risk? 

Mr. WILSON. To the extent that the community bank decides to 

sell that loan, that would be the model that existed before DoddFrank. So if the community bank decides to hold the loan on the 

books, then risk retention does not come into play. But we consciously tried to consider this factor when we debated whether we 

would make the originator retain the risk versus the securitizer 

themselves, and it was this consideration that went into that debate. 

Senator CORKER. Listen, thank you. I know I have taken over my 

time. Thanks for having the hearing. I would just close by saying 

that I know you guys have 300 rulemakings to make, and I know 

in many cases you feel like you are making them too quickly, trying to meet deadlines. And I do know for a fact that it is creating 

tremendous lack of clarity out in the financial markets and people 

have no idea what the rules of the road are and I know that is 

hurting our economy. I know that. I do not know many things, but 

I know that. 

I do hope that as you move along, if you see things that you feel 

like you are rushing, that you will not be cowered by those people 

who just want to see Dodd-Frank pushed through regardless, but 

that you will tell us that you need more time, and I thank you very 

much for what you do and appreciate the opportunity to be with 

you today. 

Chairman BROWN. Thank you, Senator Corker. 

Senator Reed. 

Senator REED. Thank you very much, Mr. Chairman. 

Just to follow, a point of clarification, Mr. Wilson. The 20 percent 

downpayment is not specified—I do not believe it is specified in 

Dodd-Frank in terms of qualifying. Is it specified? 

Mr. WILSON. No, the 20 percent down is not specified. 

Senator REED. Yes. In fact, the agencies have the flexibility to 

design a rule which would reflect an appropriate downpayment, but 

20 percent is something you are proposing now. 

Mr. WILSON. That is correct. 

Senator REED. Thank you. Mr. Wilson, I am still, as you are 

probably aware, awaiting questions, or responses from the May 12 

hearing from the OCC and I would appreciate very much if those 

responses would be forthcoming. I know my staff has talked to you. 

I appreciate that. But they are important questions and I would 

like answers. Any idea when we are going to get them? 

Mr. WILSON. Senator Reed, we understand that. We are well 

along on answering those questions and I would hope it would be 

very soon. 

Senator REED. Thank you. 

Mr. WILSON. We take it very seriously. 

Senator REED. Thank you. You have mentioned the OCC consent 

order. At the heart of it seems to be the requirement that the 

banks engage an independent consultant to look back at their servicing processes, which begs a couple of questions. First, why was 

the OCC looking at these processes? And then a related question 

15 

is at what point did the OCC become aware of what appears to be, 

and Senator Brown’s example is just one of thousands, hundreds 

of thousands, serious deficiencies, in fact, deficiencies that appear 

to be violating law? So could you respond to those two issues? 

Mr. WILSON. Yes, sir. We become aware, not really until it became public with the Allied Bank publicity, but we jumped in very 

quickly after that with horizontal examinations on an interagency 

basis. 

As to why were we not looking at before, this is another lesson 

learned, but we do look at mortgage servicing operations. We do 

look at modification procedures, the basic transaction of the notary 

signing and affidavits, and things like that traditionally was a lowrisk business. We did not have any indicators from internal audit 

or other risk management functions around the bank. We did not 

pick up any complaints in our consumer complaint process. So it 

was not something that we had a big focus on until we understood 

the nature of the problems. 

Senator REED. Let me—just two points. One, I presume based on 

not only the response to this question but your previous responses 

that you have taken corrective action with respect to these issues 

in terms of your examination procedures, the training of examiners, and I would also sort of emphasize the consumer complaint 

process, because, frankly, our offices are deluged by consumer complaints. If you were getting a quarter of the complaints which were 

originating two or 3 years ago that I think some of them are also 

getting, then you have to look very carefully at your consumer relations and how you identify complaints and follow them up, because 

there was a lot of noise out there in terms of consumers, frustrated 

consumers literally banging down our doors, and I think I speak 

for everybody on this Committee and in every part of the country. 

Let me shift gears briefly, and still in the context of this process 

of mortgage foreclosures. Yesterday, 11 of my colleagues, including 

the Chairman of the Committee, Chairman Brown, Chairman 

Leahy of the Judiciary Committee, sent a letter to the Comptroller 

asking the Comptroller to work very closely with the States’ Attorneys General, with the Department of Justice, with the Department of Housing and Urban Development, to produce a comprehensive solution to this foreclosure crisis, not just rectifying the 

robosigns, et cetera. And I think at the heart of it is the notion that 

we have—until we stabilize the housing market, which we have 

not, we will not have any economic growth of consequence nor will 

the safety and soundness of banks begin to be self-sustaining and 

something that you have to worry about. 

So let me just specifically ask, can you describe your proposed 

collaboration with the Attorneys General at all? 

Mr. WILSON. I will try. I will say, number one, we agree with the 

letter. We agree that not only should we fix what is wrong with the 

foreclosure process, provide restitution to consumers that have 

been harmed, but then also address the broader issue of servicing 

and servicing standards and some of the things that got us to this 

place in the first place. 

In terms of cooperation, we went forward with the consent orders 

to do that first piece of the two-piece puzzle, but we were very careful not to interfere with ongoing negotiations from the Department 

16 

of Justice and the State AGs, and, in fact, we are trying to coordinate. We just announced that we delayed the responses back from 

the banks by 30 days at the specific request of the Department of 

Justice, and so we do look forward to going forward. There are a 

number of groups working on national servicing standards and we 

all agree that we need to get to a commonplace at some point. 

Senator REED. Let me, again, in the context of a comprehensive 

approach, I think—and the letter indicates this—there is also the 

possibility of modification, including principal reductions, in terms 

of terms, extensions of mortgages, so that we avoid foreclosures, 

basically. I think simply getting the foreclosure process correct, 

then go out and foreclosing more homes is not going to help anybody. And, in fact, in talking to the Attorneys General, this modification process is one of the things that was used in the Iowa farm 

crisis of the 1980s in terms of trying to correct similar situations. 

So I would presume that you would be working as best you can 

along with the Attorneys General in this regard, too, is that correct? 

Mr. WILSON. That would be correct. I mean, the devil is in the 

details, but yes. 

Senator REED. Thank you very much. Thank you, Mr. Chairman. 

Chairman BROWN. Thank you. 

Before turning to Senator Merkley and Senator Moran, we will 

also in a moment introduce one of the members of the next panel. 

A couple of questions before Senator Merkley. 

For you, Mr. Wilson, brief questions. As Dodd-Frank in the Senate and the House worked together on sort of, obviously, reconfiguring the regulatory agencies with OCC and FDIC and the Fed and 

the new CFPB, I have two brief questions for you, Mr. Wilson, just 

so I understand, so we understand the structure better as we move 

forward. Does the OCC have a single head or a board? I understand they have a single head, correct? 

Mr. WILSON. We have a single head, yes. 

Chairman BROWN. OK. And the OCC is subject to the appropriations process or not? 

Mr. WILSON. They are not, no. 

Chairman BROWN. They are not. OK. It is important to make 

that clear. 

Senator Merkley. 

Senator MERKLEY. Thank you, Mr. Chair, and thank you all for 

your testimony. 

I wanted to get a better sense of the contrast between the strategies used for overseeing or supervising or auditing the large, complex financial institutions as compared with community banks. 

Certainly in a smaller institution, the FDIC as it supervises community banks can go in and basically look at every loan file. In 

large, complex institutions, the strategy is more on the side of having, as I understand it, a staff member on-site working with the 

risk management staff of that institution. 

I would like to get a sense of whether that embedded risk management approach is the best strategy. What have we learned from 

this financial crisis? Do we need to have kind of some more, if not 

loan level, but more deeper understanding or inspection of what is 

going on in the guts of complex institutions? And Mr. Wilson and 

17 

Mr. Foley, if you could share your thoughts on that, it would be 

helpful. 

Mr. WILSON. I will start. We do have a significant difference between the way we supervise large institutions and community 

banks. Community banks tend to be more of a point in time examination where we go in periodically. In our large banks, we have 

core staffs—some of them can be quite large—that are resident in 

the bank at all times. And you are right. We try to work with risk 

management, audit, some of the risk functions. But to say that that 

is all we do is not correct. We do a lot of transaction testing, especially looking at individual loans, sampling individual loans. Every 

spring, we do a Shared National Credit Program, which is where 

we review all the big shared credits in the country that are significant. So that testing is there. 

I think the question is, do we need to do more? I think in some 

cases we should. And in products that were homogeneous, we may 

have become a little more comfortable with the process and did not 

call a residential mortgage and say, how is this thing actually 

being underwritten. I think it is a lesson learned for the future. 

Senator MERKLEY. Well, you are talking about transaction testing. Are you randomly selecting a few out of, of course, a very large 

volume of transactions to see kind of just what you find, whether, 

one, it was real, and two, presented to reflect the reality of the 

transaction and so forth? 

Mr. WILSON. For things like credit, structural products, bonds, 

things like that, we would do a random selection. For example, in 

CMBS for commercial real estate, we will look at the quality of the 

loans that are going into those structures. 

Senator MERKLEY. And before we shift over, is there anything 

that you feel has really been a modification of your strategy based 

on the lessons learned from the 2008–2009 crisis? 

Mr. WILSON. Yes, as I said in my testimony, we are doing a lot 

more data collection from the banks, the large banks themselves. 

This is loan level data collection which started in 2008 and we have 

expanded it to additional asset classes to the point now where we 

are collecting on almost all major asset classes. We are doing a lot 

more modeling on that. 

From our core staffs on our large banks, we have significantly 

ramped up our expectations for risk management in those institutions. I think before we were somewhat OK if we rated the risk 

management functions as satisfactory. We have communicated to 

our banks that that is no longer the grade. They have to be strong 

and we are working toward getting to strong risk management. 

Senator MERKLEY. So are you designing any independent risk 

models or utilizing just simply kind of following what the bank 

itself is using? 

Mr. WILSON. We do both, but on the loan level data collection 

that I was talking about, those are independent. 

Senator MERKLEY. Mr. Foley. 

Mr. FOLEY. Thank you, Senator. I think, again, part of this is 

looking at the structure in place before, and I think there were a 

number of limitations, many of which have been addressed by the 

Dodd-Frank Act. But the Federal Reserve, for example, by statute, 

was very narrowly focused to consider nonbank subsidiaries and 

18 

the impact they could have on depository institutions. Primary and 

functional regulators were very focused on the particular legal entities they were responsible for. But no Federal regulator had sufficient authority to consider those risks across the entire organization, and for very large, complex firms. For example, they may 

have a client in Asia that enters into a contract that is booked in 

the U.S., with the risk on that contract hedged in the U.K. Therefore the supervisory approaches that we take have to recognize the 

underlying business approaches that these firms use. 

Transaction testing is a key element of that, but we are increasingly using techniques such as the SCAP, which involve a broader 

horizontal assessment. The nature of that exercise is to have the 

firms consider, for example, a particular stress situation. That 

could be an economic stress. That could be an idiosyncratic stress 

particular to the businesses that firm is engaged in. We collect extensive information from the firm to understand the impact of a 

stress on each of their loan portfolios, to understand the impact on 

their profitability going forward, to understand the impact on their 

liquidity. 

It is important for the firm to be able to demonstrate they can 

collect data across the entire consolidated organization, that they 

can aggregate their risk exposures, that they can understand the 

potential impact on their profitability going forward and be able to 

translate that into what their capital and liquidity needs might be, 

not just as a point in time, but under a more stressful scenario 

going forward. 

Those approaches are much more sophisticated. They allow us as 

supervisors to collect extensive, robust data on these firms that 

permits us to independently validate the firms’ suggestions in their 

models. Additionally, we are able to run scenario analysis on any 

range of scenarios that we may have to consider beyond what the 

firms are focused on. 

Senator MERKLEY. Thank you. 

Chairman BROWN. Thank you, Senator Merkley. 

Thank you very much for joining us. We very much appreciate 

it. 

I call the second panel forward, Salvatore Marranca and Frank 

Suellentrop, and Senator Moran, as you get situated—he can wait 

a moment if he wants—but introduce Mr. Suellentrop. 

Senator MORAN. Mr. Chairman, thank you very much. Thank 

you for accommodating our desire to have a Kansas community 

banker testify before this Subcommittee, and I appreciate your cooperation in that regard. 

Frank Suellentrop is a fourth generation banker. The bank has 

been in his family for four generations and his bank is outside of 

Wichita, Kansas. He is an active member of the Kansas Bankers 

Association as well as the independent community bankers. Like 

community bankers across the country, he is so actively engaged in 

his community. 

You have heard me say many times in this Subcommittee and 

more so in the full committee about my concern about the potential 

demise of community banking because of the regulatory environment. I do not know exactly what Mr. Suellentrop will testify to, 

but I am anxious to hear his and our other witness’s testimony in 

19 

regard to the regulatory environment and the changes that have 

occurred since Dodd-Frank, and I thank you for allowing this Kansan to join us today. 

Chairman BROWN. Thank you, Senator Moran, and welcome, Mr. 

Suellentrop. 

Salvatore Marranca is Chairman of the Independent Community 

Bankers of America, the only national trade organization that exclusively represents community banks. He is Director, President, 

and CEO of Cattraugus County Bank in Little Valley, New York. 

He has served the community banking industry in many leadership 

positions. 

Mr. Marranca served in the U.S. Army with a tour of duty during the Vietnam War. Thank you for your service to our country, 

Mr. Marranca. He is the past Board President of the New York 

State Banking Department, Director and Past President of the 

Independent Bankers Association of New York State. 

Welcome to both of you. Mr. Marranca, if you would begin. 

Thank you. 

STATEMENT OF SALVATORE MARRANCA, DIRECTOR, PRESIDENT, AND CHIEF EXECUTIVE OFFICER, CATTRAUGUS 

COUNTY BANK, LITTLE VALLEY, NEW YORK 

Mr. MARRANCA. Thank you. Chairman Brown, Senator Moran, 

Senator Merkley, I am Sal Marranca, Director, President, and CEO 

of Cattraugus County Bank, a $174 million community bank founded in 1902 in Little Valley, New York. I am pleased to be here 

today as Chairman of the Independent Community Bankers of 

America, the ICBA. 

The safety and soundness of our banking system is a significant 

concern to the nearly 5,000 community bank members of the ICBA. 

Early in my banking career, for more than a decade, I was a senior 

bank examiner with the FDIC. The commitment I made then to 

safety and soundness is still ingrained. 

The recent financial crisis was fueled by high-risk lending and 

speculation by the megabanks and Wall Street firms. Significant 

harm was done to taxpayers and the economy. Community banks, 

too, were harmed. The economic decline retracted consumer spending and dramatically reduced the demand for credit. Residential 

and commercial real estate markets remain stressed in some areas. 

Still, the community banking industry remains well capitalized 

and, because we take a conservative, common sense approach to 

lending, has fewer problem assets than any other segment of the 

industry. 

We must ensure this crisis never repeats itself and appropriate 

supervision of all financial services providers is a key component 

of that effort. However, the way safety and soundness is achieved 

is also very important. Misguided, though well intentioned, efforts 

could be very economically damaging. Frankly, many community 

bankers are deeply frustrated with the current exam environment. 

I am fortunate to enjoy a cooperative and constructive working 

relationship with my regulator, the FDIC. Having been a bank examiner, I have been on both sides of the table and appreciate the 

concerns and the challenges examiners face. It is a difficult job 

20 

with a great deal at stake. The stakes were raised sharply after the 

financial crisis. 

The pendulum has swung too far in the direction of overregulation. As a community banker, I have met with thousands of bankers from every part of the country in recent years and I can tell 

you there is an unmistakable trend toward arbitrary, micromanaged, unreasonable examinations that have the effect of suffocating 

lending. What is more, these exams—in fact, all regulatory compliance—are more costly and a burden to small banks because we 

have a smaller asset base and staff over which to spread the costs. 

ICBA supports bringing consistency to the examination process. 

Arbitrary loan classifications are a particular source of frustration 

to community bankers. ICBA strongly supports legislation recently 

introduced in the House by Representative Bill Posey, the Common 

Sense Economic Recovery Act. This legislation would help establish 

conservative common sense criteria for determining when a loan is 

performing and provide more consistent classifications. We are 

hopeful a Senate companion bill will soon be introduced and considered by this Committee. 

ICBA also supports House legislation introduced by Representative Blaine Luetkemeyer, the Communities First Act, the CFA. 

This bill contains many reforms that would improve the regulatory 

environment and community bank viability to the benefit of our 

customers and communities. To cite just a few examples, this bill 

would raise the threshold number of bank shareholders that triggers costly SEC registration, from 500 to 2,000. Another provision 

would extend the 5-year net operating loss carryback provision to 

free up community bank capital, when it is needed most. Again, 

ICBA hopes to see a companion bill introduced in the Senate. 

The greatest threat to safety and soundness remains the too-bigto-fail institutions that dominate the financial services sector. The 

financial crisis has, in fact, accelerated industry concentration. 

Today, the ten largest banks hold 77 percent of all bank assets. A 

more diverse financial system would reduce risk and promote competition, innovation, and access to credit. This is why ICBA generally supports the too-big-to-fail measures in the Dodd-Frank Act. 

Finally, I would note that some of the housing finance reforms 

being considered by the agencies and by Congress, if not done carefully, could have the unintended effect of driving further industry 

consolidation and jeopardizing safety and soundness. For example, 

the Dodd-Frank risk retention rule on securitized mortgages should 

include a fairly broad exemption for Qualified Residential Mortgages. 

Thank you again for convening this hearing and giving ICBA the 

opportunity to testify. We share your commitment to enhancing the 

safety and soundness of our financial institution. I look forward to 

your questions. Thank you. 

Chairman BROWN. Thank you, Mr. Marranca, and thanks to the 

Independent Community Bankers. 

Mr. Suellentrop, welcome. 

21 

STATEMENT OF FRANK A. SUELLENTROP, CHAIRMAN AND 

PRESIDENT, LEGACY BANK, COLWICH, KANSAS 

Mr. SUELLENTROP. Thank you, Mr. Chairman, Senator Brown, 

Ranking Member Corker, and Members of the Subcommittee. 

Thank you for the opportunity to testify before you today regarding 

lessons learned and opportunities for continued improvement. 

My name is Frank Suellentrop. I am President and Chairman of Legacy Bank in Colwich, Kansas. We are a $250 million closely 

held community bank providing banking services to the area of 

Sedgwick County, Kansas. We have five branch locations, our charter bank location in Colwich, Kansas, population 1,400, and four 

branch locations in the Wichita, Kansas, community. Our bank was 

established in 1886, which means we are celebrating our 125th 

year in banking this year. I am fourth generation President of our 

bank since 1991. From that experience, I have seen the beginning 

of the consumer regulation in the early 1970s, the agriculture and 

real estate crisis of the 1980s, and now the Wall Street-induced 

real estate crisis of 2008. 

Legacy Bank is significantly involved in residential development, 

residential construction, and commercial property lending, therefore, greatly impacted by the economic slowdown and depressed 

real estate market values. Fortunately, the economy in Wichita, 

Kansas, has fared reasonably well throughout the current crisis 

relative to other markets, primarily due to the fact that Kansas, 

specifically Wichita, had not experienced inflated real estate values 

of the past decade. 

I would like to preference my comments regarding recent examination by saying that I understand examiners are charged with a 

difficult task. On one hand, they are expected to protect against 

bank failures, ensure consumer compliance and regulations are adhered to, to satisfy community groups and organizations’ demand 

for fair banking practices, and heed Congressional demands for 

banking or financial oversight. On the other hand, regulators 

should be tasked with not interfering with the bank’s corporate 

mission of creating value for its shareholders. Legacy Bank is a forprofit corporation. 

Our most recent 2010 examination revealed stark differences 

from prior exams: Expectations of higher capital and liquidity 

standards, more demanding asset loan quality evaluations, expectations for higher allowance for loan and lease loss reserves, increased focus on management assessment and compensation practices. Comments made by regulators during our last exam include, 

‘‘We do not like your risk profile,’’ and ‘‘We are not going to bat for 

you in Washington.’’ 

To put the first comment in context, our bank has been a lender 

to residential real estate developers, home builders, and commercial property owners since the late 1980s. We feel our lending staff 

has the knowledge and experience to manage our loan portfolio 

composition. Examiners were significantly more aggressive compared to prior examination observations. Due to recent failures of 

problem banks in other areas of the country, our lending risk profile is now unacceptable. 

In addition to the standard underwriting criteria of evaluating a 

borrower’s capital, collateral, and capacity to repay, and market 

22 

conditions, our loan committee has added a new component to our 

loan approval discussion: Will the loan pass examiner review and 

approval? This component should not be a part of the loan approval 

process. A customer’s loan request should be based on its viability 

and productive value. With respect to the latter comment, it illustrates the regulatory attitude that banks in real estate lending may 

be unsafe and unsound in their practices. 

Banks are evaluated on a CAMELS component rating, which 

measures a bank’s capital, asset quality, management, earnings, liquidity, and sensitivity to market risk. My comments on each of 

those follows. 

Capital standards are being dictated above the levels for regulatory defined well capitalized banks and those standards that are 

required for our Nation’s largest institutions. Regulators quite 

often use discretionary capital standards to demand higher capital 

levels for community banks—than those at large banks. Capital 

below the mandated Tier One risk-based levels are likely to receive 

a lower capital component rating in an examination, which may 

subject the bank to troubled bank status. The discretionary capital 

standards create a difficult moving target for community banks as 

we seek to achieve an acceptable capital component rating. 

Asset quality loan evaluations have become more critical. Examiners are slow to recognize when a credit risk has been mitigated 

and classifications can be inconsistent. 

Community banks’ management compensation is being reviewed 

by examiners by suggesting potential negative impact to earnings 

and capital. Without a significant discussion, examiner comments 

dictated that we justify management compensation benefits by use 

of an outside source. Somehow, Wall Street excesses on executive 

pay have crept into the regulators’ view of Main Street banking 

compensation practices when there is no valid comparison to Wall 

Street compensation abuses. 

Earnings were reviewed and projected to be half by examiners of 

what actual 2010 actual earnings were for our bank, causing concerns for our earnings component. 

In summary, micromanaging community banks is unproductive. 

Examiners should expect results, but if capital is solid and management is capable, then overregulation is unnecessary. Regulatory 

burden and examiner expectations are disproportionate in their impact on community banks versus the largest banks. 

I appreciate the opportunity to comment and am open to your 

questions. Thank you. 

Chairman BROWN. Thank you very much, Mr. Suellentrop and 

Mr. Marranca. Thank you very much. 

I think that across the political spectrum and across both parties 

and everyone on this Committee is supportive of efforts to work 

with community banks, one, to help community banks deal with 

the difficulties of Dodd-Frank. I think that all of us want to see 

community banks succeed. I think all of us understand that the 

guilty parties on Wall Street caused—as Mr. Suellentrop said, the 

Wall Street-caused debacle to our financial system and to our economy had little to do with community bank practices, and all of us 

I think are disturbed—I can just talk for myself, but I think we all 

are. Mr. Marranca, your comments that the ten largest banks 

23 

today hold 77 percent of all U.S. bank assets, I am quoting you, 

compared with 55 percent of total assets in 2002. We know what 

that bank crisis, what the disaster on Wall Street, we know what 

it did to community banks as we have seen more concentration just 

in that 9-year period. We know what it has done to our economy. 

We also know how it has made regulation more difficult. When you 

put up the OCC or the Office of Thrift Supervision or any of these 

regulatory—the FDIC, any of these regulatory bodies dealing with 

the sophistication and the resources of the biggest banks, it obviously is too often a mismatch. 

The former head of the OTS said an organization like OTS cannot supervise AIG, Merrill Lynch, or entities that have worldwide 

offices. There is no way. And that makes all of this more difficult. 

But shifting, Mr. Marranca, to your comments and understanding that megabanks were rewarded so often for the regulatory 

failures with bailouts while community banks too often are being 

shut down and the concentration of the larger banks gets greater 

and greater, talk to me specifically—and I like the thoughts of— 

and your testimony was helpful in this way from both of you. Talk 

about the costs and burden and supervision for your bank as compared to a too-big-to-fail bank. Put that in context, if you would, 

with your bank personally or with some of your member banks, but 

obviously you know yours best. 

Mr. MARRANCA. Yes, sir, Senator, and I would confidently say 

that my experience is the same as the vast majority of community 

banks across the country, and I will give you an example. I received an email 2 days ago that we would be—that soon an upcoming compliance examination by the FDIC would occur in my bank 

and that it would have a minimum of two people in my bank for 

a minimum of 4 weeks. That is just one compliance examination. 

I should add that at the current time I have the New York State 

Banking Department in my bank for a compliance examination. 

The point is we have a small shop, approximately 30 people. 

There is an opportunity cost for all the time, attention, and energy 

let alone what I feel is there could be a better utilization of the resources of the examiners. 

Again, this is just specialized compliance. In addition to compliance, we have a CRA examination, which is a separate examination. In my particular case, in New York State, I have a separate 

CRA examination by the State and by the FDIC. 

In addition to that, I have a BSA examination. I have an IAT or 

ADP examination. I just completed an examination by the Federal 

Home Loan regarding our secondary mortgage market. We just 

completed—the IRS just left our bank. 

There are very few times in my small, one-light town in Little 

Valley, New York, that I do not have examiners in my bank, and 

we are a 109-year-old institution, highly rated, low risk profile, and 

not a complex organization. It seems to me there is a better way 

to allocate the resources of examination. And this takes me away 

from lending and away from my consumers and away from my customers. 

Chairman BROWN. You are a $174 million bank. 

Mr. MARRANCA. Yes, sir. 

24 

Chairman BROWN. Your comments about that, if you would, Mr. 

Suellentrop. 

Mr. SUELLENTROP. Thank you, Senator. Truth be known, we actually started an examination on Monday, so I should probably be 

there. We have, I believe, 17 examiners at our bank for probably 

a period of 2 to 3 weeks. We will review safety and soundness, information technology, BSA, and I am sure I am forgetting something, but it will take the time of the majority of our staff to accommodate getting their information and support, the bank’s practices. 

Our bank is fortunate in that we are of the size where we have 

a sufficient number of employees where those efforts can be delegated amongst a number of our staff, although it is still a tremendous burden. We have many banks in the State of Kansas and 

throughout the Nation, substantially smaller than we are, who 

those burdens fall on one or two individuals and can be tremendous 

in terms of their cost to the bank as well as the time that it takes 

away from serving their customers and their community. 

So that is just the examination part. That does not take into account the daily routines of going through processes to ensure compliance and ensure safety and soundness and bank secrecy and the 

like. So it is a tremendous burden for community banks, and hopefully there are some alternative options to reducing that burden. 

Chairman BROWN. You expressed, Mr. Suellentrop, you are reflecting, I think, what many community bankers, at least in my 

State and the conversations I have, and I think what you seemed 

to say of anger at what Wall Street did and the damage it caused 

to the economy, writ large, but obviously the damage it did to community banks, and the added scrutiny and pressure and costs to 

community banks. 

Do you think regulators are doing enough to oversee the—understanding that you do not want it to spill on you in terms of more 

regulation, but do you think the regulators are doing enough to 

oversee these trillion-dollar banks? The last question for each of 

you. 

Mr. MARRANCA. I would be happy to jump in there. The answer 

is no. I am held accountable for—my board and I are held accountable for what we do at our bank. We have skin in the game. We 

take care of our communities, we take care of our customers, and 

we take care of our employees. To bail out the largest banks because of their failures, and in some cases borderline criminal behavior, I think goes against the capitalistic ways of this country 

and I think has done great harm. 

I have a tremendous competitive disadvantage when the 20 largest banks in this country are too big to fail, and my customers 

know that. 

Are they held accountable? No. Are they scrutinized to the degree that we are? No. Should they be? Yes. 

Chairman BROWN. Mr. Suellentrop, your comments on that? 

Mr. SUELLENTROP. Thank you, Senator. Probably examiners’ efforts with the largest banks is above my pay grade in making that 

determination, but I can tell you from sitting in our bank and the 

impact that we feel from recent economic problems and the conditions we have today, it certainly feels like we are receiving the 

brunt of the examination overload. 

25 

What additional regulation and examination is needed for the 

largest banks? I do not pretend to know that, but I know that for 

community banks the overload is significant, and they are certainly 

not slowing down. As the gentleman before us noted, there is a 

myriad of rules and regulations that are forthcoming. 

Chairman BROWN. Thank you. And then a last comment. It 

seems that some in this town have been sort of lobbying the press 

and the media, and the agencies are using your situation to weaken the rules on some of the big banks, and I just do not want that 

ever conflated, that while virtually all of us I think here want to 

see the regulatory burden lifted from community banks and the 

banks in towns like where I grew up in Mansfield, Ohio, we do not 

want to see that as an excuse to weaken rules and further deregulation and weaken the Dodd-Frank implementation of the big 

banks that Mr. Marranca referred to. 

Senator Moran. 

Mr. MORAN. Mr. Chairman, thank you very much. I thank both 

witnesses for their testimony. 

Let me ask in this case both of you, you heard—let me start with 

you, Mr. Suellentrop. You heard the previous panel in which we 

had representatives from the Federal Reserve, the Office of the 

Comptroller of the Currency, and the FDIC. Did you hear anything 

there that you would like to comment on as—at least it has been 

in my experience in every conversation I have had with regulators 

at the table that you are seated at, they all indicate to me they 

make special consideration for community banks, they understand 

the challenges they face, they have task forces that have been created to make sure that community banks are not overregulated. 

There is the whole list of disclaimers about all the things we are 

doing to address the concerns that we are talking about, overregulation of community banks. And yet it never seems to me in my 

conversations with my bankers that there is any consequence to 

that constant effort that is claimed by the regulators to avoid overregulation. And I wondered if you heard anything from the witnesses today that did or did not make sense to you. 

Mr. SUELLENTROP. No, I cannot say that I did hear anything that 

would change my perspective on how community banks are going 

to be regulated or examined going forward. I would say that there 

is a significant persuasive attitude that an examiner in the field 

would be the same as the examiner in Washington, that they are 

not interested in having a problem bank or a failure on their 

watch. In other words, the comment was also made, ‘‘We are going 

to err on the side of caution,’’ in the first part of our examination 

in 2010. And I do not think that is going to change. I think they 

have a significant interest in protecting their reputation, and one 

way to do that is to be aggressive and to be thorough in their examinations. We are not suggesting they should not be thorough. 

We just ask that they are equitable. 

Mr. MARRANCA. Senator Moran, I would just ask—and the word 

that comes to my mind is—and it has been used often—is the ‘‘disconnect’’ between Washington and the examiner in the field. Again, 

the examiner in the field has a difficult job, but yet they are out 

there and, generally speaking, there is no compromise, there is no 

discussion, there is no ‘‘Let us get this fixed now, and we will take 

26 

care of this.’’ The way it—ancient history now. The way it used to 

be in the examination field was a more cooperative basis and working together with the banker. Today’s world—and I understand the 

world has changed. In the last 29 years that I have been CEO at 

Cattaraugus County Bank, every regulation that has landed on 

Wells Fargo or Bank of America has landed on my desk. There 

needs to be some type of tiered regulation. There needs to be a 

function where the examiners realize a difference between my risk 

profile and my business model and my relationship banking and 

the way that a $2 trillion bank does business. They do not have 

the flexibility to do that right now, so there is a real disconnect. 

Senator MORAN. So the common conversation that we have that 

community banks, by regulators headquartered here in Washington, DC, their leadership tells us that community banks are 

treated differently. But your statement, your sentence stands out 

to me about what happens to Wells Fargo—every regulation that 

has been imposed upon them is imposed upon a community bank. 

Is that true? 

Mr. MARRANCA. That is true. And I look around, and Wells 

Fargo, or whoever it may be, has X number of attorneys and X 

number of resources that they can allocate toward that new regulation. And, again, over 30 years they have built up and built up and 

built up. Every time I get that regulation, I look out of my office, 

and I am looking at Sue or Mary or Bob and trying to figure out 

how are we going to do this. In some cases, it does not relate to 

my market or my business model in a very rural part of New York 

State. 

Senator MORAN. Any sense of the qualifications, the background, 

and experience of the examiners that are in your banks today as 

compared to what they were in the past? Is there a change in the 

personnel that are examining your banks and their qualifications 

or characteristics? You mentioned in a sense the good old days, but 

is there a change in who is in our banks today as far as ability? 

Mr. MARRANCA. My perspective would be—and these are extremely sharp, smart, intelligent young people in many cases. In 

many cases—I do not know the average age of the examiner today, 

but the old corps, if you will, is gone, and the new youth is there. 

They are very smart. They are very intelligent. Do they have experience in banking? Not specifically. 

Also, I do want to add, in today’s world when you have an ADP 

specialist, a compliance specialist, a BSA specialist, a CRA specialist, none of those examiners have a holistic approach to the 

bank as a whole. They are not in any way concerned about my capital, my 100-year-old history, even my CAMELS rating or my profits. They are only concerned with their very narrow point of view 

of their expertise. So they are smart, they are intelligent, they are 

experts. But in my humble opinion, they need to broaden their holistic approach to the bank as a whole. We are not a risk to the 

FDIC fund, nor are we a risk to the economic system. So treat us 

in that way. Understand the role that we provide in the community. Because if they put us out of business, when we are gone we 

are gone, and it will be too late for my community. 

Mr. MORAN. Mr. Suellentrop, Kansas has lost thirty banks in the 

last 5 years, as I understand the numbers. One of my concerns is 

27 

that community banking may become a thing of the past based 

upon increasing regulations and the cost associated with that. And 

by that I mean that community banks will need to have more 

branches, be acquired by a larger bank to spread those costs 

among, more assets, more loans, more customers. 

Is there a consequence to the ability to keep community banking 

alive and well? Is there a consequence to this regulatory environment? And is there anything you see that is coming down the road? 

We still have the Consumer Protection Financial Bureau regulations to be put in place. Are there fears about what the next—my 

guess is you may tell me you may survive today, but are you worried about what is coming in the future and the uncertainty of 

that? How does it affect the operations of your bank? 

Mr. SUELLENTROP. Senator, I would say that there is a concern 

in terms of the number of community banks continuing to decline. 

In conversations with bankers through meetings I attended, I 

would say that in the past year or 2 years there is a significant 

concern that bankers who are likely to sell their bank and to probably merge with another institution. And one of the things that I 

think is holding them back is that their market for that is not good 

right now. But there are many bankers frustrated by the rules and 

regulations and examinations and looking to possibly get out of the 

banking business in the next several years. I do not see anything 

immediate that is on the horizon that is going to change that. The 

Consumer Protection Bureau, as you suggested, has not yet begun 

to issue its regulations. That has certainly bankers concerned 

about the potential impact of additional regulatory burden. 

Things that were discussed earlier, such as access to the secondary mortgage market, are very important to our bank and community banks because that is one of the significant ways we can 

increase our business exposure in our community. 

Mr. MORAN. Thank you, Mr. Chairman. 

Chairman BROWN. Thank you, Senator Moran. 

Senator Merkley. 

Senator MERKLEY. Thank you, Mr. Chairman, and thank you 

both for bringing your insights from the front line, if you will. 

Mr. Marranca, you addressed in part the risk retention rule and 

noted that we should have a broad exemption for qualified mortgages. By broad exemption, I wanted to interpret that, but I wanted to make sure I had the correct interpretation. Currently there 

is discussion of a very sizable downpayment requirement, which 

has been of great concern to me. When you are speaking about a 

broad exemption, are you talking about a much smaller downpayment requirement, if you will? 

Mr. MARRANCA. I think—and I will use the word ‘‘arbitrary’’—20 

percent is just unrealistic in the market, at least for a community 

bank, especially in my rural market. We have a very low per capita 

income and so forth. We have two family income earners struggling 

to either get into their first home or upgrade their home. We try 

very hard to make that dream come true and get a person in the 

right house. Mandatory 20 percent or a concentration of the secondary mortgage market out of my control, and I would hate to see 

it be with one of those 20 largest banks, I think would be—do a 

disservice to the housing market in our country and in my market. 

28 

Senator MERKLEY. Thank you. I think of what 20 percent is in 

the working community that I live in where houses are about 

$200,000, and the idea of families having $40,000 in savings to put 

down on a house seems one in a million. Thus, the folks would fall 

into a second category or a different mortgage market with yet to 

be understood interest penalties for that. My concern—and it 

sounds like you are echoing this—is that we essentially put home 

ownership out of reach of families. 

Mr. MARRANCA. I do not think you can legislate or mandate, if 

you will, the underwriting process. Our job—and I have 30 years’ 

experience, and I have a mortgage officer with many—our job is to 

underwrite our consumers when they walk in and they want that 

mortgage. We know how to do that, and it is not just downpayment. It is the ability to pay and certainly their credit and the 

debt-to-income. There are many, many factors involved. 

We can make a business judgment if somebody can afford it and 

that is the right home for them at the right price. We certainly 

have never done any subprime and 110-percent loans, et cetera, et 

cetera. So leave the business of lending to us. 

Senator MERKLEY. Mr. Suellentrop, do you share that concern 

over the potential 20-percent requirement? 

Mr. SUELLENTROP. Absolutely, Senator. We have been in the 

business of making residential lending since I joined the bank 40 

years ago almost as a key component of what we do for our customers in our community. Twenty percent down for the vast majority of homeowners is unreasonable. With the use of private mortgage insurance, there are many, many ways to satisfy safety and 

soundness in a mortgage transaction, and we originated over $30 

million in mortgage lending last year. A very important part of our 

business and serving our customers and our community, and 20 

percent would be a substantial impact to that process and that 

product for our customers. 

Senator MERKLEY. Thank you both. I want to turn to a different 

topic, which is the ability to make additional loans. Mr. Marranca, 

in your testimony you note that banks have had to pass up sound 

loan opportunities, or at least your bank has, in order to preserve 

capital. This goes to the leverage ratio that the FDIC holds. And 

as I was talking to community banks in Oregon, they expressed the 

challenge of raising capital. We have gone from irrational exuberance to irrational fear, if you will, of investing in community 

banks. 

So the result was developing the Small Business Lending Fund, 

which ICBA endorsed and assists with. We have had 600 to 700 

applications so far to Treasury for Small Business Lending Fund 

equity so that banks could do additional lending but are constrained by the capital requirements, and not a single decision has 

been made yet by Treasury. 

What is going wrong? Why isn’t Treasury making decisions and 

using this program to increase access to capital, both important to 

the community banks and important to small Main Street businesses across America? 

Mr. MARRANCA. Senator, I certainly cannot speak for the Treasury, but I would comment—I would love to participate in that, but 

I have looked at it very carefully, and there is just no way I can 

29 

do it. First of all, one capital ratio size does not fit all, just like one 

regulation does not fit all. We have plenty of capital at our bank, 

and, in fact, we need to grow our capital, but for a good reason: 

because our bank has grown 30 percent in the last 3 to 4 years. 

We acquired two branches in an adjoining county. That dropped 

our capital level down. But I am making a decision for my shareholders in the long run. What is in the best interests of the bank 

in the long run? So we dropped down, if you will, to a 7-percent 

capital level. Given our CAMELS ratings, our risk rating and so 

forth, 7 percent capital is more than adequate. 

When an examiner comes in and says, ‘‘I do not know about that 

7. It looks like you have dropped. I think you need to get up to 9, 

and we will see how you do, and we are going to be watching,’’ that 

gets my attention. It does not make me not make a loan, but yet 

it gets my attention. And I have had to slow down the growth of 

our bank from a depository standpoint because that affects the capital ratio, too. 

On the Small Business Lending Fund, our bank has $100 million—we are a small bank—a $100 million loan portfolio. It takes 

$1 million a month in new loans just to maintain that level at $100 

million, $1 million in new loans a month. I am in a very rural, nongrowth market. It is very difficult to do that. But we are doing it. 

If it is very difficult to do that, it is going to be extremely difficult if not impossible for me to raise my lending 5 percent, 6 percent, 4 percent. Thus, I cannot participate in the Small Business 

Lending Fund. I cannot create loan demand. I have the products, 

I have the people, I have the money to lend. But I cannot create 

loan demand in a recessionary, very challenges economic market. 

Senator MERKLEY. Yes. And you are in a different situation than 

some community banks in that access to capital was not your primary challenge, if you will, so that makes a lot of sense. 

Any thoughts on this, Mr. Suellentrop? 

Mr. SUELLENTROP. Well, Senator, I know there is a lot of interest 

in the Small Business Lending Fund, but I honestly do not have 

any insight into why the program is floundering. 

Senator MERKLEY. Well, the main challenge is Treasury is not 

making any decisions. 

Mr. SUELLENTROP. That is right. 

Senator MERKLEY. So I am just trying to get a sense from the 

field. I know I am hearing from community banks that are very 

frustrated that have applied, feel like this would—these are banks 

that are constrained by their capital ratios, and so their ability to 

make additional loans is directly impacted by that. 

I wanted to go back to—actually I am over my time, so thank you 

all. 

Chairman BROWN. Thank you, Senator Merkley. 

I wanted to follow up on one comment that Senator Merkley 

made or your response to the question about the 20 percent. I appreciate the flexibility and how you know your customers and know 

your communities, and a 20-percent downpayment might make 

sense for some, somebody else doing 15 percent, but having a 

strong financial credibility with you and all. So I certainly understand that flexibility. 

30 

Senator Corker mentioned that earlier. He had had an amendment, my recollection is, on the Senate floor during Dodd-Frank. 

He had an amendment for a requirement of a downpayment of 5 

or 10 percent. I cannot remember. Understanding if we had had 

that, some standard across the country, some of our problems 

might not have—surely would not have happened. Would any requirement make sense? I understand 20 percent can be harsh when 

you know your customers well and need flexibility. If there were— 

and, again, this is not in the statute, to my understanding, but if 

there were a 5- or 10-percent requirement, would community banks 

object to that? Is that something that would make sense to you? 

Mr. MARRANCA. It makes a lot of sense to me, Senator. I am a 

strong proponent of you have to have some skin in the game, 

whether it is buying a car, a house—— 

Chairman BROWN. And you do not mind a Federal rule perhaps 

saying 5 or 10? You would rather not have 20, but 5 or 10? 

Mr. MARRANCA. If there were some flexibility there with some 

limited skin in the game, I do not see—I do not believe in 100-percent lending. 

Chairman BROWN. OK. Any thoughts, Mr. Marranca? 

Mr. MARRANCA. Well, I know that the recent past has proven 

that downpayments are important. However, I know that there are 

a number of first-time home buyer programs out there through various sources that are important to the housing industry and individuals and families getting into their own homes. So I think we 

would need to recognize that there are some programs that might 

be impacted if we demand a minimum amount of 5 or 10 percent. 

Chairman BROWN. OK. Thank you very much, Mr. Suellentrop 

and Mr. Marranca. Thank you very, very much. 

The record will remain open for 5 days, as we typically do. I appreciate your attendance, and thank you, Senator Merkley and 

Senator Moran. 

The Subcommittee is adjourned. 

[Whereupon, at 11:44 a.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 

31 

PREPARED STATEMENT OF MICHAEL R. FOLEY 

SENIOR ASSOCIATE DIRECTOR, DIVISION OF BANKING SUPERVISION AND REGULATION, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

JUNE 15, 2011 

Introduction 

Chairman Brown, Ranking Member Corker, and other Members of the Subcommittee, thank you for the opportunity to testify today regarding the Federal Reserve Board’s supervision and examination of financial institutions and changes to 

our supervisory policies and procedures for these institutions in response to the recent financial crisis. I am a senior associate director in our Banking Supervision and 

Regulation division. 

Background 

The Federal Reserve has supervisory and regulatory authority for bank holding 

companies, including the consolidated supervision of large, complex financial firms, 

State-chartered banks that are members of the Federal Reserve System (State member banks), and certain other financial institutions and activities. We work with 

other Federal and State supervisory authorities to ensure the safety and soundness 

of the banking industry, foster the stability of the financial system, and provide for 

fair and equitable treatment of consumers in their financial transactions. 

The Federal Reserve is involved in both regulation, that is, establishing the rules 

within which banking organizations must operate, and supervision, ensuring that 

banking organizations abide by those rules and remain, overall, in safe and sound 

condition. A key aspect of the supervisory process is evaluating risk-management 

practices. Because rules and regulations cannot always reasonably prescribe the 

exact practices each individual bank should use for risk management, supervisors 

design policies and guidance that expand upon requirements set in rules and regulations and establish expectations for the range of acceptable practices. Supervisors 

rely extensively on these policies and guidance as they conduct examinations and 

assign supervisory ratings. 

Enhancing Supervision of Large Institutions 

The recent financial crisis revealed critical vulnerabilities in the financial regulatory framework and the financial system. In the years before the crisis, nonbank 

financial entities proliferated by exploiting gaps in the regulatory framework. This 

occurred during a period of increasing asset prices and abundant capital and liquidity, which eventually led to a relaxing of underwriting standards, deterioration in 

risk-management practices, and rapid growth of complex and opaque financial products for both consumers and investors. The combination of these factors created the 

vulnerabilities that ultimately led to the financial crisis and, in response, the Congress and the Administration last year addressed many of these issues by enacting 

the Dodd-Frank Wall Street Reform and Consumer Protection Act. 

However, even before passage of the Dodd-Frank Act, the Federal Reserve had 

been taking action to reorient its supervisory structure and strengthen its supervision of the largest, most complex financial firms in response to the crisis. In so 

doing, the Federal Reserve enhanced its large bank supervision program through 

the creation of the Large Institution Supervision Coordinating Committee, a centralized, multidisciplinary body made up of bank supervisors, economists, attorneys, 

and others. Relative to previous practices, this body makes greater use of horizontal, 

or cross-firm, evaluations of the practices and portfolios of the largest institutions. 

It relies more on additional and improved quantitative methods for evaluating the 

performance of firms, and it employs the broad range of skills of Federal Reserve 

staff more effectively. In addition, we have reorganized to more effectively coordinate and integrate policy development for, and supervision of, systemically important financial market utilities. 

More recently, we have also created an Office of Financial Stability Policy and Research at the Federal Reserve Board. This office coordinates our efforts to identify 

and analyze potential risks to the broader financial system and the economy. It also 

helps evaluate policies to promote financial stability and serves as the Board’s liaison to the Financial Stability Oversight Council. 

The crisis demonstrated that a too narrow focus on the safety and soundness of 

individual firms can result in a failure to detect and thwart emerging threats to financial stability that cut across many firms. The Dodd-Frank Act requires supervisors to take more of a macroprudential approach; that is, to supervise financial 

institutions and critical infrastructures with an eye toward not only the safety and 

soundness of each individual firm, but also taking into account risks to overall financial stability. The Supervisory Capital Assessment Program (SCAP), led by the 

32 

Federal Reserve in early 2009 as a key element of the plan to stabilize the U.S. financial system, demonstrated the feasibility and benefits of employing such a perspective. 

Building on SCAP and other supervisory work coming out of the crisis, the Federal Reserve initiated the Comprehensive Capital Analysis and Review (CCAR) in 

late 2010 to evaluate the internal capital planning processes of large, complex bank 

holding companies. The CCAR represented a substantial strengthening of previous 

approaches to ensuring that large firms have thorough and robust processes for 

managing and allocating their capital resources. We also focused on the risk measurement and management practices supporting firms’ capital adequacy assessments, 

including their ability to deliver credible inputs to their loss estimation techniques. 

While our revised internal organizational structure facilitates our implementation 

of a macroprudential approach to supervision, it does not diminish the need for careful microprudential oversight of individual institutions. This serves many purposes 

beyond the enhancement of systemic stability, including the protection of the deposit 

insurance fund, the detection of money laundering and other forms of financial 

crime, and the prevention of unlawful discrimination or abusive lending practices. 

Equally important, is that microprudential oversight also provides the knowledge 

base on which a more systemic approach must be built; we cannot understand what 

is going on in the system as a whole without a clear view of developments within 

key firms and markets. Without a strong microprudential framework, 

macroprudential policies would be ineffective. 

Supervision of Community and Regional Banks 

While many of our recent actions have focused on enhancing the supervision programs for the largest institutions, we have also been making adjustments to the supervision programs for community and regional banks in response to lessons 

learned. As liquidity strains developed at many banks during the crisis, we adjusted 

our focus to place greater emphasis on evaluating liquidity contingency funding 

plans at supervised community and regional banks. Liquidity pressures have eased 

considerably due to actions taken by the banking agencies during the crisis, recent 

legislative changes to increase the level of deposits insured by the Federal Deposit 

Insurance Corporation, and more stable market conditions. But given our experience 

during the crisis we are retaining a heightened focus on liquidity management and 

planning, particularly for institutions that rely on more volatile or nontraditional 

funding sources. 

As commercial real estate (CRE) began to deteriorate and affect the performance 

of supervised institutions, we conducted reviews of our implementation of the 2006 

interagency guidance addressing CRE concentrations. These reviews helped us to 

identify issues for which examiners and bankers needed clarification and to contribute to the 2009 interagency guidance aimed at facilitating prudent workouts of 

CRE loans. As real estate conditions have remained weak and adversely affected the 

performance of many banks, we have continued to refine our examination procedures to address emerging supervisory issues related to CRE lending. 

To learn more from recent events, we have begun to analyze the characteristics 

of community banks that remained in sound condition throughout the crisis. Our 

preliminary work suggests that these institutions had many fundamental characteristics in common. For example, most of these banks had relatively well-diversified 

loan portfolios and because of that were able to report strong earnings and net interest margins throughout the crisis. They tended to have limited reliance on 

noncore funding and had strong capital levels as they entered the crisis. As we continue our study, we hope that what we learn will prove helpful in our efforts to 

evaluate and refine supervisory processes in the wake of the crisis. 

In addition to these efforts, we have also increased our outreach efforts with community and regional banks. In October 2010, the Board formed a Community Depository Institutions Advisory Council that includes representatives from across the 

country and provides the Federal Reserve with direct insight and information from 

community bankers about the economy, lending conditions, supervisory matters, and 

other issues of interest. We expect these ongoing discussions will provide a particularly useful and relevant forum for improving our community bank supervision program, and a better understanding of how legislation, regulation, and evolving examination activities affect small banking organizations. 

Additionally, the Board recently established a special supervision subcommittee 

that provides leadership and oversight on a variety of matters related specifically 

to community bank supervision. A primary role of this subcommittee, which includes Governors Elizabeth A. Duke and Sarah Bloom Raskin, two Board members 

with significant community banking experience, is to review policy proposals and 

33 

evaluate their potential effect on smaller institutions, both in terms of safety and 

soundness and potential regulatory burden. 

While the crisis has made it clear that some tightening of supervisory expectations was needed, we are also mindful of the risks that excessive tightening could 

have on banks’ willingness to lend to creditworthy small businesses and consumers. 

Consequently, we have worked hard to ensure that our examiners are well-trained 

and employ a balanced approach when reviewing banks’ underwriting and risk-management practices. We expect examiners to strive for consistency in the examination 

process throughout the business cycle. Our Rapid Response program, which has 

been in effect since the crisis, is a widely attended weekly conference call for examiners that has been invaluable in delivering these messages, and others, to our field 

examiners. 

Compliance and Examination Costs 

Banks consistently tell us that they face a number of regulatory uncertainties, 

which makes it hard for them to calculate the potential cost of compliance and its 

potential effect on operations and profitability. Firms of all sizes have been communicating these concerns, despite the fact that the requirements of the Dodd-Frank 

Act are primarily directed at firms with consolidated assets of $50 billion or more. 

Smaller institutions voice concerns that supervisory expectations being set for the 

largest institutions could ultimately be imposed on them in a burdensome way, 

which will adversely affect community bank competitiveness and profitability, as 

these institutions have less ability to absorb increased compliance costs and have 

less staff available to manage new processes. 

The Federal Reserve is cognizant of the challenges institutions, especially smaller 

institutions, face in the current environment. Banking supervision should be conducted in a way that is effective for all institutions, but it should also be scaled to 

the size and complexity of the supervised firm. The largest, most complex banks will 

incur costs to comply with the requirements of the Dodd-Frank Act. For example, 

stress testing provisions in the Dodd-Frank Act require these institutions to adequately identify the risks associated with their diverse business lines and to quantify this risk taking, which will require investments in data management technology 

and other risk identification systems. Smaller institutions, while still expected to 

adequately measure, monitor, and control risk in their organizations, will not necessarily need to incur additional costs, assuming existing risk management structures are sufficiently robust. 

Continuing Credit Challenges 

Credit markets have been recovering slowly since the financial crises, and recent 

measures of aggregate credit outstanding have shown signs of improvement after 

declining throughout 2009 and much of 2010. Nonrevolving consumer credit outstanding, which includes auto and student loans, has increased for the past 9 

months. Issuance of corporate bonds and syndicated loans has been robust for the 

past few quarters, and new issuance of commercial mortgage-backed securities increased in the first quarter of 2011, albeit from very low levels. Outstanding balances of commercial and industrial loans have also resumed modest growth. 

However, residential and commercial real estate remain lagging sectors. This continues to present challenges for banks and supervisors. With housing values flat or 

deteriorating in many markets, there are renewed concerns about the health of the 

mortgage market and home equity loans in particular. In addition, weak fundamentals in the CRE sector, including high vacancy rates and declining rents, continue 

to place pressure on all but the highest quality properties with strong tenants in 

healthier markets. With residential and commercial property values still under 

strain, heightened reserve levels at banks remain appropriate for these sectors, and 

we expect that banks will continue to incur losses due to ongoing weakness in real 

estate markets. It will take time to make progress on the overhang of distressed 

commercial and residential real estate, and banks will need to take strong steps to 

ensure that losses are recognized in a timely manner, and that reserves and capital 

levels remain adequate. 

Conclusion 

The crisis demonstrated the need to always be mindful of and diligent about addressing the possible implications of severely adverse outcomes for individual institutions and the financial system more broadly. Enhancements the Federal Reserve 

has made to its supervisory process, coupled with improvements required by the 

Dodd-Frank Act, support enhanced regulation and supervision of large, complex 

firms that have the potential to trigger systemic risks. But, improvements in the 

supervisory framework will lead to better outcomes only if day-to-day supervision 

is well executed, with risks identified early and promptly remediated. When we 

34 

1 Noncurrent loans are those that are 90 or more days past due or are on nonaccrual. 

have significant concerns about risk management at complex firms, we are raising 

those concerns forcefully with senior management at the firms, holding them accountable to respond, and tracking their progress. 

The Federal Reserve is also enhancing supervision of regional and community 

banks, placing greater emphasis on the development of sound risk-management 

practices. In so doing, we are mindful of the need to ensure that bank supervision 

is scaled to the size and complexity of the supervised firm; and that bank management and examiners take a balanced approach to ensuring the safety and soundness 

of the banking system and serving the credit needs of the community. 

PREPARED STATEMENT OF CHRISTOPHER J. SPOTH 

SENIOR DEPUTY DIRECTOR, DIVISION OF RISK MANAGEMENT SUPERVISION, FEDERAL

DEPOSIT INSURANCE CORPORATION

JUNE 15, 2011 

Chairman Brown, Ranking Member Corker, and Members of the Subcommittee, 

thank you for the opportunity to testify on behalf of the Federal Deposit Insurance 

Corporation (FDIC) about our supervisory process, how it has changed based on lessons we learned from the crisis, and what we see as opportunities for continued improvement. 

Congress created the FDIC in 1933 in response to the most serious financial crisis 

in U.S. history. Our mission is to promote financial stability and public confidence 

in individual banks and in our Nation’s banking system through bank supervision, 

deposit insurance, consumer protection, and the orderly resolution of failed banking 

institutions. As the primary Federal supervisor for the majority of U.S. community 

banks, the FDIC seeks to maintain a balanced approach to bank supervision, regardless of financial and economic conditions. In our unique role as deposit insurer, 

we have a vital interest in assessing risks to the Deposit Insurance Fund (DIF) 

posed by all FDIC-insured institutions. 

My testimony today first provides some background information on the condition 

of the industry and the problems that led to the recent financial crisis. I will discuss 

our approaches to supervising large institutions and smaller community banks. Finally, I will discuss some provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) that we are incorporating into our supervisory process. 

Condition of the Industry 

Leading up to the financial crisis, FDIC-insured institutions recorded 6 consecutive years of record earnings, culminating in $145.2 billion in 2006. However, this 

extended period of industry profitability masked the underlying weaknesses in credit quality that would emerge starting in 2007 as real estate markets weakened and 

the U.S. economy moved into recession. By 2008, annual industry earnings had fallen to just $4.5 billion and, in 2009, the industry recorded a net loss of $9.8 billion— 

the largest loss in its history. Quarterly provisions for loan losses taken by FDICinsured institutions since the end of 2007 now total just under $645 billion, equal 

to over 8 percent of the book value of loans outstanding at the beginning of 2008. 

During the first quarter of 2011, FDIC-insured institutions recorded annual net 

income of $29 billion, the highest level since before the recession, but still well 

below the all-time highs of the mid-2000s. The main driver of earnings improvement 

has been steadily reduced provisions for loan losses. This reflects general improvement in asset quality indicators, including declining levels of noncurrent loans and 

net charge-offs for all major loan types. However, the ratio of noncurrent loans 1 to 

total loans, at 4.7 percent, is still relatively high and remains above the levels seen 

in the late 1980s and early 1990s. While the reduced provisions for loan losses are 

encouraging, it is important to note that net operating revenue fell by $5.5 billion 

in the first quarter of 2011 compared to 1 year ago. Lower revenues, in part, reflect 

reduced loan balances, which have declined in 10 of the past 11 quarters. Growth 

in well-underwritten loans is essential not only for banks to build revenues but also 

to provide a stronger foundation for economic recovery. Recent surveys, such as the 

Federal Reserve Senior Loan Officers’ Opinion Survey and the National Federation 

of Independent Businesses’ Survey on Small Business Economic Trends, also indicate that borrower demand remains sluggish. 

Despite the economic challenges, community banks, which comprise the vast majority of banks that we supervise, continue to play a vital role in credit creation 

35 

2 In merger-adjusted growth analysis, loan balances reported by banks with assets less than 

$1 billion in the current quarter are compared with these same institutions’ loan balances in 

a prior period. Prior-period loan balances include those of any institutions merged or acquired 

in intervening periods. 

across the country, especially for small businesses. This has been borne out by loan 

originations over the past several years. On a merger-adjusted basis, community 

bank loan balances have increased by about 1 percent since the second quarter of 

2008. 2 However, over the same period, overall industry loan balances fell by about 

9 percent. 

While commercial property fundamentals point to stabilization, recent weakness 

in both residential and commercial property price trends highlight continued concerns. The S&P/Case-Shiller National Housing Index is down 5.1 percent year-overyear through first quarter 2011 and the Moody’s/REAL Commercial Property Price 

Index has decreased by 8.5 percent in the year ending in March 2011. In both cases, 

distressed properties are weighing down prices. 

Overall, we are cautiously optimistic regarding the current condition and trends 

in the banking industry. The number of institutions on the FDIC’s ‘‘Problem List’’ 

is leveling off and the number of institution failures appears to have peaked in 

2010. During the first quarter of 2011, the number of institutions on the FDIC’s 

‘‘Problem List’’ increased slightly from 884 to 888. Similarly, the current pace of failures is lower than the 157 failures in 2010. Nevertheless, the number of troubled 

institutions remains high at 12 percent of all insured institutions, indicating that 

a portion of the industry continues to struggle with lingering credit-quality issues. 

These issues adversely impact the ability of many institutions to grow their lending 

activity. 

Factors That Led to the Recent Financial Crisis 

Factors that led to the crisis of 2008 and motivated the legislative reforms were 

in four broad areas: excessive reliance on debt and financial leverage, misaligned 

incentives in financial markets, failures and gaps in financial regulation, and the 

erosion of market discipline due to regulatory arbitrage and ‘‘Too Big to Fail.’’ 

With regard to financial regulation, the regulatory reforms put in place for federally insured depository institutions following the banking crisis of the 1980s and 

early 1990s helped to constrain risk-taking on bank balance sheets. However, opportunities for regulatory arbitrage allowed risks to grow in the so-called shadow banking system—a network of large-bank affiliates, special-purpose vehicles, and 

nonbank financial companies that existed largely outside of the prudential supervision, capital requirements, and FDIC receivership powers that apply to federally 

insured depository institutions in the U.S. The migration of financial activities outside of regulated financial institutions to the shadow banking system ultimately 

lessened the effectiveness of regulation and made the financial markets more vulnerable to a breakdown. 

Many of the structured finance activities that generated the largest losses were 

complex and opaque transactions undertaken at the intersection of the lightly regulated shadow banking system and the more heavily regulated traditional banking 

system. For instance, private-label mortgage backed securities (MBS) and associated 

derivatives were originated through mortgage companies and brokers and facilitated 

by banks that were securitizers. As became evident, many of the underlying mortgage loans were poorly underwritten and contained a host of layered risks. 

The housing bubble ensued, fueled with poorly underwritten loans originated for 

sale into the securitization market. The MBS were subject to minimum securities 

disclosure rules that are not designed to evaluate loan underwriting quality. For 

banks, once these loans were securitized, they were off the balance sheet and no 

longer on the radar of many banks and bank regulators. The mortgage loans began 

to default in high numbers undermining the MBS market. Eventually, the housing 

bubble collapsed, construction and development slowed, unemployment rose, and the 

economy went into recession. In addition, home prices continue to be depressed due 

to several factors including flawed mortgage servicing practices, which are not yet 

fully corrected, the overhang of foreclosure inventory, and the potential for litigation 

exposure. 

One of the most powerful inducements toward excess leverage and institutional 

risk-taking in the period leading up to the crisis was the lack of effective market 

discipline. Several large, complex U.S. financial companies at the center of the 2008 

crisis could not be wound down in an orderly manner when they became nonviable. 

With the exception of any insured depository institutions that they owned, their operations were subject to the commercial bankruptcy code, as opposed to FDIC receivership laws. In addition, some major important segments of their operations were 

36 

located abroad and therefore outside of U.S. jurisdiction. In the heat of the crisis, 

policy makers in several instances resorted to bailouts instead of letting these firms 

collapse into bankruptcy because they feared that the losses generated in a failure 

would create a cascade of defaults through the financial system, freezing financial 

markets and seriously damaging our economic system. 

Community banks were generally not involved in the mortgage-related issues at 

the first stages of the financial crisis, but were impacted as the recession took hold. 

Community banks tend to focus on local markets and loans for which local knowledge and personal service provide a competitive advantage, such as residential construction loans and other smaller commercial real estate projects. Construction and 

development (C&D) lending in areas that had experienced the steepest increase in 

home prices during the boom was hit first. Credit losses rose and subsequently 

spread across all loan types and rose as borrowers were caught in the recession and 

then slow recovery. At the same time, community banks’ other sources of revenue 

used to offset credit losses from real estate portfolios was limited. 

FDIC Supervisory Responsibilities 

Despite the recent economic disruptions and subsequent stabilization, the FDIC’s 

supervisory programs, while responsive to intensified problems in the industry, remain balanced. To accomplish this goal, the FDIC continuously enhances its examination and other supervisory approaches and maintains dialogue with institutions 

throughout the examination cycle. 

The FDIC serves as the primary Federal regulator for State-chartered institutions 

that are not members of the Federal Reserve System. The FDIC currently supervises 4,664 institutions, 4,358 of which have total assets of less than $1 billion. Regardless of size, as deposit insurer, the FDIC has an important interest in the condition of all insured institutions and their individual and aggregate impact on the 

DIF. As a result, the FDIC also has back-up authority to participate in examinations, with the primary Federal regulator, at any insured institution. 

The FDIC has, for a number of years, had different approaches to its supervision 

of larger, complex institutions from that of community banks. The larger, more complex institutions, and some mid-tier institutions, are subject to continuous on-site 

examination by teams of examiners and to extensive reporting. The smaller community banks have an annual or 18-month exam cycle and are also monitored off-site 

using quarterly Call Report information. The differences in the supervision of large 

and small banks are discussed in more detail below. 

Supervision of Large Banks and Financial Firms 

Supervisory programs, particularly for the larger institutions, have evolved to address the issues that led to the financial crisis, and to reflect the important protections and changes added by the Dodd-Frank Act. The Act requires that the FDIC 

and the Federal Reserve Board jointly issue regulations to implement new resolution planning and reporting requirements. These rules will apply to bank holding 

companies with total assets of $50 billion or more and nonbank financial companies 

designated by the Financial Stability Oversight Council (FSOC) as ‘‘Systemically 

Important Financial Institutions’’ (SIFIs). 

In addition, covered companies would be required to submit a resolution plan. 

Resolution plans should identify and map covered companies’ business lines to legal 

entities and provide integrated analyses of their corporate structure; credit and 

other exposures; funding, capital, and cash flows; domestic and foreign jurisdictions 

in which they operate; their supporting information systems and other essential 

services; and other key components of their business operations. The resolution plan 

requirement in the Dodd-Frank Act appropriately places the responsibility on financial companies to develop their own plans ‘‘for rapid and orderly resolution in the 

event of material financial distress or failure’’ with review by the FDIC and the Federal Reserve Board. 

The agencies are also working to develop a substantive process for reviewing resolution plans to determine whether a plan is both credible and would facilitate an 

orderly resolution of the company under the Bankruptcy Code. If a resolution plan 

is found to be ‘‘not credible,’’ then the FDIC and the Federal Reserve Board may 

impose more stringent standards and take other action. If, after 2 years, the company’s plan is still ‘‘not credible,’’ the FDIC and the Federal Reserve Board may, 

in consultation with the FSOC, direct a company to divest certain assets or operations. 

To focus the FDIC’s expanded responsibilities to monitor and, potentially, resolve 

SIFIs, we established an Office of Complex Financial Institutions (OCFI). The OCFI 

will be responsible for the FDIC’s role in the oversight of large bank holding companies and their corresponding insured depository institutions as well as for nonbank 

37 

3Throughout this testimony, for purposes of data analysis, community banks are defined as 

banks and thrifts with total assets of less than $1 billion. 

financial companies designated as systemically important by the FSOC. The OCFI 

will handle the FDIC’s responsibilities, in concert with the Federal Reserve Board, 

for reviewing resolution plans and credit exposure reports developed by the SIFIs. 

Also, the OCFI will be responsible for implementing and administering the FDIC’s 

SIFI resolution authority and for conducting special examinations of SIFIs under 

the FDIC’s back-up examination and enforcement authority. 

Supervision of Community Banks 

Supervision of community banks consists of regular on-site examinations along 

with quarterly off-site monitoring of financial performance. Where conditions dictate 

closer supervision, we conduct on-site visits and collect supplemental information. 

As the supervisor of 4,358 community banks, 3 the FDIC has a keen appreciation 

for the important role community banks play in the national economy. Community 

banks have branches in nearly all towns and urban areas, and about two-thirds of 

all branches in rural areas belong to community banks. 

The FDIC’s supervisory activities are carried out by examiners working from field 

offices located in 85 communities across the country. These examiners know the 

community banks in their areas and are familiar with the local conditions facing 

those banks. Many have seen more than one previous economic down cycle and recognize the critical role that community banks play in credit availability. 

As discussed earlier, community banks still face lingering problems in their real 

estate loan portfolios and spillover effects caused by the collapsed housing bubble 

and the slow economy. Asset quality is not deteriorating as before, but volumes of 

troubled assets and charge-offs remain high, especially in the most affected geographic areas. The FDIC supervisory responses are scaled according to the severity 

of the weaknesses that a bank may exhibit. Banks with significant loan problems 

require close supervisory attention. 

Supervisory Action To Encourage Real Estate Recovery and Lending 

Throughout the real estate and economic downturn, the FDIC has advocated for 

policies that will help community banks and their customers navigate this challenging period and mitigate unnecessary losses. We share community banks’ desire 

to restore profitability, strengthen asset quality, and serve the credit needs of local 

markets. The FDIC has worked closely with banks as they have taken steps to raise 

capital, enhance their loan workout functions, and revise strategic plans to remain 

competitive in the financial services industry. Through our regional and field offices 

located throughout the country, the FDIC actively communicates with the community banks we supervise and provides recommendations for addressing operational 

and financial weaknesses as appropriate. 

In addition, the FDIC has joined several interagency efforts that encourage banks 

to originate and restructure loans to creditworthy borrowers, and to clarify outstanding guidance. For example, the Federal bank regulatory agencies issued the 

Interagency Statement on Meeting the Needs of Creditworthy Borrowers on November 12, 2008, which encouraged banks to prudently make loans available in their 

markets. The agencies also issued the Interagency Statement on Meeting the Credit 

Needs of Creditworthy Small Business Borrowers on February 12, 2010, to encourage prudent small business lending and emphasize that examiners will apply a balanced approach in evaluating loans. This guidance was issued subsequent to the October 30, 2009, Policy Statement on Prudent Commercial Real Estate Workouts that 

encourages banks to restructure loans for commercial real estate mortgage customers experiencing difficulties making payments. The CRE Workouts Guidance reinforces long-standing supervisory principles in a manner that recognizes pragmatic 

actions by lenders and small business borrowers are necessary to weather this difficult economic period. 

The FDIC also joined the other banking agencies in issuing the Interagency Appraisal and Evaluation Guidelines on December 2, 2010, to clarify expectations for 

real estate appraisals. Clarification of these guidelines was important for the industry given changes in property values over the past several years. We do not require 

banks to recognize losses on loans solely because of collateral depreciation or require 

appraisals on performing loans unless an advance of new funds is being contemplated. Moreover, the interagency guidance recognizes that borrowers’ ability to 

repay real estate loans according to reasonable terms remains the primary consideration in a lending decision. 

We also actively engage with community banks at the State level and nationally 

through various trade associations, which helps our agency articulate its superVerDate Nov 24 2008 07:49 Mar 06, 2012 Jkt 048080 PO 00000 Frm 00041 Fmt 6621 Sfmt 6621 L:\HEARINGS 2011\06-15B DISTILLER\61511.TXT JASON
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visory expectations on important issues through a variety of forums. For example, 

the FDIC established an Advisory Committee on Community Banking to provide us 

with advice and guidance on a broad range of policy issues impacting small community banks, as well as the local communities they serve, with a focus on rural areas. 

The Advisory Committee has provided valuable input on examination policies and 

procedures, credit and lending practices, deposit insurance assessments, insurance 

coverage issues, regulatory compliance matters, and obstacles to the continued 

growth and ability to extend financial services in their local markets. We also sponsor training events for community banks including regional and national teleconferences on risk management and consumer protection matters, as well as Directors 

Colleges to help bank directors better understand the supervisory process. 

The FDIC conducts more than 2,500 on-site examinations annually, and we recognize that questions and even disagreements with individual examination findings 

may sometimes arise, especially in difficult economic times. The FDIC has a number 

of outlets for bankers to express their concerns when this occurs. On March 1, we 

issued guidance reiterating that FDIC-supervised institutions can voice their concerns about an examination or other supervisory determination through informal 

and formal channels. The FDIC takes pride in the professionalism of its examination force but also strongly encourages banks to provide feedback on FDIC examinations. The guidance highlights that often the most effective method for understanding why the FDIC reached a particular conclusion during its examination is 

for the bankers to discuss the issue with the examiner-in-charge, field office supervisor, or the appropriate official in the Regional Office. 

Addressing Regulatory Burden 

The FDIC is interested in finding ways to eliminate unnecessary regulatory burden on community banks, whose balance sheets are much less complicated than 

those of the larger banks. We continuously pursue methods to streamline our supervisory process through the use of technology and other means to reduce disruption 

associated with examination activity. While maintaining an effective examination 

process is paramount, we are sensitive to banks’ business priorities and strive to 

be efficient in our work. 

Certain supervisory programs are designed to be less burdensome on small banks 

compared to the larger, more complex institutions. For example, statutorily mandated examinations are less frequent for certain well-managed, well-capitalized institutions under $500 million in size. There are also fewer reporting requirements 

for smaller institutions, including Call Report line items and requirements for other 

reporting. In addition, to make it easier for smaller institutions to understand the 

impact of new regulatory changes or guidance, we specifically note up front in our 

Financial Institution Letters (the vehicle used to alert banks to any regulatory 

changes or guidance) whether the change applies to institutions under $1 billion. 

Finally, there are less burdensome requirements for smaller institutions in their implementation of the Community Reinvestment Act. 

As we testified before this Subcommittee in April, much of the Dodd-Frank Act 

should have no direct impact on community banks, and certain changes in the Act 

provide benefits. For example, the Act permanently increased deposit insurance coverage to $250,000 and made changes in the assessment base that will result in significantly lower premiums for most banks under $10 billion in assets. Further, provisions of the Act that impose additional capital and other heightened prudential 

requirements on the largest financial institutions are aimed at reducing systemic 

risks. Those and other provisions of the Act should do much to return competitive 

balance to the marketplace by restoring market discipline and ensuring appropriate 

regulatory oversight of systemically important financial companies. 

Finally, the Dodd-Frank Act should help level the playing field with nonbanks as 

they will now be required to meet the same standards as banking institutions, especially in the mortgage finance arena. However, it is clear that consumers have come 

to expect, and depend greatly on, insured institutions to design and offer fair and 

equitable financial products and services. We believe the public’s significant trust 

in community banks has been fostered by their diligence in maintaining effective 

consumer protection programs. 

Much of the regulatory cost of the Dodd-Frank Act will fall, as it should, directly 

on the large institutions that create systemic risk. The leveling of the competitive 

playing field will help preserve the essential diversity of our financial system, and 

prevent any institution from taking undue risks at the expense of the public. 

Conclusion 

The FDIC understands the significant challenges faced by banks and their borrowers as the real estate markets and the financial sector recover from the dislocaVerDate Nov 24 2008 07:49 Mar 06, 2012 Jkt 048080 PO 00000 Frm 00042 Fmt 6621 Sfmt 6621 L:\HEARINGS 2011\06-15B DISTILLER\61511.TXT JASON
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* Statement Required by 12 U.S.C. §250: The views expressed herein are those of the Office 

of the Comptroller of the Currency and do not necessarily represent the views of the President. 

tions that precipitated the crisis. The FDIC has made supervisory enhancements 

that address the lessons learned from the recent crisis and organizational changes 

to implement our new responsibilities from the Dodd-Frank Act. The FDIC has 

joined with other Federal financial regulators in encouraging lenders to continue 

making prudent loans and working with borrowers experiencing financial difficulties. As the primary Federal regulator for most community banks, the FDIC recognizes their critical role in helping local businesses fuel economic growth and we support their efforts to make good loans in this challenging environment. 

Thank you and I would be pleased to answer any questions. 

PREPARED STATEMENT OF DAVID K. WILSON 

DEPUTY COMPTROLLER, CREDIT AND MARKET RISK, OFFICE OF THE COMPTROLLER OF

THE CURRENCY

JUNE 15, 2011 

I. Introduction* 

Chairman Brown, Ranking Member Corker, and Members of the Subcommittee, 

my name is Dave Wilson, and I am currently the Deputy Comptroller for Credit and 

Market Risk at the Office of the Comptroller of the Currency. In July, I will assume 

the position of Senior Deputy Comptroller for Bank Supervision Policy and Chief 

National Bank Examiner at the OCC. I appreciate the opportunity to discuss the 

OCC’s perspectives on lessons learned from the financial crisis and our ensuing approach to bank supervision. 

My testimony addresses four key areas. First, I briefly summarize some of the 

major factors that contributed to the financial crisis. Next, I discuss lessons learned 

from the crisis and specific steps the OCC is taking to incorporate those lessons 

learned into our bank supervision activities and practices. With this background, I 

then describe the OCC’s overall approach to bank supervision—our role as supervisors, and the efforts we are taking to ensure that as we implement needed supervisory enhancements and the reforms mandated by the Dodd-Frank Act, our supervision remains balanced, fair, and appropriately tailored to the size and risk of individual institutions. Finally, pursuant to the Subcommittee’s request, I provide a 

brief update on small business and real estate lending, mortgage servicing, and 

trading. 

II. Factors That Contributed to the Financial Crisis 

Numerous studies and papers have been written that explore in depth the causes 

and factors that led to the recent crisis. Rather than catalog and summarize those 

findings, I want to offer my perspective, as a bank examiner and supervisor, on key 

precipitating factors that both supervisors and bankers failed to adequately recognize and mitigate. 

In many respects, the seeds for the crisis were sown by the prolonged period of 

a relatively benign economy that fostered a market environment where investors, 

lenders, and supervisors became overly complacent about risk. This environment, 

characterized by low interest rates, strong economic growth, excess liquidity, and 

very low rates of borrower defaults spurred investors to chase yields, and U.S. mortgage-backed securities offered higher yields on historically safe investments. Hungry 

investors tolerated increased risk to obtain those higher yields, especially from securities backed by subprime markets, where yields were highest. This demand attracted new mortgage lenders and brokers many of whom had limited business experience or financial strength and operated outside of the commercial banking system and with little regulatory oversight. Increased risk layering—in the form of 

smaller downpayments, lower required credit scores, higher debt-to-income ratios, 

reduced documentation of income, and temporary reductions in monthly payments— 

became prevalent as lenders and borrowers became willing to finance and take on 

ever higher levels of debt, often on the belief that such debt could be easily refinanced or extinguished through the sale of underlying assets whose prices, it was 

assumed, would continue to escalate. The rapid increase in market share by unregulated brokers and originators put pressure on regulated banks to lower their underwriting standards, which they did, though not to the same extent as was true for 

unregulated mortgage lenders. 

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ment terms, reduced financial covenants, and higher borrower leverage in return for 

marginally higher yields. The apparent risk to commercial banks’ own loan portfolios was considered limited, because such banks and bank affiliates increasingly 

followed an ‘‘originate-to-distribute’’ model, syndicating most of these exposures for 

sale to institutional investors rather than holding them on their balance sheets for 

extended periods. 

Compensation structures that rewarded loan production over loan quality placed 

added incentives for lenders to originate and produce loan products. Over time, 

product structures and funding mechanisms became more complex and opaque as 

underlying loans were repackaged, tranched, and further leveraged and financed in 

the form of various securitization and off-balance sheet funding conduits. Some of 

these structures, such as complex collateralized debt obligations, were poorly understood. Credit rating agencies and investors had a false sense of security that, no 

matter how poor the underwriting of the underlying asset, the risk could be adequately mitigated through geographic and product diversification, sufficient credit 

tranching, and other financial engineering. In many cases, the net result was poorly 

underwritten loans that financed longer-term assets and that were funded through 

short-term wholesale funds providers who, as it was later revealed, were extremely 

sensitive to real or perceived risks. 

Smaller community banks were not immune from the build-up of risks occurring 

in the system. In particular, as the larger players increased their market shares in 

various retail credit products, such as residential mortgage loans and credit cards, 

community banks increasingly had to look elsewhere for profitable lending opportunities. For many community bankers, the housing and attendant real estate boom 

provided a natural area for growth—CRE (commercial real estate) lending for construction and development. This was especially true in areas with vibrant housing 

markets, where home building was a key part of the regional economy. Because this 

type of lending puts more of a premium on knowledge of individual borrowers and 

local market conditions, this type of lending is often well-suited for community 

banks. However, many smaller banks became overly concentrated in this sector and 

a smaller, but not insignificant, number fueled their rapid CRE growth—often in 

areas outside of their home market—with short-term volatile funding sources. 

Lax underwriting, excessive leverage, rapid growth, and concentrations are all too 

familiar refrains from past credit cycles and were symptoms that, with the benefit 

of hindsight, supervisors and market participants should have better mitigated at 

a much earlier stage. What amplified these factors from past cycles was the manner 

in which these excesses were spread and disbursed throughout the global financial 

system. When the subprime mortgage market began to collapse, the opaqueness of 

the more complex product and funding structures made it difficult for bankers, investors, funds providers, and supervisors to readily assess the nature and scope of 

potential risk exposures. This uncertainty contributed to an abrupt shift in risk tolerance by many market participants across the globe and served to compound losses 

as investors attempted to unwind positions. Secondary market liquidity for mortgages and leveraged loan products largely evaporated, leaving many larger banks 

with an unfunded pipeline of loan commitments that would require on-balance sheet 

funding. Likewise, short-term funding vehicles, such as asset-backed commercial 

paper conduits, became strained as investors increasingly chose not to roll over maturing paper, placing further strains on the balance sheets of banks that served as 

sponsors to such conduits. Bankers and supervisors underestimated the resulting 

rapidity and depth of the global liquidity freeze. 

As various external funding sources evaporated, concentrations and correlations 

that bank risk managers believed had been diversified away became more apparent. 

For example, direct exposures to subprime mortgages that had been avoided in a 

bank’s lending operations nonetheless emerged through bank affiliate activities and 

affiliate-sponsored off-balance sheet vehicles. Products, markets, and geographic regions that previously were looked to as a source of risk diversification became more 

highly correlated as contagion effects spread across the globe and industry sectors. 

The resulting strains of the financial crisis have been felt by both large and small 

banks. While the initial impact was largely confined to the largest institutions that 

were heavily reliant on wholesale funding, as the economy continued to deteriorate, 

banks of all sizes faced higher loan losses, lower margins, and reduced profitability, 

and are only now showing signs of recovery. 

III. Lessons Learned and Areas for Continued Improvement for Bank Supervision 

The financial crisis underscored that no amount of financial engineering can obviate the need for bankers and bank supervisors to adhere to and monitor the basic 

precepts of sound banking practice: prudent underwriting practices throughout the 

41 

credit cycle; strong risk-management systems that identify and control the build-up 

of risk concentrations across products and business lines; diversified funding 

sources, adequate loan loss reserves, and strong capital cushions that allow the 

bank to continue its normal operations during downturns or funding strains; and 

strong corporate governance, including compensation structures, that set the tone 

for balanced and prudent risk taking. While these fundamentals are clearly important, they primarily focus on the risks within an individual banking organization. 

As the financial crisis highlighted, bankers, and more importantly supervisors, must 

develop better tools to evaluate and address emerging risks across the system and 

how those risks may be interconnected. Similarly, regulators need to take steps to 

restore greater transparency and accountability by all market participants—lenders, 

borrowers, and investors—to facilitate market discipline on excessive risk taking 

and dispel reliance on potential or perceived Government backstops. 

The sections that follow describe in some detail steps that the OCC has or is taking to address each of these areas. But let me begin by noting that while the OCC 

believes that these lessons are applicable for banks of all sizes, we are cognizant 

of the need to tailor our expectations to the scope and complexity of each bank’s activities. As a result, our expectations for large banking organizations are generally 

more stringent and higher than for community banks whose scale of operations and 

complexity are considerably smaller. While we believe large banks must be held to 

higher standards, we do not subscribe to the view that big, in and of itself, is bad. 

Our country’s economic well-being is inevitably linked to the global economy and if 

the U.S. financial system is to remain a predominant force in the global environment, we need to have banking organizations that can compete effectively with their 

global counterparts across product and business lines. Similarly, as we institute reforms to address some of the problems and abuses stemming from the last crisis, 

we need be careful that we do not attempt to wring all the risk or complexity out 

of the banking system. Banks’ fundamental role is risk intermediation, and financial 

innovation and expansion of credit are important drivers of our economy. Banks 

must be able to respond to customer and investor demand for new and innovative 

products and services. As corporations become more risk management savvy, so do 

their demands for risk management products, such as various derivative instruments. Similarly, as technology advances, the methods and ways that consumers 

choose to interface with banks will become more complex and varied. We must allow 

banks to respond to this changing landscape provided that they do so in a manner 

that is safe and sound and conducted with integrity. 

A. Prudent Underwriting Throughout the Cycle 

The financial crisis underscored that underwriting standards matter, regardless 

of whether loans are being originated to hold on the bank’s own balance sheet or 

sold to third party investors. Supervisors and banking organizations must be more 

diligent in ensuring that underwriting standards are not compromised by competitive pressures from unregulated firms, by investors who may be willing to take on 

more risk for incremental yield, or by desire for rapid growth or market share in 

products or geographic regions. 

In the immediate aftermath of the subprime crisis, the OCC cautioned national 

banks that they should apply sound, consistent underwriting standards regardless 

of whether a loan is originated with the intent to hold or sell. Likewise, we have 

admonished national banks not to compromise their underwriting standards due to 

competitive pressures. Where we see signs of such slippage, we are intervening at 

an early stage. For example, last June in response to signs of slippage that examiners were seeing in some leveraged loan facilities, we issued guidance to our examiners that reinforced our supervisory expectations for this type of lending and directed them to criticize or classify credits that exhibit minimal repayment capacity, 

excessive leverage or weak/nonexistent covenants, even when the credits had been 

recently advanced. 

Because of the adverse impact that competitive pressures can have on underwriting standards, the OCC has been a strong proponent for national, uniform 

standards for certain lending products, most notably residential mortgage loans. 

As we take steps to promote more consistent and uniform underwriting practices 

and standards and to lean in more forcefully when we see slippage either in the 

system or at individual banks, we are mindful of the need to strike an appropriate 

balance. Ensuring that banks remain safe and sound, while at the same time meeting the credit needs of their communities and customers is one of the OCC’s core 

missions, and knowing when to bear down is one of the most fundamental calls that 

examiners and policy makers must make. Waiting too long or supervising too lightly 

will result in some banks using federally insured deposits to make unsafe loans that 

can ultimately cause them to fail. On the other hand, supervising too strictly or inVerDate Nov 24 2008 07:49 Mar 06, 2012 Jkt 048080 PO 00000 Frm 00045 Fmt 6621 Sfmt 6621 L:\HEARINGS 2011\06-15B DISTILLER\61511.TXT JASON
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consistently can cause banks to become too conservative and deny loans to creditworthy borrowers. 

Since the onset of the financial crisis, the OCC has taken a number of actions 

to improve our ability to objectively monitor trends in credit quality and underwriting standards to help us determine when stronger supervisory intervention is 

needed. These actions supplement our more traditional tools of on-site examinations, the annual interagency Shared National Credit review, and the OCC’s annual 

underwriting survey. In 2009, we began collecting and analyzing detailed loan-level 

data on home equity, credit card, CRE, and large corporate syndicated credits at 

some of the largest national banks. This effort builds off of the highly valuable 

Mortgage Metrics data project that the OCC initiated in 2008 and provides us with 

much more granular level data than could be collected cost-effectively through the 

Call Report. This comprehensive loan-level credit data allows us to conduct comparative analysis of credit risk across large banks in a timelier manner and to identify potential systemic risk issues. In addition, these large comprehensive data sets 

provide us with the ability to conduct more forward-looking analyses to determine 

what could happen to credit quality under varying economic scenarios and assumptions. A key focus of our large bank examination and policy staff will be to identify 

and institutionalize critical underwriting metrics and related benchmarks so that 

we can objectively track the migration of practices over the course of future credit 

cycles. By limiting our data collection to the largest players, we are able to develop 

a system-wide view while minimizing undue reporting and compliance costs on 

smaller institutions. 

For smaller institutions, our emphasis has been more tailored and focused on ensuring that these banks effectively recognize and manage the inherent concentrations that they may have in their lending portfolios. These efforts have included targeted examinations of key portfolios, most notably CRE portfolios, and providing examiners and bankers more analytical tools to assess how stresses in external market factors may affect those portfolios. 

B. Strong Risk Management Systems That Identify and Control Risk Concentrations 

The financial crisis exposed weaknesses in many banks’ risk management systems 

and models. In many cases, risk concentrations accumulated undetected across products, business lines, and legal entities within an organization. Complex product 

structures and various off-balance sheet funding structures obfuscated certain exposures and risks. Credit risk models relied too heavily on historical correlations and 

did not adequately address their risk exposures to highly rated CDOs and other 

structured securities. Similarly, banks’ internal stress tests failed to fully capture 

the risks that could be posed from various ‘‘tail’’ events and from off-balance sheet 

structures that were legally separate from the firm, but that the firm ultimately 

supported in order to maintain relationships with counterparties, funds providers, 

and investors. Many stress tests failed to fully estimate the potential severity and 

duration of stress events or focused on a single line of business. 

Strengthening risk management practices and institutionalizing more robust and 

enterprise-wide stress testing has and continues to be a point of supervisory emphasis, particularly at the largest national banks. Given the need to implement such 

practices across the entire banking organization, we are working closely with our 

colleagues at the Federal Reserve on many of these efforts. 

Given the importance and the role that these large institutions play in the overall 

financial stability of the U.S., we have instructed our examiners that these organizations should not operate with anything less than strong risk management and 

audit functions—anything less will no longer be sufficient. To build out this capability, examiners are directing these banks to improve their risk concentration aggregation and stress testing processes, requiring more robust model validations, and 

stepping up their challenges of quantitative models and the key assumptions supporting those models. These examiner directives have been supplemented with supervisory guidance, including the enhanced risk management requirements adopted 

by the Basel Committee for banks operating under the Basel II capital framework. 

Critics of Basel II have focused on the potential for an internal-models-based approach to produce lower capital charges for certain portfolios, a concern that has 

been addressed in the past year by substantial strengthening of the framework and 

the increased capital levels under Basel III. Meanwhile, the great benefit of the 

framework has been, and remains, its requirement for more stringent and robust 

risk management standards at applicable banks. The compliance costs associated 

with the Basel II advanced approaches rule is one reason why the OCC and other 

U.S. banking agencies limited its mandatory application to the largest U.S. banking 

organizations. 

43 

More recently, in April, the OCC and Federal Reserve issued guidance on model 

risk management that expands upon the OCC’s previous guidance on model validation. The guidance articulates the elements of a sound program for effective management of risks that arise when using quantitative models in bank decision making. It also provides guidance to OCC examining personnel and national banks on 

prudent model risk management policies, procedures, practices, and standards. Last 

week, the OCC, Federal Reserve, and FDIC issued for comment Proposed Guidance on Stress Testing for Banking Organizations With More Than $10 Billion in Total 

Consolidated Assets. This joint interagency guidance outlines high-level principles 

for stress testing practices, applicable to all banking organizations with more than 

$10 billion in total consolidated assets. The proposed guidance highlights the importance of stress testing as an ongoing risk management practice that supports a 

banking organization’s forward-looking assessment of its risks. It outlines broad 

principles for a satisfactory stress testing framework, and describes the manner in 

which stress testing should be employed as an integral component of risk management. While not intended to provide detailed instructions for conducting stress testing for any particular risk or business area, the proposed guidance describes several 

types of stress testing activities and how they may be most appropriately used by 

banking organizations. Although the guidance does not explicitly address the stress 

testing requirements imposed upon certain companies by section 165 (i) of the DoddFrank Act, the agencies anticipate those provisions, to be addressed in a future rulemaking, will be consistent with the principles in the proposed guidance. 

As with other risk management practices, the OCC believes certain aspects of 

stress testing—such as scenario analysis of key portfolios—can also be a valuable 

tool for smaller banks. Thus, as previously noted, we have been working with community bankers to improve their ability to stress test CRE and other highly concentrated and volatile portfolios. For example, we have instructed banks that their 

stress testing of CRE transactions should consider the effect of multiple variables 

(e.g., changes in interest rates, vacancy rates, and capitalization rates), and that 

such stress tests should be performed periodically throughout the life of the loan. 

To assist community bankers in identifying and assessing potential CRE 

vulnerabilities, we developed, and have made available via our National BankNet 

Web site, loan level CRE stress testing tools that bankers can use. We also have 

developed a portfolio level model, which our examiners are now testing. Our intent 

is to also publish this on BankNet after proper validation. In addition to these tools, 

we provide examiners with access to various market databases that allow them to 

monitor and analyze CRE trends by major geographies and product types and are 

developing additional tools that they can use in their discussions with bank management about potential concentrations. 

While more robust stress testing and improved risk management can help identify 

and mitigate the risks arising from concentrations, the financial crisis illustrated 

that there may be some types and levels of concentrations that, in a severe or protracted downturn, may simply be too large for a bank to absorb. Indeed, a common 

thread in the vast majority of bank failures in both this and previous credit cycles 

has been a concentration in certain types of CRE lending. Many of these banks had 

other risk management weaknesses that accentuated their CRE problems; however, 

some banks that had sound underwriting and internal controls for the CRE operations nonetheless failed due to their level of concentrations to this sector and the 

cascading effects that the downturn had on their borrowers and projects. This is the 

primary reason why we are directing smaller banks with these types of concentrations to shore up their capital base and to maintain capital levels above required 

regulatory minimums. Consistent with the GAO’s recent report on CRE concentrations, we are continuing to assess and discuss with our supervisory colleagues 

whether additional clarification on supervisory expectations or other measures, such 

as more explicit limits, capital requirements, or triggers within the Prompt Corrective Action framework may be warranted to address the risks posed by excessive 

concentrations. 

C. Diversified Funding, Strong Capital Cushions, and Adequate Loan Loss Reserves 

In periods of severe financial stress, having sufficient liquidity, loan loss reserves, 

and capital become paramount in ensuring a bank’s continued operations. Each of 

these components of a strong balance sheet had weakened in the years preceding 

the crisis. 

As previously noted, many banks—both large and small—relied excessively on 

short-term and volatile funding sources to expand and fuel their growth. As banks 

competed for short-term profits and higher margins, traditional sources of assetbased liquidity, such as short-term, readily marketable securities were replaced with 

less liquid assets that offered higher yields. Many banks’ liquidity plans assumed 

44 

1See, Testimony of John Walsh, Acting Comptroller of the Currency, before the Committee 

on Banking, Housing, and Urban Affairs of the United States Senate, February 17, 2011. 

that there would be a continuously ready market for highly rated assets that could 

provide liquidity and likewise failed to fully anticipate the liquidity demands resulting from their ‘‘originate to distribute’’ loan pipelines or off-balance sheet conduits. 

This combination of factors—undue reliance on short-term liabilities, little asset liquidity, and a growing accumulation of off-balance sheet assets that would require 

funding—proved disastrous for some firms when the short-term funding markets 

abruptly shut down in 2007. 

Similarly, the crisis clearly demonstrated that common equity is superior to other 

capital instruments in its ability to absorb losses on a going-concern basis. Hybrid 

capital instruments that paid cumulative dividends and/or had a set maturity date 

had become an ever-larger proportion of the capital base for bank holding companies 

of all sizes, but were found lacking. While many banks hold innovative instruments 

that would have permitted them to defer or cancel dividends, during the financial 

crisis many banks did not exercise this option, which could have preserved liquidity 

and capital, for fear that such actions would reinforce market perceptions of the 

bank’s weakened financial condition. Many non-U.S. banks even exercised call options to redeem hybrid instruments for fear that failure to do so would send strong 

market signals about the deteriorating condition of the bank. 

Correcting these shortcomings has been the focus of considerable work by the 

OCC and other regulators and, as Acting Comptroller Walsh noted in his testimony 

before the full Committee in February, is the objective of various provisions of the 

Dodd-Frank Act. 1 The hallmark of this work internationally has been the enhanced 

and more stringent global capital and liquidity standards for large, internationally 

active banks adopted by the Basel Committee, known as Basel III. These reforms, 

when integrated with the various capital and liquidity provisions of Dodd-Frank will 

materially affect the level and composition of capital and liquidity for large banks. 

Together, these reforms tighten the definition of what counts as regulatory capital; 

expand the types of risk captured within the regulatory capital framework; increase 

overall capital requirements; establish an international leverage ratio applicable to 

global financial institutions that constrains leverage from both on- and off-balance 

sheet exposures; and provide for a more balanced consideration of financial stability 

in bank supervision practices and capital rules. The Basel reforms also introduce 

global minimum liquidity standards that set forth explicit ratios that banks must 

meet to ensure that they have adequate short-term liquidity to offset cash outflows 

under acute short-term stresses and maintain a sustainable maturity structure of 

assets and liabilities. 

Since the Basel III enhancements can take effect in the U.S. only through formal 

rulemaking by the banking agencies, U.S. agencies have the opportunity to integrate certain Basel III implementation efforts with the heightened prudential standards required by the Dodd-Frank Act. Such coordination in rulemaking will ensure 

consistency in the establishment of capital and liquidity standards for similarly situated organizations, appropriately differentiate relevant standards for less complex 

organizations, and consider broader economic impact assessments in the development of these standards. Beyond the Basel III reforms, we have been directing 

banks of all sizes to improve their capital planning and liquidity risk management 

processes to ensure their ability to adequately fund and support anticipated growth 

and withstand unforeseen events. As part of this effort, we expect all banks to maintain a contingency funding plan that sets forth the bank’s strategy for addressing 

unexpected liquidity shortfalls. 

One of the most striking sidebars in the story of the financial crisis is the unprecedented speed with which once well-capitalized institutions succumbed to their credit losses. One reason for this is that banks held historically low levels of loan-loss 

reserves coming into the current recession. We agree with the findings and recommendations of the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) Financial Crisis Advisory Group on 

the need to amend accounting standards that contributed to the delayed recognition 

of losses on loans. Specifically, the accounting rules and the way they were applied 

made it difficult for bankers to reserve for losses that could be reasonably anticipated. The result was that when subsequent charge-offs on impaired loans did 

occur, the loan loss reserves were not there to support them, and higher provision 

levels reduced capital. This accelerated the spiral into insolvency for many financial 

institutions. As the FASB and IASB (collectively, the Boards) have recognized, this 

emphasizes the need for a revised accounting model for more adequate loan losses 

to supplement the strong capital cushions required by prudential regulators. The 

OCC has been a strong proponent of this need to make the loan loss allowances 

45 

more forward looking so that banks can appropriately build their reserves when inherent credit risk is increasing, rather than waiting until loan problems are obvious. 

The OCC has been actively engaged in efforts by the Boards to revise the current 

impairment model for recognizing loan losses to provide for more forward-looking reserves. As part of this effort, OCC staff has served as the U.S. banking agencies’ 

representative on the IASB’s Expert Advisory Panel on Impairment and participated 

in various educational sessions as well as drafting interagency and Basel Committee 

comments to the Boards on this issue. 

A challenge we and the industry face as implementation of these and other reforms mandated by the Dodd-Frank Act move forward is assessing their potential 

interaction and cumulative impact on banks’ business models and strategic plans. 

While we support efforts to raise and strengthen capital and liquidity cushions, 

these standards must be reflective of the underlying risks and not become so excessive that they serve to promote rather than discourage risk-taking. In addition, we 

are concerned that some of the parameters underlying the Basel III liquidity standards are excessively conservative and, if implemented in their current form, could 

unnecessarily impede banks’ balance sheet capacity for lending activities. 

D. Strong Corporate Governance 

The financial crisis highlighted that risk management is, and must be, more than 

simply a collection of policies, procedures, limits, and models. Effective risk management requires a strong corporate culture and corporate risk governance. This culture must be set, embraced, and enforced by the bank’s board of directors and its 

senior management, and it must permeate all of the bank’s activities. This is a point 

of emphasis in all of our meetings with senior management teams and directors. We 

are reminding bank directors that they should not be passive bystanders and should 

be willing and able to provide credible challenges to bank management on key 

issues and strategic plans. Informed directors are well positioned to engage in valueadded discussions that provide knowledgeable approvals, guidance to clarify areas 

of uncertainty, and prudently question the propriety of strategic initiatives, human 

capital decisions (including compensation arrangements), and the balance between 

risk taking and reward. 

Fulfilling these roles and responsibilities can be especially challenging for directors at smaller institutions who may have fewer resources or outside expertise to 

assist them. To assist them in this task, we offer a comprehensive series of director 

workshops, taught by some of our senior supervisory staff. These workshops, offered 

throughout the year in various locations across the country, cover four topics: a director’s fundamental responsibilities, risk assessment, compliance risk, and credit 

risk. Participants receive an extensive package of resources, including a precourse 

reading packet, course materials, a CD containing selected OCC Web and telephone 

seminars, and other supporting materials. 

A key component of prudent corporate governance is the establishment of welldefined and understood risk tolerances and limits. At larger banks, the science of 

defining and measuring risk tolerance levels has typically been confined to the business unit and more micro levels of the organization. While these lower level risk 

limits are generally effective in controlling individual areas of risk taking, they do 

not enable senior management or board members to monitor or evaluate concentrations and risks on a firm-wide basis. Consequently, we are directing larger banks 

to complement existing risk tolerance structures with more comprehensive measures 

and limits of risk addressing the amount of capital or earnings that may be at risk 

on a firm-wide basis, including the amount of risk that may be taken in each line 

of business, and the amount of risk that may be taken in each of the key risk categories monitored by the banks. For banks of all sizes, we are emphasizing the need 

for sound enterprise-wide asset-liability management systems that identify, monitor, 

and effectively limit the bank’s liquidity and interest rate risks exposures. As part 

of our ongoing supervisory process, we are reviewing compliance with these directives. 

As previously noted, flawed incentive compensation practices in the financial industry were among the factors contributing to the financial crisis. To address this 

issue, in June 2010, the OCC and other Federal banking agencies issued guidance 

on sound incentive compensation policies and practices. Key tenets of that guidance 

are that such practices should appropriately balance risk and reward; be compatible 

with effective controls and risk management; and be supported by strong corporate 

governance, including active and effective oversight by the organization’s board of 

directors. In April, the OCC and other regulators issued proposed rules to implement the incentive-based compensation provisions of section 956 of the Dodd-Frank 

Act. This rule would build upon the agencies’ June 2010 guidance by requiring the 

reporting of certain incentive-based compensation arrangements and prohibit incenVerDate Nov 24 2008 07:49 Mar 06, 2012 Jkt 048080 PO 00000 Frm 00049 Fmt 6621 Sfmt 6621 L:\HEARINGS 2011\06-15B DISTILLER\61511.TXT JASON
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tive-based compensation arrangements that provide excessive compensation or that 

could expose the institution to inappropriate risks that could lead to material financial loss. Consistent with the statute, institutions with less than $1 billion in assets 

would not be subject to this rule. 

E. Identifying, Assessing, and Addressing Emerging Risks Across the Financial System 

As I noted earlier, the financial crisis demonstrated the need for supervisors to 

improve their ability to identify, assess, and address emerging risks not only within 

a banking organization, but across the banking and broader financial system. 

Strengthening supervisors’ ability to identify and respond to emerging systemic 

risks is clearly a key objective of the Dodd-Frank Act and a core mission of the 

FSOC. Beyond the measures provided for by the Dodd-Frank Act and the activities 

being conducted through the FSOC and its various staff committees, the OCC has 

taken a number of steps to enhance our ability to identify and respond to risks 

across the industry and financial system. 

As previously noted, we are now obtaining granular, loan level information on key 

credit portfolios from the largest national banks to help identify underwriting and 

performance trends across the system. We have also developed a liquidity risk monitoring program to standardize liquidity monitoring information across 15 of the largest national banks and to provide more forward looking assessments of liquidity 

mismatches and capacity constraints that could signal future problems. We also 

have established network groups among our examiners at large national banks to 

facilitate information sharing and promote consistent supervisory actions for nine 

key risk areas. 

In 2008, we established a Financial Markets Group within the agency and tasked 

it with the build-out of a market intelligence program. Their mission is to seek out 

early warning signs of emerging and systemic risk issues. This team is comprised 

of highly experienced bank examiners and subject matter specialists, and they spend 

considerable time meeting with bank investors, bank counterparties, bank analysts, 

and other relevant stakeholders to gain insights on emerging trends. To support the 

work of the OCC’s National Risk Committee (NRC), this group has also developed 

a dashboard of metrics that provide early indicators of the build-up of risks within 

the system that may signal the need for firmer supervisory intervention at a juncture when such action can be modulated and most effective. These metrics are designed to provide warning signs before risks become manifested in market performance such as prolonged periods of low volatility that can promote complacency 

among investors and bankers and lead to excessive risk taking. While any one metric would be insufficient grounds for firmer intervention, warning signals across a 

number of measures will trigger a more formal review and assessment of the risks 

and the need for appropriate supervisory response by the OCC’s NRC and Committee on Bank Supervision. 

F. Restoring Transparency and Market Discipline 

The problems that supervisors and market participants faced when trying to assess the nature and scope of exposures in complex structured products, off-balance 

sheet funding vehicles, derivatives, and trading strategies have been well documented. In many cases these challenges were further exacerbated by complex organizational structures of individual firms. 

Providing greater transparency in financial statements has been a key objective 

of recent proposals by the FASB, and the OCC has provided its views and expertise 

on these proposals. One of the most significant revisions, as it pertains to various 

securitization and off-balance sheet funding vehicles that were prevalent before the 

crisis, has been the adoption and implementation of revisions to the Accounting 

Standards Codification (ASC) Topic 860, Transfers and Servicing, and ASC Topic 

810, Consolidation (through Statements No. 166, Accounting for Transfers of Financial Assets—an amendment of FASB Statement No. 140, No. 167, Amendments to 

FASB Interpretation No. 46(R)). As a result of these statements, many securitized 

assets must now be reflected on banks’ balance sheets. The OCC and other Federal 

banking agencies have amended the agencies’ risk-based capital rules to be consistent with these accounting changes. Many of the derivatives-related provisions of 

the Dodd-Frank Act will likewise provide greater transparency through increased 

disclosures and more extensive use of central counterparties or clearinghouses. 

The combined provisions of Titles I and II of the Dodd-Frank Act that provide the 

authority to extend the Federal Reserve’s supervisory oversight of certain nonbank 

financial companies and for the orderly liquidation of failing financial companies 

that pose significant risk to the financial stability of the U.S., are critical tools in 

47 

restoring market discipline and accountability for large financial firms. Through 

FSOC, the OCC is actively engaged in efforts to implement these provisions. 

As problems in the mortgage market have vividly demonstrated, improved transparency and disclosures about the terms, costs, and risks of retail banking products 

are critical to promote informed consumer choice and responsibility. We have long 

supported that goal and applaud the Consumer Financial Protection Bureau’s initiative to start this process through the testing of revised residential mortgage disclosure forms. 

IV. OCC’s Supervisory Approach—Balanced Supervision, Tailored to Risks 

The OCC’s core mission is to assure the safety and soundness of the institutions 

subject to our jurisdiction and to ensure that those institutions support fair access 

to financial services and fair treatment of their customers. We carry out this mission through our ongoing supervisory activities. Through these activities we evaluate banks’ compliance with applicable laws, regulations, and supervisory requirements, and we assess whether they have adequate risk management systems, controls, and capital to support the size, scope, and complexity of their activities. Where 

we find weaknesses or violations, we direct management to take appropriate and 

timely corrective action. Provided that the bank has the requisite corporate governance, risk management, and capital infrastructure to support risk taking, it is not 

the job or role of an examiner to determine whether or what lines of business, products, or strategic focus is appropriate—these are decisions that the bank’s board 

must make. Likewise, examiners do not tell bankers which loans to make or deny. 

However, they will assess whether such loans have been prudently underwritten, 

properly risk-rated, and, if any show signs of trouble, are appropriately classified 

and reserved for. 

As I previously noted, one of the most difficult jobs we have in carrying our this 

mission is knowing when and how hard to tap on the brakes to rein in excessive 

risk taking without causing bankers to become so conservative or uncertain about 

regulatory actions that they unduly restrict credit. We are acutely aware that our 

actions—both on the policy side at the 50,000 foot level, and on the ground, through 

our on-site examinations—can and do influence banks’ behavior and their appetite 

for taking risk. We also recognize that in past downturns, many believed that overzealous regulators and examiners exacerbated the contraction in credit. 

One of the lessons we learned is the detrimental effect of waiting too long to warn 

the industry about excesses building up in the system, resulting in bankers and examiners slamming on the brakes too hard when the economy experienced problems. 

This is one reason why we are working to develop better tools that will enable us 

to identify signs of accelerating risk taking at an earlier stage when our actions can 

be more modulated. We know that it is critical that our expectations for bankers 

be clear and consistent, that the ‘‘rules of the game’’ under which banks operate not 

be changed abruptly, and that changes in regulatory policies are made in an open 

and transparent manner that provides bankers with reasonable time frames to 

make necessary adjustments. This will be especially true as bankers try to absorb 

and comply with the myriad of rules and regulations that will result from the implementation of the Dodd-Frank Act. 

We are particularly mindful that new or changing regulatory requirements can 

often have a disproportionate cost and burden on community banks due to their limited size and resources. For this reason, as we develop regulations, supervisory policies, and examination standards, we strive to provide sufficient flexibility in the application of those standards to reflect the size and complexity of the institution. As 

the complexity and scope of a bank’s activities and its potential impact on the financial system increases, so do our expectations for their internal controls and risk 

management systems. 

To provide consistency and continuity in our supervision, we organize our supervision programs around a common framework and national perspective that is then 

supplemented by the hands-on knowledge of our examiners. Our supervision by risk 

framework establishes a common examination philosophy and structure that is used 

at all national banks. This structure includes a common risk assessment system 

(RAS) that evaluates each bank’s risk profile across eight risk areas—compliance, 

credit, interest rate, liquidity, operational, price, reputation, and strategic—and assigns each bank an overall composite rating and component ratings on the bank’s 

capital adequacy, asset quality, management, earnings, liquidity, and sensitivity to 

market risks using the interagency Uniform Financial Ratings System (informally 

known as CAMELS). Specific examination activities and supervisory strategies are 

tailored to each bank’s risk profile. These strategies are updated and approved annually. While tailored to each individual bank’s risk profile, they also incorporate 

key agency supervisory priorities for the coming year. 

48 

To reflect the different expectations for controls and risk management between 

large and small banks, our bank supervision programs and core examination procedures to determine a bank’s RAS and CAMELS ratings are aligned across two primary lines of business: Midsize and Community Bank Supervision, and Large Bank 

Supervision. Upon full integration of OTS, we will align Federal thrifts into these 

lines of business. 

Our community bank supervision program is built around our local field offices 

located in over 60 cities throughout the U.S. Every national community bank is assigned to an examiner who monitors the bank’s condition on an ongoing basis and 

who serves as the focal point for communications with the bank. The primary responsibility for the supervision of individual community banks is delegated to the 

local Assistant Deputy Comptroller, who is under the oversight of a district Deputy 

Comptroller, who in turn, reports to our Senior Deputy Comptroller, Jennifer Kelly. 

The frequency of our on-site examinations for community banks follows the statutory provisions set forth in 12 USC 1820(d), with on-site exams occurring every 12 

to 18 months. The scope of these examinations is set forth in the OCC’s Community 

Bank Supervision handbook and requires sufficient examination work and transaction testing to complete the core assessment activities in that handbook, and to 

determine the bank’s RAS and CAMELS ratings. On-site activities are supplemented by off-site monitoring and quarterly analyses to determine if significant 

changes have occurred in the bank’s condition or activities. 

Our Large Bank program is organized with a national perspective. It is centralized and headquartered in Washington, and structured to promote consistent uniform coordination across institutions. As part of our Large Bank Supervision program, we maintain on-site resident examination staff that conducts ongoing supervisory activities and targeted examinations of specific areas of focus. This process 

allows the OCC to maintain an ongoing program of risk assessment, monitoring, 

and communication with bank management and directors. Given the volume and 

complexity of the literally hundreds of thousands of transactions that flow through 

large banking organizations, it is not feasible to review every transaction in each 

bank, or for that matter, every single product line or bank activity in each supervisory cycle. Nonetheless, as in our community bank examinations, examiners must 

complete sufficient work and transaction testing throughout the year to complete 

the core assessment activities set forth in the OCC’s Large Bank Supervision handbook, and to determine the bank’s RAS and CAMELS ratings. The on-site teams at 

each bank are led by an Examiner-in-Charge, who reports directly to the Deputy 

Comptrollers in our Large Bank Supervision Office, and in turn, to our Senior Deputy Comptroller, Mike Brosnan. 

In January 2010, we updated and revised our RAS system as it applies to both 

community and large banks to reflect and incorporate lessons learned from the financial crisis. We also have directed examiners to be more forward looking when 

they are assessing and assigning RAS ratings. Specifically, when assessing direction 

of risk for all risk categories, examiners should consider current practices in the 

bank and how those practices, combined with other quantitative and qualitative factors, affect direction of risk over the next 12 months. For example, the direction of 

credit risk may be increasing if a bank has relaxed its underwriting standards during a strong economic cycle, even though the volume of troubled credits and credit 

losses remain low. Similarly, the direction of liquidity risk may be increasing if a 

bank has not implemented a well-developed contingency funding plan during a 

strong economic cycle, even though existing liquidity sources are sufficient for current conditions. We will be reinforcing this message with our examination staffs at 

our upcoming staff conferences in July that will bring together all of our examination staffs across our lines of business and those examiners who are joining the OCC 

from the Office of Thrift Supervision. 

In both our Midsize and Community Bank Supervision and Large Bank Supervision programs, we have mechanisms in place to ensure that our supervisory policies and procedures are applied in a consistent and balanced manner. Every report 

of examination is reviewed and approved by the responsible ADC or Deputy Comptroller before it is finalized. Both units have formal quality assurance processes that 

assess the effectiveness of our supervision and compliance with OCC policies. Our 

examination force is kept abreast of emerging issues and supervisory policies 

through weekly email updates and periodic nationwide conference calls, team meetings, and staff conferences. 

A key element of the OCC’s supervisory philosophy is open and frequent communication with the banks we supervise. In this regard, our senior management teams 

encourage any banker that has concerns about a particular examination finding to 

raise those concerns with his or her examination team and with the district management team that oversees the bank. Should a banker not want to pursue those 

49 

2See, NFIB Small Business Economic Trends, May 2011, p. 2. 

chains of communication, our Ombudsman’s office provides a venue for bankers to 

discuss their concerns informally or to formally request an appeal of examination 

findings. The OCC’s Ombudsman is fully independent of the supervisory process, 

and he reports directly to the Comptroller. In addition to hearing formal appeals, 

the Ombudsman’s office provides bankers with an impartial ear to hear complaints 

and a mechanism to facilitate the resolution of disputes with our supervisory staff. 

The OCC also recognizes the importance of communicating regularly with the industry outside of the supervision process to clarify our expectations, discuss emerging issues of interest to the industry, and respond to bankers’ concerns. We participate in numerous industry-sponsored events, as well as conduct a variety of outreach activities, including Meet the Comptroller events, chief executive officer 

roundtables, and teleconferences on topical issues. 

V. Current State of Small Business and Real Estate Lending, Mortgage 

Servicing, and Trading Lines of Business 

The Subcommittee’s letter of invitation noted the uncertainty that remains in 

small business and real estate lending, mortgage servicing, and trading, and requested the OCC’s views on the state of those business lines. Let me conclude with 

a brief overview of each. 

A. Small Business Lending 

National banks are significant providers of small business credit, but discerning 

trends in small business lending is difficult due to the variety of lending facilities 

that small business owners use for financing. One proxy for a portion of small business lending is the data collected in the quarterly Call Reports on commercial and 

industrial loans in amounts less than $1 million and agricultural loans less than 

$500,000. In the last few years, the outstanding balance of these loans has declined, 

reflecting both demand and supply factors. Mirroring trends in the broader economy, demand for credit by many businesses has weakened as both businesses and 

their consumers have scaled back spending and investments. It is also true that 

some bankers, in response to deteriorating credit and economic conditions, have become more risk averse and selective in their lending. 

The OCC recognizes the important role of small businesses in the economy, their 

dependence on banks for credit, and the difficulty that some small business owners 

have reported in obtaining new credit or renewing existing credit. In response to 

these concerns, in February 2010, the OCC and other Federal banking agencies 

issued a statement on creditworthy small businesses. The statement is intended to 

facilitate small business lending and provide bankers with more regulatory certainty 

by outlining our expectations for prudent underwriting practices. In this statement 

and in our ongoing discussions with examiners and bankers, we reiterate our policies that we encourage bankers to lend to creditworthy borrowers and to work constructively with borrowers who may be facing difficulties, and that examiners 

should take a balanced approach and not criticize banks that follow sound lending 

practices. 

We actively encourage national banks to participate in various Government programs that are designed to support small business lending. These include the Small 

Business Administration loan guarantee programs and the $30 billion Small Business Lending Fund program established as part of the Small Business Jobs Act of 

2010. To-date approximately 106 national banks have applied for this program, and 

we are in the process of providing Treasury with information to assist them in evaluating those requests. 

There is some evidence that credit conditions for small business lending are improving. In our recent annual credit underwriting survey, a few respondents have 

eased small business underwriting standards in anticipation of market growth and 

an opportunity to compete. Just over half of the banks in the survey are planning 

to grow their small business lending portfolio greater than 10 percent over the next 

year. Many of the largest national banks have revamped and built up their small 

business lending operations. 

Despite these positive signs, the ongoing lack of sales revenue and widespread uncertainty about the economy continue to hamper small business owners’ sentiments 

and bankers’ ability to develop loan growth in this market segment. In its May 2011 

report on small business economic trends, the National Federation of Independent 

Business (NFIB) stated credit supply was not the problem for the overwhelming majority of small business owners and that weak sales and uncertainty continue to be 

major factors for the lack of credit demand. 2 This uncertainty is reflected in the 

50 

3 Ibid., p. 4. 4See, Remarks by John Walsh, Acting Comptroller of the Currency, Before the Housing Policy 

Council of The Financial Services Roundtable, May 19, 2011, available at: http://www.occ.gov/ 

news-issuances/speeches/2011/pubspeech-2011-60.pdf. 

NFIB’s small business optimism index: while this index has bounced back from the 

2009 lows, its level has declined in March and April. 3

B. Real Estate Lending 

Commercial real estate lending is a prominent business line for many national 

banks and is a sector that the OCC monitors very closely. While there are signs that 

the commercial real estate markets are beginning to stabilize, we are a long way 

away from a full recovery. Vacancy rates across all major property types are starting to recover, but remain high by historical standards. We expect vacancy rates to 

remain elevated and recovery to be slow. 

Capitalization rates—the rate of return demanded by investors—have also shown 

recent signs of stabilization. Cap rates fell substantially from 2002 through 2007 to 

a point where they often did not fully reflect the risks associated with the properties 

being financed. Then they increased markedly in 2008 and 2009 as investors became 

more risk averse. Recently, cap rates appear to have stabilized, particularly for high 

quality assets, but the spreads being demanded by investors, relative to Treasuries, 

for lower quality assets remain wide. 

A key driver for property values and CRE loan performance is the net operating 

income (NOI)—or cash flows—generated by the underlying commercial properties. 

Overall, NOI has continued to decline due to soft rental rates. While we expect the 

rate of decline to lessen, only apartments are expected to show meaningful NOI 

growth this year, with other major market segments expected to turn positive in 

2012. 

Property prices have also shown some signs of stabilization. Although the Moody’s 

All Property Index recorded a decline of 4.2 percent in March 2011, transaction volumes have increased. We expect volatile prices until underlying market fundamentals improve consistently. 

The trends and performance of CRE loans within the national banking system 

mirror those in the broader CRE market. While there are signs of stabilization in 

charge-off rates and a decline in nonperforming loans, levels remain elevated and 

continue to require significant attention by bank management and supervisors. The 

effect of the distressed CRE market on individual national banks varies by the size, 

location, and type of CRE exposure. Because charge-off rates for construction loans 

led performance problems in the sector, banks with heavier concentrations in this 

segment tended to experience losses at an earlier stage. Performance in this segment is expected to improve more rapidly as the pool of potentially distressed construction loans has diminished. In contrast, performance of income-producing commercial mortgages continues to be more stressed and one that we continue to monitor closely. 

C. Mortgage Servicing 

As the Subcommittee’s letter of invitation references, the mortgage servicing business is also under severe stress. Its business model was already challenged by the 

mortgage crisis, and that challenge is now compounded by widespread deficiencies 

in foreclosure processing. Through our recent consent orders, the OCC is focused on 

fixing the very serious problems we found in foreclosure processing; ensuring that 

any borrowers harmed by shoddy practices receive appropriate remedies; and getting mortgage markets operating again. Yet as Acting Comptroller Walsh recently 

noted in his remarks before the Housing Policy Council of the Financial Services 

Roundtable, additional challenges and uncertainties loom ahead for this line of business. 4 The new Basel III framework will require that servicing rights beyond relatively modest levels be deducted from capital for regulatory capital calculations, effectively increasing the capital requirements for mortgage servicers. The DoddFrank Act will impose a myriad of new requirements that mortgage lenders will 

need to address. As the Acting Comptroller noted, while each of these requirements 

individually have merit, it is hard to predict how all of these requirements will work 

together. 

In addition to the requirements of Dodd-Frank, an important area for reform in 

the mortgage servicing business is the need for uniform mortgage servicing standards that apply to all facets of servicing the loan, from loan closing to payoff. A 

number of months ago, to further this effort and interagency discussions, the OCC 

developed a framework for comprehensive mortgage servicing standards that we 

shared with other agencies, and other agencies put forward their recommendations 

51 

as well. We now have underway an active interagency effort to develop a set of comprehensive, nationally applicable mortgage servicing standards. As an example, 

these standards would address: 

• Handling borrower payments, including applying payments to principal and interest and taxes and insurance before they are applied to fees, and avoiding 

payment allocation processes designed primarily to increase fee income; 

• Providing adequate borrower notices about their accounts and payment records, 

including a schedule of fees, periodic and annual statements, and notices of payment history, payoff amount, late payment, delinquency, and loss mitigation; 

• Providing an easily accessible single point of contact for borrower inquiries 

about loss mitigation and loan modifications; 

• Ensuring appropriate levels of trained staff to meet current and projected workloads; 

• Responding promptly to borrower inquiries and complaints, and promptly resolving disputes; 

• Providing an avenue for escalation and appeal of unresolved disputes; 

• Effective incentives to work with troubled borrowers, including early outreach 

and counseling; 

• Making good faith efforts to engage in loss mitigation and foreclosure prevention for delinquent loans, including modifying loans to provide affordable and 

sustainable payments for eligible troubled borrowers; 

• Implementing procedures to ensure that documents provided by borrowers and 

third parties are maintained and tracked so that borrowers generally will not 

be required to resubmit the same documented information; 

• Eliminating ‘‘dual track’’ processes where legal steps to foreclose on a property 

or conduct a foreclosure sale go forward even when a borrower has completed 

an application for a loan modification or is in a trial or permanent modification 

and is not in default on the modification agreement; 

• Notifying borrowers of the reasons for denial of a loan modification, including 

information on the NPV calculation; and 

• Implementing strong foreclosure governance processes that ensure compliance 

with all applicable legal standards and documentation requirements, and oversight and audit of third party vendors. 

While we are at an early stage in this interagency process, the OCC is optimistic 

that the agencies can achieve significant reforms in mortgage servicing practices 

across the board for all types of mortgage servicing firms. These types of standards 

should help put the mortgage servicing business on sound footing for the future. 

D. Trading Activities 

Trading revenues in the banking system have been quite strong, as the industry 

reported record trading revenues in both 2009 and 2010. After a loss of $836 million 

in 2008, insured commercial banks reported trading revenues of $22.6 billion and 

$22.5 billion in 2009 and 2010 respectively despite reductions in trading assets and 

risk. A key driver of the strong results has been predominately one-way bull markets as bonds, equities, commodities, and foreign currencies rallied. In the first 

quarter of 2011, insured commercial banks added another $7.4 billion in trading 

revenues. Notwithstanding the current strength of trading revenues, however, there 

are a number of issues that create uncertainty, and will likely limit, trading revenues prospectively. Section 619 of the Dodd-Frank Act restricts many forms of proprietary trading, but for banks, stand alone proprietary trading has generally accounted for a relatively small portion of trading activity, so the impact of this 

change should be limited. There are, however, other provisions of the Act that could 

affect trading activities at national banks. Legislative mandates to increase central 

clearing may reduce trading activity generally and narrow profit margins. Recently 

proposed swap margin rules require, for the first time, initial margin for inter-dealer and dealer/financial end-user trading activity, raising costs and potentially reducing the transaction volumes that create revenue. Revenues from securitization activities remain weak due to continued weakness in loan volumes and underlying 

asset prices for housing. In addition, securitization markets may be affected by uncertainty associated with implementation of the Dodd-Frank Act risk retention requirements and proposed changes in the regulatory capital treatment of mortgage 

servicing rights. Finally, bull markets for the past 2 years have stimulated client 

demand for risk management products, reduced market-making risk, and increased 

interest income spread on market-making inventory resulting from the steep yield 

52 

curve. The potential for markets to be less bullish and to become more volatile may 

put further pressure on bank trading revenues. 

VI. Conclusion 

The financial crisis exposed fundamental weaknesses in risk management and supervisory practices across the financial industry and supervisory community. Numerous initiatives, including those mandated by the Dodd-Frank Act, are underway 

to address these failures. The OCC has and is continuing to take steps to enhance 

its supervision programs and to implement its responsibilities under the DoddFrank Act. As we implement these changes, we will strive to do so in a manner 

that, to the greatest extent possible, continues to allow all U.S. financial firms to 

compete fairly both within our own financial system and the broader global economy. We are also mindful of the special role that community banks play in our financial system and the disproportionate burden that changing regulatory requirements can pose to these entities. In this respect, our overarching goal and mission 

remains the same—to assure the safety and soundness of the institutions under our 

jurisdiction, to ensure that they treat their customers fairly, and in carrying out this 

mission, to conduct our supervision in a balanced and fair manner that reflects and 

is tailored to the risks posed by each institution. 

PREPARED STATEMENT OF SALVATORE MARRANCA 

DIRECTOR, PRESIDENT, AND CHIEF EXECUTIVE OFFICER, CATTRAUGUS COUNTY BANK, LITTLE VALLEY, NEW YORK

JUNE 15, 2011 

Chairman Brown, Ranking Member Corker, and Members of the Subcommittee, 

I am Sal Marranca, Director, President, and CEO of Cattaraugus County Bank, a 

$174 million asset bank in Little Valley, New York. I am pleased to be here today 

to represent the nearly 5,000 members of the Independent Community Bankers of 

America. Thank you for convening this hearing on ‘‘Enhancing Safety and Soundness: Lessons Learned and Opportunities for Continued Improvement.’’ 

The safety and soundness of our banking system is a significant concern to community banks. Early in my career, I was a Senior Bank Examiner with the FDIC 

for over a decade, and the commitment I made then to safety and soundness I still 

carry with me today as President of Cattaraugus County Bank and as Chairman 

of ICBA. 

The recent financial crisis was caused by high risk lending and speculation by the 

megabanks and Wall Street firms. Significant harm was done to taxpayers and the 

economy. Community banks too were harmed. The economic decline retracted consumer spending and dramatically reduced the demand for credit. Residential and 

commercial real estate markets remain stressed in some areas. Still, the community 

banking industry remains well capitalized and—because we take a conservative, 

commonsense approach to lending—we have fewer problem assets than other segments of the industry. 

We must ensure the crisis never repeats itself, and appropriate supervision of all 

financial services providers is an important part of that. But how safety and soundness is achieved is very important. Misguided, though well intentioned, efforts could 

be very economically damaging. Frankly, many community bankers are deeply frustrated with the current exam environment, which has consistently registered as a 

top concern among ICBA members. 

Difficult Exam Environment 

As we consider the topic of safety and soundness, we must remember that community banks did not cause the financial crisis, nor are they a source of ongoing systemic risk. Community banks have a starkly different risk profile from other financial services providers because of their smaller scale, which precludes systemic risk, 

and more importantly, because they practice conservative, common sense lending to 

customers they often know personally. This different risk profile must be taken into 

consideration as policy makers consider how community banks should be examined. 

Community banks are eager to make prudent loans in their communities, and as 

we consider ways to enhance safety and soundness, we must not tip the scale into 

actions that will suffocate economic activity. Safety and soundness is a very real 

concern, but so is the seemingly intractable unemployment that has plagued our 

economy for nearly 3 years. Smart examination and compliance practices will allow 

for more lending without creating undue risk to the financial system. 

Specifically, exams could be greatly improved by being more consistent and rational. This would encourage prudent lending without loosening standards. ArbiVerDate Nov 24 2008 07:49 Mar 06, 2012 Jkt 048080 PO 00000 Frm 00056 Fmt 6621 Sfmt 6621 L:\HEARINGS 2011\06-15B DISTILLER\61511.TXT JASON
53 

trary exams chill lending indiscriminately—sound loans as well as risky loans. 

There are more thoughtful, systematic ways to reduce risk without discouraging 

sound lending. 

I’m fortunate to enjoy a cooperative and constructive working relationship with 

my regulator, the FDIC. I value this relationship very highly. It is an important 

part of the success of my bank and has allowed me to weather the financial crisis. 

Having worked as a bank examiner, I’ve been on both sides of the table and can 

appreciate the concerns and challenges examiners face. It’s a difficult job with a 

great deal at stake. The stakes were raised sharply after the financial crisis, but 

I believe many examiners overreacted and the pendulum has swung too far in the 

direction of overregulation. I’ve met with thousands of community bankers from 

every part of the country in recent years, and I can tell you there is an unmistakable trend toward arbitrary, micromanaged, unreasonably harsh examinations that 

have the effect of suffocating lending. 

This has not always been the case. Before the crisis, examiners frequently worked 

in partnership with the banks they examined. They were a resource, a help in interpreting often ambiguous guidance. Where corrections were needed, opportunity was 

given to make them, and compliance was a mutual goal. This was the model of examination I followed when I was an examiner. I believed then and still believe today 

it is the best means of achieving safety and soundness without interfering with the 

business of lending. Currently, the relationships are too often adversarial. Understandably, an examiner does not want to be blamed for the next crisis. Examiners 

are not evaluated on banks’ contributions to the economy. At all costs, they want 

to avoid a bank failure that would put a black mark on their record. The examiner’s 

incentive is to err on the side of writing down too many loans, demanding too much 

capital. 

The crisis was not caused by a failure to adequately examine community banks, 

but examiners have reacted to the crisis with overreaching exams that have harmed 

the economy and made it harder to emerge from the recession. 

A particularly frustrating aspect of the exam environment is the disconnect between the examiners in the field and the directives from Washington. A November 

2008, Interagency Statement on Meeting the Needs of Creditworthy Borrowers established a national policy for banks to extend credit to creditworthy borrowers in 

order to help initiate and sustain an economic recovery. It stated, ‘‘The agencies expect all banking organizations to fulfill their fundamental role in the economy as 

intermediaries of credit to businesses, consumers, and other creditworthy borrowers.’’ Unfortunately, this policy is often neglected by examiners in the field, especially in the regions most severely affected by the recession. Field examiners are 

second guessing bankers and independent professional appraisers. They are demanding unreasonably aggressive write-downs and reclassifications of viable commercial real estate loans and other assets. The misplaced zeal of these examiners 

is having a chilling effect on lending. Good loan opportunities are passed over for 

fear of examiner write-down and the resulting loss of income and capital. The contraction in credit is having a direct, adverse impact on the recovery. 

Furthermore, examiners are demanding capital levels higher than those required 

by regulation. To bankers, the process feels arbitrary and punitive. Many community banks complain that the required capital level goalpost is unpredictable. Regulators simply keep moving it further, making it nearly impossible to satisfy capital 

demands in a difficult economy and capital marketplace. So bankers are forced to 

pull in their horns and pass up sound loan opportunities in order to preserve capital. This is not helpful for their communities and economic growth. Bankers used 

to expect prompt feedback that they could act on immediately as part of the exam 

process. Quick, useful feedback has been replaced by examination reports that follow months after the examiner’s visit, with no opportunity for the banker to sit 

down with the examiner, go over the results, and respond to the examiner’s concerns on the spot. 

Legislative Help Is Needed 

ICBA supports legislation to bring more consistency to the examination process. 

With regard to loan classifications, for example, one of community bankers’ greatest 

concerns, a bill recently introduced in the House would establish criteria for determining when a loan is performing and thereby provide for more consistent classifications. When loans become troubled often the best course for the borrower, lender, 

and the community is a modification that will keep the loan out of foreclosure. But 

in recent years, many examiners have penalized loan modifications by aggressively 

placing loans on nonaccrual status following a modification—even though the borrower has demonstrated a pattern of making contractual principal and interest payments under the loan’s modified terms. This adverse regulatory classification results 

54 

in the appearance of a weak capital position for the lender, which dampens further 

lending in the community and puts a drag on the economic recovery. Representative 

Bill Posey’s Common Sense Economic Recovery Act of 2011 (H.R. 1723) would establish conservative, commonsense criteria for loan classifications. 

Community bankers enthusiastically support this bill because it resonates with 

their experience in examination. It would give bankers flexibility to work with 

struggling but viable borrowers and help them maintain the capital they need to 

support their communities. We hope a counterpart bill will soon be introduced in 

the Senate and considered by this Committee. 

Consumer Financial Protection Bureau 

The new Consumer Financial Protection Bureau (CFPB) presents another potential challenge to the safety and soundness of community banks, which will be subject to its rules though institutions with less than $10 billion in assets are exempt 

from primary examination. Because the CFPB is not charged with protecting safety 

and soundness, and does not have experience or expertise in this area, there is a 

real risk CFPB rules could promote consumer protection at the expense of safety 

and soundness. For example, any rule that interferes with a bank’s ability to price 

for risk in a given product, or that disrupts an important revenue stream, could 

compromise safety and soundness. Prudential regulators, on the other hand, have 

long experience with regulating consumer protection in the context of safety and 

soundness. This is why ICBA supports legislation that would give prudential regulators a stronger voice in CFPB rulemaking. 

There are different ways of accomplishing this. One example is a bill recently 

passed by the House Financial Services Committee. The Consumer Financial Protection Safety and Soundness Improvement Act, sponsored by Representative Sean 

Duffy, would strengthen prudential regulatory review of CFPB rules, which is extremely limited under the Dodd-Frank Act. Prudential regulators have the ability 

to comment on CFPB proposals before they are released for comment and an extremely limited ability to veto regulations before they become final. This veto can 

only be exercised if, by a 2⁄3 vote, the Financial Stability Oversight Council (FSOC) 

determines that a rule ‘‘puts at risk the safety and soundness of the banking system 

or the stability of the financial system,’’ a standard that is nearly impossible to 

meet. A rule that doesn’t meet this high standard could nevertheless do extraordinary harm to banks and consumers. H.R. 1315 would change the voting requirement for an FSOC veto to a simple majority, excluding the CFPB Director, and 

change the standard to allow for a veto of a rule that ‘‘is inconsistent with the safe 

and sound operations of United States financial institutions.’’ While this change 

would improve CFPB rulemaking, ICBA has proposed language that would further 

broaden the standard to allow FSOC to veto a rule that could adversely impact a 

subset of the industry in a disproportionate way. We believe that this standard 

would give prudential regulators a more meaningful role in CFPB rule writing. 

Communities First Act 

The ICBA-backed Communities First Act (CFA, H.R. 1697) captures many reforms the community banking sector deems necessary to alleviate the difficult regulatory burden they face, including a change to the FSOC veto standard for CFPB 

rules very similar to H.R. 1315 discussed above. This legislation was recently introduced in the House and cosponsored by members from both sides of the aisle. ICBA 

is working to introduce a similar bill in the Senate. Notably CFA would: 

• Increase the threshold number of bank shareholders from 500 to 2,000 that trigger SEC registration. Annual SEC compliance costs are a significant expense 

for listed banks. 

• Reduce the paperwork burden that acts as a dead-weight cost for community 

banks, consuming scarce resources that could support lending. 

• Defer taxation of interest on long-term certificates of deposits and tax the interest at capital gains rates so more consumers are rewarded for saving and investing. 

• Extend the 5-year net operating loss (NOL) carryback provision to free up community bank capital now when it is most needed to boost local economies. 

These and other provisions would improve the regulatory environment and community bank viability, to the benefit of their customers and communities. 

Moral Hazard and Too-Big-To-Fail Institutions 

The greatest threat to safety and soundness remains the too-big-to-fail institutions that dominate the financial services sector. Today, the four largest banking 

companies control more than 40 percent of the Nation’s deposits and more than 50 

55 

percent of the assets held by U.S. banks. The largest banks have grown larger since 

the financial crisis. The ten largest hold 77 percent of all U.S. bank assets compared 

with 55 percent of total assets in 2002, according to a recent Bloomberg study. ICBA 

does not believe it is in the public interest to have 10 institutions controlling a significant majority of the assets of the banking industry. A more diverse financial system would reduce risk and promote competition, innovation, and the availability of 

credit to consumers of various means and businesses of all sizes. 

As a result of the financial crisis, our Nation went through an agonizing series 

of forced buy-outs or mergers of some of the Nation’s largest banking and investment houses, costing American taxpayers hundreds of billions of dollars. Some 

mega-institutions—too-big-to-fail and also too big-to-be-sold to another firm—were 

directly propped up by the Government. One large institution, Lehman Brothers, 

was allowed to go bankrupt, with disastrous consequences that only confirmed the 

policy of too-big-to-fail. The doctrine of too-big—or too-interconnected—to-fail finally 

came home to roost, to the detriment of the American taxpayer and our economy. 

Our Nation cannot afford to go through that again. Systemic risk institutions that 

are too big or interconnected to manage, regulate or fail should either be broken up 

or required to divest assets until they no longer pose systemic risk. 

In a speech made as the country was emerging from the crisis, Federal Reserve 

Chairman Ben S. Bernanke outlined the risks of the too-big-to-fail system: 

The belief of market participants that a particular firm is considered too 

big to fail has many undesirable effects. For instance, it reduces market discipline and encourages excessive risk-taking by the firm. It also provides an 

artificial incentive for firms to grow in order to be perceived as too big to 

fail. And it creates an unlevel playing field with smaller firms, which may 

not be regarded as having implicit Government support. Moreover, Government rescues of too-big-to-fail firms can be costly to taxpayers, as we have 

seen recently. Indeed, in the present crisis, the too-big-to-fail issue has 

emerged as an enormous problem. 

Unfortunately, Government interventions necessitated by the too-big-to-fail policy 

have exacerbated rather than abated the long-term problems in our financial structure. Through Federal Reserve and Treasury orchestrated mergers, acquisitions and 

closures, the big have become bigger. A recent Bloomberg Government study concluded that the number of too-big-to-fail banks will increase by 40 percent over the 

next 15 years. 

Government efforts to stabilize the financial system, though necessary to stave off 

a full scale financial collapse and even deeper recession, were deeply unfair to community banks. The Government bailed out too-big-to-fail institutions, while the 

FDIC summarily closed too-small-to-save institutions, victims of a crisis created on 

Wall Street. Community bankers across the country were deeply angered by the results of too big to fail. 

This is why ICBA generally supports the too-big-to-fail measures in the DoddFrank Act. These include measures to prevent firms from getting too big; offset the 

advantages of being too big; more diligent monitoring for systemic risk; subject 

large, interconnected firms to enhanced capital and prudential standards; and create 

a resolution authority for large firms so the Government is never again forced to 

choose between propping up a failing firm and allowing it to fail and wreak havoc 

on the financial system. However, whether the Dodd-Frank Act will succeed in ending the market perception that large, interconnected firms are too big to fail will 

largely depend on the implementing rules and how diligently they are enforced in 

the coming months and years. 

Housing Finance Reform, If Not Done Properly, Could Lead to Industry 

Concentration 

Key aspects of the housing finance system—the rules governing underwriting, risk 

retention, servicing, foreclosure, securitization, and the structure of secondary market entities—are facing review and revision. This is an expected and appropriate response to the housing-driven financial and economic crisis we’ve just experienced. 

But we must recognize that ill-considered changes—singly and cumulatively across 

a number of areas—could unintentionally reduce competition, amplify moral hazard, 

and jeopardize safety and soundness. Specifically: 

• The agencies ‘‘qualified residential mortgage’’ (QRM) exemption from the DoddFrank risk retention requirement on mortgages sold and securitized should be 

sufficiently broad to encompass the majority of the residential mortgage market, 

consistent with stronger underwriting standards. Because risk retention will require increased capital, which will pose a challenge for community banks, a narrow definition of QRM will drive thousands of community banks and other lendVerDate Nov 24 2008 07:49 Mar 06, 2012 Jkt 048080 PO 00000 Frm 00059 Fmt 6621 Sfmt 6621 L:\HEARINGS 2011\06-15B DISTILLER\61511.TXT JASON
56 

ers from the residential mortgage market, leaving it to the largest lenders 

whose actions brought about the financial crisis. In our view, the QRM definition currently proposed by the banking agencies, which includes a 20 percent 

downpayment requirement, is too narrow. 

• While policy makers are rightly alarmed by the sloppy and abusive servicing 

standards of some large lenders, they must recognize that community banks 

have fundamentally different standards, practices, and risks. With smaller servicing portfolios, better control of mortgage documents, and close ties to their 

customers and communities, community banks have generally been able to identify repayment problems at the first signs of distress and work out mutually 

agreeable solutions with struggling borrowers. Overly prescriptive servicing requirements—a burden for community banks which do not have the staffing and 

financial resources to implement extensive new programs—could cause many 

community banks to exit the mortgage servicing business and accelerate consolidation of the servicing industry with only the largest too-big-to-fail lenders 

surviving. 

• As proposals for replacing Fannie Mae and Freddie Mac are considered, policy 

makers should be extremely careful not to recreate the moral hazard they represented. Some of the proposals put forward would, by allowing just a small 

number of large banks to dominate the secondary mortgage market, create a 

new variety of moral hazard, just as pernicious as the old variety. Any solution 

that fuels consolidation is only setting up the financial system for an even bigger collapse than the one we’ve just been through. 

Policy makers must proceed with caution in housing finance reform. The mortgage 

market is critical to the broader economy, as we learned during the recent crisis, 

and the potential for unintended consequences is significant. 

Conclusion 

Thank you again for convening this hearing and giving ICBA the opportunity to 

testify. We share your commitment to enhancing the safety and soundness of our 

financial system and hope that the community bank perspective has been valuable. 

PREPARED STATEMENT OF FRANK A. SUELLENTROP 

CHAIRMAN AND PRESIDENT, LEGACY BANK, COLWICH, KANSAS

JUNE 15, 2011 

Chairman Brown, Ranking Member Corker, and Members of the Subcommittee, 

thank you for the opportunity to testify before you today regarding the topic of ‘‘Enhancing Safety and Soundness: Lessons Learned and Opportunities for Continued 

Improvement.’’ 

My name is Frank Suellentrop and I am President and Chairman of Legacy Bank in Colwich, Kansas. We are a $250 million closely held community bank providing 

banking services to the area of Sedgwick County, Kansas. We have five branch locations: our charter bank location in Colwich, Kansas, population 1,400, and four 

branch locations in the Wichita, Kansas, community. 

Our bank was established in February 1886, which means that we are celebrating 

125 years in 2011. I am fourth generation President of our bank with over 38 years 

of employment at Legacy Bank. I have been President of our bank since 1991. From 

that experience, I have seen the beginnings of consumer regulation in the early 

1970s, the agriculture crisis, the savings and loan and real estate crisis of the 1980s 

and early 1990s, and now, the Wall Street-induced real estate crisis of 2008. 

Legacy Bank is significantly involved in residential development, residential construction, and commercial property lending and therefore, has been impacted greatly 

by the economic slowdown and depressed real estate market values. Fortunately, 

the economy in the Wichita, Kansas, area has fared reasonably well throughout the 

current crisis relative to other markets, primarily due to the fact that Kansas, specifically Wichita, had not experienced inflated real estate values of the past decade. 

I would like to preface my comments regarding a recent examination by saying 

that I understand examiners are charged with a difficult task. On one hand, they 

are expected to protect against bank failures, insure consumer compliance and regulation are adhered to, satisfy community groups and organizations demand for fair 

banking practices, and Congressional demands for banking/financial oversight. On 

the other hand, regulators are/should be tasked with not interfering with a bank’s 

corporate mission of creating value for its shareholders. Legacy Bank is a ‘‘for-profit’’ 

corporation. Our most recent 2010 examination revealed stark differences from prior 

exams: higher capital and liquidity standards, more demanding asset quality evalVerDate Nov 24 2008 07:49 Mar 06, 2012 Jkt 048080 PO 00000 Frm 00060 Fmt 6621 Sfmt 6621 L:\HEARINGS 2011\06-15B DISTILLER\61511.TXT JASON
57 

uations, expectations for higher allowance for loan and lease loss reserves (ALLL), 

and increased focus on management assessment and compensation practices. 

Comments made by regulators during our last exam include, ‘‘We don’t like your 

risk profile’’ and ‘‘We’re not going ‘to bat’ for you in Washington.’’ To put the first 

comment in context, our bank has been a lender to residential real estate developers, homebuilders, and commercial property owners since the late 1980s. We feel 

our lending staff has the experience and knowledge to manage our loan portfolio 

composition. These comments were significantly more aggressive compared to prior 

examination observations. Due to recent failures or problem banks in other areas 

of the country, our lending ‘‘risk profile’’ is now unacceptable. In addition to standard loan underwriting criteria of evaluating a borrower’s capital, collateral, capacity 

to repay, and market conditions, we have added a new component to our loan approval discussion process—‘‘Will the loan pass examiners’ review and approval?’’ 

This component should not be a loan approval consideration. A customer’s loan request should be based on its viability and productive value. With respect to the latter comment, it illustrates a regulatory attitude that all banks in real estate lending 

are unsafe and unsound in their practices. 

Banks are evaluated based on their CAMELS component ratings, which measures 

a bank’s capital, asset quality, management, earnings, liquidity, and sensitivity to 

interest rates. My comments on each of these bank evaluation components under 

the current regulatory environment are provided below. 

Capital 

Capital standards for most banks are being dictated above levels for regulatory 

defined ‘‘well-capitalized’ banks and standards required for our Nation’s largest financial institutions. Regulators are using their discretionary capital standards caveat to demand capital levels above those banks defined as ‘‘well-capitalized.’’ Capital below the mandated Tier-One and risk-based levels are likely to receive a lower 

‘‘capital component,’’ which may subject banks to a ‘‘troubled bank’’ status. Discretionary capital standards create a difficult moving target for banks as we seek to 

achieve an acceptable capital component rating. 

Asset Quality 

Examiners are slow to recognize when credit risk has been mitigated. Classifications are inconsistent. No credit given for past performance of the borrower. Some 

classifications are backdated after the borrower begins to show improvement. 

Management 

Management compensation is now being reviewed by examiners, suggesting potential negative impact to earnings and capital. Without significant discussion during our last examination, examiner comments dictated a requirement that we justify 

management compensation and benefits. Somehow ‘‘Wall Street’’ excesses on executive pay have crept into regulators view of ‘‘Main Street’’ banking compensation 

practices when there is no valid comparison to their abuses. 

Earnings 

Earnings evaluations are focused on budget expectations and provide a source of 

capital growth. Budgets are a fluid document where changes occur relative to changing market conditions. Variances occur throughout the year and are detailed in 

monthly review of performance vs. a rebudgeting process as suggested by an examiner. 

Liquidity 

Current examination expectations dictate a higher level of liquidity to protect 

against the ‘‘what ifs’’ for funding assets. Examiners are reluctant to recognize the 

value of purchased funding costs vs. core deposit funding. Levels of purchased funding should be variable to the institution and not an industry standard. 

At each examination, an Examiner in Charge (EIC) is designated. My experience 

with this practice is that often an EIC does not want to overrule another examiner’s 

findings regarding loan quality issues or other components of an examination. On 

completion of an examination, EIC comments are submitted to a Review Examiner. 

The Review Examiner then does not want to overrule an EIC’s submitted comments; 

therefore, the process can be problematic for bankers where an inexperienced or unqualified examiner’s findings become a part of the ‘‘report of examination.’’ These 

results then become a part of the final report for bank examination ratings and 

mandated actions to address findings. Only experienced examiners capable of managing others’ activities should be designated as an ‘‘Examiner in Charge’’ to insure 

quality in a final report of examination. Recourse for bankers disputes regarding examination findings are often treated as we agree to disagree by examiners. 

58 

In summary, micromanaging is unproductive. Part of the regulator’s role is to 

offer insight into latest industry trends and issues. Instead, exam outcomes now 

seem predetermined with enforcement actions imposed for minor issues that do not 

enhance a bank’s viability. To move forward in a productive, mutually beneficial 

manner, there should be more focus on the root cause of examination findings. Examiners should expect results, but if capital is solid and management is capable, 

then overregulation is unnecessary. Regulatory burden and examiner expectations 

are disproportionate in their impact on community banks vs. the largest banks. 

Many community banks have a limited staff to respond to examiner expectations vs. 

the largest banks full-time staff devoted to regulatory compliance. 

Thank you again for the opportunity to comment. I hope that this testimony provides productive insight into the current regulatory environment for community 

banks. 

59 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED 

FROM MICHAEL R. FOLEY 

Q.1. What is the purpose of the Commercial Bank Examination 

Manual? While certain sections were updated in April (which was 

identified as ‘‘Supplement 35’’), it appears that there has been no 

comprehensive review and update of the entire manual. Does the 

Federal Reserve intend to conduct a comprehensive rewrite of this 

manual? Why or why not? 

A.1. Response not provided. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR MERKLEY 

FROM MICHAEL R. FOLEY 

Q.1. Examination Staffing—Recent reports indicate the Federal 

banking agencies are increasing their on-site examination teams at 

the largest banks. For each of the six largest banking organizations 

that your agency respectively supervises today, please detail: (a) 

how many examiners you have had dedicated to supervising each 

such organization for each year beginning in 2005 through the 

present; (b) whether those examiners resided on-site at the firm’s 

headquarters permanently, whether those examiners resided onsite occasionally for examination periods, or whether those examiners remained at the agency (and if so, which office/Reserve 

Bank); and (c) what the principal responsibilities of those examiners were (for example, data analysis of risk models, supervising 

management compliance with policies and procedures, etc.). 

For those 6 largest banking organizations, please also quantify 

the number of personnel at each banking organization working in 

the risk management group, or the internal audit department. 

A.1. Response not provided. 

Q.2. Examination Staffing—Please provide specific detail regarding 

the methodology you used/use for determining how many examiners you dedicate to firms you supervise. Please provide other information relevant to staffing levels and practices for your examinations, such as the FTE examination hours applicable per $10 billion of assets at the 10 largest banking organizations and the FTE 

examination hours applicable for $10 billion of assets at all other 

banking organizations. 

A.2. Response not provided. 

Q.3. Examination Staffing—During the 2005 through 2010 period, 

please detail the dates on which peer reviews or other internal reviews were conducted within your organizations that evaluated the 

sufficiency of examination staffing for the six largest institutions 

under your supervision. Please state the staffing conclusions for 

each such peer review. 

A.3. Response not provided. 

Q.4. Interagency Cooperation—Senior examiners have indicated 

that the largest banking organizations run their businesses without respect to the legal entity involved, and that specific business 

operations can straddle entities with different regulatory jurisdictions. In light of Dodd-Frank, how has the communication among 

agencies changed? When multiple regulators oversee a banking orVerDate Nov 24 2008 07:49 Mar 06, 2012 Jkt 048080 PO 00000 Frm 00063 Fmt 6602 Sfmt 6602 L:\HEARINGS 2011\06-15B DISTILLER\61511.TXT JASON
60 

ganization, what procedures do you have in place to review and follow-up on concerns raised by one regulator when such concerns 

may touch upon oversight conducted by other regulators or the entire firm? 

A.4. Response not provided. 

Q.5. Investigations—The HUD Inspector General has recently 

issued findings that at least one major financial institution has obstructed a State attorneys general investigation and a HUD investigation into foreclosure and servicing abuses. What specific steps 

have you taken to ensure that all institutions under your supervision are complying with both your supervision and with relevant 

investigations by other regulatory agencies and law enforcement officials? 

A.5. Response not provided. 

Q.6. Documentation Oversight—Following the robosigning scandal 

and the difficulty some banks have had documenting the claim of 

ownership on mortgages on which they are pursuing foreclosure, 

what steps have you taken to increase oversight of documentation 

requirements at large complex financial institutions? 

A.6. Response not provided. 

Q.7. International—What systems do you have in place or do you 

envision needing to ensure the proper supervision of large complex 

foreign financial institutions which either operate in the U.S. or 

which materially affect U.S. financial markets? 

A.7. Response not provided. 

Q.8. Trading Book—For the firms that now make up the six largest 

bank holding companies, what percentage of losses by those firms 

on a consolidated basis during the 2008 financial crisis were due 

to losses in their respective trading books as opposed to their banking books? Please include within that analysis assets which would 

have been losses had those assets not been transferred from the 

trading book to the banking book and therefore not subject to fair 

value accounting. Also include in those losses assets or positions 

that were placed on the books of that national bank, after the outbreak of the crisis, such as the liquidity puts that were used to 

bring back CDQs onto a bank’s balance sheet. 

Please provide relevant data/analysis as appropriate. 

A.8. Response not provided. 

Q.9. Review of Trading Operations Under FRB Manuals—Section 

2030.3 of the Federal Reserve’s Commercial Bank Examination 

Manual, in effect since March 1994, lists certain specific procedures 

that examiners are expected to conduct in their supervision of commercial banks’ trading operations. For example it asks examiners 

to ‘‘test for compliance with policies, practices, procedures, and internal controls . . . ’’ (#3); requests a series of schedules, including 

‘‘an aged schedule of securities,’’ ‘‘an aged schedule of trading account securities . . . held for trading or arbitrage purposes,’’ ‘‘a 

schedule of loaned securities,’’ etc. (#4); requests the examiner to 

‘‘review customer ledgers, securities position ledgers, etc., and analyze the soundness of the bank’s trading practices by . . . reviewing a representative sample of agency and contemporaneous prinVerDate Nov 24 2008 07:49 Mar 06, 2012 Jkt 048080 PO 00000 Frm 00064 Fmt 6602 Sfmt 6602 L:\HEARINGS 2011\06-15B DISTILLER\61511.TXT JASON
61 

cipal trades . . . and reviewing significant inventory positions 

taken since the prior examination’’ (#9). 

Today, some of the largest bank holding companies conduct their 

derivatives trading operations directly through Federal Reserveregulated member banks. How frequently do examiners conduct the 

reviews directed by section 2030.3? Under what circumstances will 

you discipline an examination team for failing to follow policies and 

procedures set out in agency manuals—please describe up to three 

examples? 

A.9. Response not provided. 

Q.10. Safety and Soundness Review of Trading Operations—The 

Federal Reserve Trading and Capital Markets manual sets out a 

wide range of approaches to monitoring firms’ trading activities, in 

particular focusing on whether firms have in place policies and procedures to monitor risks. As part of this monitoring of risks, on 

what occasions might you make an independent evaluation of the 

trading positions themselves on a safety and soundness basis, rather than simply the policies and procedures regarding risk management? 

For example, the former CEO of one large banking group said he 

couldn’t be bothered with his firm’s $43 billion dollar exposure on 

subprime CDOs because he had a $2 trillion balance sheet to manage. However, that $43 billion dollar exposure represented 1⁄3 of the 

group’s capital. Meanwhile, community bank examiners regularly 

examine the substance of large loans for conformance with safety 

and soundness. Under what circumstances would a trading position 

such as the one outlined above be reviewed for the underlying risk 

by your examiners? Please detail at least three examples in the 

last 5 years. 

How has oversight of trading activities changed between 

prefinancial crisis and now? 

A.10. Response not provided. 

RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN BROWN 

FROM DAVID K. WILSON 

Q.1. In a speech in London yesterday, Acting Comptroller Walsh 

cited a 2007 study which stated that ‘‘there is widespread agreement in the theoretical academic literature that the immediate effects of constraining capital standards are likely to be a reduction 

in total lending and accompanying increases in market loan rates 

and substitution away from lending to holding alternative assets.’’ 

If this was true prior to the financial crisis, when this study was 

conducted, it is no longer the case today. There now appears to be 

widespread agreement that equity is not expensive and that increased capital buffers are a good thing. 

In August of 2010, Professor Anat Admati and several of her colleagues published a paper explaining that requiring banks to increase their funding through equity will not contract lending. 

David Scharfstein and Jeremy Stein of Harvard University argued last September in the Financial Times that increased capital 

will make institutions safer, and actually reduce the risk of a credit 

crunch. 

62 

A study by the Bank for International Settlements suggests an 

optimal capital ratio of about 13 percent. 

A Government-sponsored panel in Switzerland has said that 

massive banks UBS and Credit Suisse should hold a 19 percent 

capital buffer. 

The Bank of England is reportedly considering capital ratios as 

high as 20 percent. 

In his recent testimony before the Congressional Oversight Panel 

of TARP (COP), Professor Allan Meltzer noted that large banks in 

the 1920s held capital equal to 15 to 20 percent of their assets. 

In response to written questions pursuant to a February hearing 

in the Senate Banking Committee, FDIC Chairman Sheila Bair 

stated, ‘‘we do not agree that the new [capital] requirements will 

reduce the availability of credit or significantly raise borrowing 

costs.’’ 

a. Do you believe that equity is expensive despite the work of respected academics showing that it is not? 

b. What are the costs of increasing banks funding through equity? 

c. What other evidence, aside from the study cited by Mr. Walsh, 

supports your conclusion that banks increasing their equity funding would be expensive and contract lending? 

d. Does the OCC have any evidence suggesting that the alleged 

costs of additional equity funding outweigh the costs associated 

with undercapitalization at rates below those required by Basel III 

combined with an additional SIFI capital buffer? 

e. What does the OCC believe to be the optimum capital buffer? 

A.1. Response not provided. 

Q.2. According to a June 12th report in the Financial Times, OCC 

data shows that nearly 20 percent of private label mortgage-backed 

securities held by banks are at least 30 days late or in some stage 

of foreclosure. Amherst Securities estimates that 30 percent of 

mortgages contained in PLS held by outside investors are at least 

60 days delinquent. 

The COP estimates that, at the end of the third quarter 2010, 

the four largest banks reported $420.0 billion in second lien mortgages. The OCC sent a letter to Representative Brad Miller in December in which you estimated that banks’ total losses on second 

liens would not exceed $18 billion. 

COP estimates that banks are subject to $52 billion in mortgagebacked security put-back claims. Institutional Risk Analytics estimates that JPMorgan Chase alone is subject to $50 billion in investor claims under the Securities Act. 

a. What losses does the OCCproject the banks to incur on their 

private label MBS holdings? Please provide a specific number, and 

please explain the assumptions and rationale behind your calculation. 

b. What losses does the OCC project banks to incur on their second lien portfolios? Please provide a specific number, and please explain the assumptions and rationale behind your calculation. 

c. What losses does the OCC project banks to incur through investors’ securities claims? Please provide a specific number, and 

63 

please explain the assumptions and rationale behind your calculation. 

A.2. Response not provided. 

Q.3. In February, Acting Comptroller Walsh testified that ‘‘[mortgage servicing] deficiencies have resulted in violations of State and 

local foreclosure laws, regulations, or rules.’’ 

a. In written questions for that hearing I asked Mr. Walsh what 

specific laws, regulations, or rules were violated. The only specific 

laws cited were State attestation and notarization laws. In a subsequent answer, he noted violations of the Servicemembers Civil Relief Act, bankruptcy law, and mortgage modification programs. 

i. Please list all of the violations of specific laws, regulations, or 

rules—either local, State, or Federal—that your reviews uncovered. 

ii. How many violations of each law, regulation, or rule did you 

uncover? 

b. The Treasury Department was unable to determine in 18.8 

percent of Bank of America’s HAMP files whether a second look 

had been conducted, and there were income miscalculations in 22 

percent of cases. The numbers for JPMorgan Chase were 11.3 percent and 31 percent, respectively. 

Mr. Walsh noted in his written responses that ‘‘Documents in the 

foreclosure files may not have disclosed certain facts that might 

have led examiners to conclude that a foreclosure should not have 

proceeded however, such as misapplication of payments that could 

have precipitated a foreclosure action or oral communications between the borrower and servicer staff that were not documented in 

the foreclosure file.’’ 

i. What other errors did you uncover in your reviews that might 

have led examiners to conclude that a foreclosure should not have 

proceeded? Please describe every error that you uncovered. 

ii. How many files reviewed by the OCC contained such errors? 

A.3. Response not provided. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED 

FROM DAVID K. WILSON 

Q.1. Please provide a response to May 12, 2011, questions that 

were submitted to the Office of the Comptroller of the Currency 

(OCC). No response has been received to date. 

A.1. Response not provided. 

Q.2. What is the purpose of the Comptroller’s Handbook? What revisions have been made to the Comptroller’s Handbook to address 

observations from the financial crisis? When will there be a comprehensive rewrite? 

A.2. Response not provided. 

Q.3. Please describe the specific changes you have made to the 

training programs for examiners in response to matters observed 

during the financial crisis. 

A.3. Response not provided. 

Q.4. What reliance do you place on a bank’s internal control system? What basis do you have for that reliance? Describe what work 

64 

the OCC has done to be assured that there are no significant weaknesses the agency is inherently relying on. 

Please describe any meetings that the OCC has had with the 

Public Company Accounting Oversight Board (PCAOB) to discuss 

any weaknesses the OCC identified in the internal control? Please 

indicate the date of such meetings and the substance of the matters discussed. 

Please describe any meetings that the OCC has had with the Securities and Exchange Commission (SEC) about such weaknesses. 

Please indicate the date of such meetings and the substance of the 

matters discussed. 

A.4. Response not provided. 

Q.5. Describe the facts and circumstances, if any, that may prevent 

principal reduction, whether structured as forbearance or forgiveness, from being considered as a viable option in mortgage modifications. Please indicate whether the agency has taken any position with respect to mortgage servicer accounting for all forms of 

mortgage modifications. Please include any guidance provided to 

servicers or other regulators, including the date and substance of 

the guidance provided. 

A.5. Response not provided. 

Q.6. Describe the facts, circumstances, and relevant accounting 

guidance that applies to accounting for mortgage modifications by 

mortgage servicers. Please provide internal or external guidance. 

A.6. Response not provided. 

Q.7. Describe the facts, circumstances, and relevant accounting 

guidance that concerns servicers consolidation of securitization 

trusts. Please describe the total mix of information considered, including all quantitative and qualitative factors, with respect to defining ‘‘significance.’’ Please indicate the reasons that servicers 

have or have not consolidated securitization trusts as a result of recently implemented generally accepted accounting principles (including SFAS Nos. 166 and 167). Please include specific discussion 

of anticipated losses as a result of servicer conduct that is the subject of the OCC Consent Orders and other reviews. 

A.7. Response not provided. 

Q.8. Provide the data that serves as the basis for the statement 

made by Mr. Walsh on June 21, 2011, ‘‘Capital levels are now extraordinarily high by historical standards.’’ Please include the period of time considered and the relevant quantitative measure at 

each interval. 

A.8. Response not provided. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR MERKLEY 

FROM DAVID K. WILSON 

Q.1. Examination Staffing—Recent reports indicate the Federal 

banking agencies are increasing their on-site examination teams at 

the largest banks. For each of the six largest banking organizations 

that your agency respectively supervises today, please detail: (a) 

how many examiners you have had dedicated to supervising each 

such organization for each year beginning in 2005 through the 

65 

present; (b) whether those examiners resided on-site at the firm’s 

headquarters permanently, whether those examiners resided onsite occasionally for examination periods, or whether those examiners remained at the agency (and if so, which office/Reserve 

Bank); and (c) what the principal responsibilities of those examiners were (for example, data analysis of risk models, supervising 

management compliance with policies and procedures, etc.). 

For those 6 largest banking organizations, please also quantify 

the number of personnel at each banking organization working in 

the risk management group, or the internal audit department. 

A.1. Response not provided. 

Q.2. Examination Staffing—Please provide specific detail regarding 

the methodology you used/use for determining how many examiners you dedicate to firms you supervise. Please provide other information relevant to staffing levels and practices for your examinations, such as the FTE examination hours applicable per $10 billion of assets at the 10 largest banking organizations and the FTE 

examination hours applicable for $10 billion of assets at all other 

banking organizations. 

A.2. Response not provided. 

Q.3. Examination Staffing—During the 2005 through 2010 period, 

please detail the dates on which peer reviews or other internal reviews were conducted within your organizations that evaluated the 

sufficiency of examination staffing for the six largest institutions 

under your supervision. Please state the staffing conclusions for 

each such peer review. 

A.3. Response not provided. 

Q.4. Interagency Cooperation—Senior examiners have indicated 

that the largest banking organizations run their businesses without respect to the legal entity involved, and that specific business 

operations can straddle entities with different regulatory jurisdictions. In light of Dodd-Frank, how has the communication among 

agencies changed? When multiple regulators oversee a banking organization, what procedures do you have in place to review and follow-up on concerns raised by one regulator when such concerns 

may touch upon oversight conducted by other regulators or the entire firm? 

A.4. Response not provided. 

Q.5. Investigations—The HUD Inspector General has recently 

issued findings that at least one major financial institution has obstructed a State attorneys general investigation and a HUD investigation into foreclosure and servicing abuses. What specific steps 

have you taken to ensure that all institutions under your supervision are complying with both your supervision and with relevant 

investigations by other regulatory agencies and law enforcement officials? 

A.5. Response not provided. 

Q.6. Documentation Oversight—Following the robosigning scandal 

and the difficulty some banks have had documenting the claim of 

ownership on mortgages on which they are pursuing foreclosure, 

66 

what steps have you taken to increase oversight of documentation 

requirements at large complex financial institutions? 

A.6. Response not provided. 

Q.7. International—What systems do you have in place or do you 

envision needing to ensure the proper supervision of large complex 

foreign financial institutions which either operate in the U.S. or 

which materially affect U.S. financial markets? 

A.7. Response not provided. 

Q.8. Trading Book—For the firms that now make up the six largest 

bank holding companies, what percentage of losses by those firms 

on a consolidated basis during the 2008 financial crisis were due 

to losses in their respective trading books as opposed to their banking books? Please include within that analysis assets which would 

have been losses had those assets not been transferred from the 

trading book to the banking book and therefore not subject to fair 

value accounting. Also include in those losses assets or positions 

that were placed on the books of that national bank, after the outbreak of the crisis, such as the liquidity puts that were used to 

bring back CDQs onto a bank’s balance sheet. 

Please provide relevant data/analysis as appropriate. 

A.8. Response not provided. 

Q.9. Review of Trading Operations Under FRB Manuals—Section 

2030.3 of the Federal Reserve’s Commercial Bank Examination 

Manual, in effect since March 1994, lists certain specific procedures 

that examiners are expected to conduct in their supervision of commercial banks’ trading operations. For example it asks examiners 

to ‘‘test for compliance with policies, practices, procedures, and internal controls . . . ’’ (#3); requests a series of schedules, including 

‘‘an aged schedule of securities,’’ ‘‘an aged schedule of trading account securities . . . held for trading or arbitrage purposes,’’ ‘‘a 

schedule of loaned securities,’’ etc. (#4); requests the examiner to 

‘‘review customer ledgers, securities position ledgers, etc., and analyze the soundness of the bank’s trading practices by . . . reviewing a representative sample of agency and contemporaneous principal trades . . . and reviewing significant inventory positions 

taken since the prior examination’’ (#9). 

Today, some of the largest bank holding companies conduct their 

derivatives trading operations directly through Federal Reserveregulated member banks. How frequently do examiners conduct the 

reviews directed by section 2030.3? Under what circumstances will 

you discipline an examination team for failing to follow policies and 

procedures set out in agency manuals—please describe up to three 

examples? 

A.9. Response not provided. 

Q.10. Safety and Soundness Review of Trading Operations—The 

Federal Reserve Trading and Capital Markets manual sets out a 

wide range of approaches to monitoring firms’ trading activities, in 

particular focusing on whether firms have in place policies and procedures to monitor risks. As part of this monitoring of risks, on 

what occasions might you make an independent evaluation of the 

trading positions themselves on a safety and soundness basis, rathVerDate Nov 24 2008 07:49 Mar 06, 2012 Jkt 048080 PO 00000 Frm 00070 Fmt 6602 Sfmt 6602 L:\HEARINGS 2011\06-15B DISTILLER\61511.TXT JASON
67 

er than simply the policies and procedures regarding risk management? 

For example, the former CEO of one large banking group said he couldn’t be bothered with his firm’s $43 billion dollar exposure on 

subprime CDOs because he had a $2 trillion balance sheet to manage. However, that $43 billion dollar exposure represented 1⁄3 of the 

group’s capital. Meanwhile, community bank examiners regularly 

examine the substance of large loans for conformance with safety 

and soundness. Under what circumstances would a trading position 

such as the one outlined above be reviewed for the underlying risk 

by your examiners? Please detail at least three examples in the 

last 5 years. 

How has oversight of trading activities changed between 

prefinancial crisis and now? 

A.10. Response not provided. 

Q.11. Your testimony on page 24 [Editor: See, Page 51, Part D, of 

this hearing] regarding section 619 suggests a narrow view of proprietary trading that seems to envision a world wherein all proprietary trading occurs on distinct, separate stand-alone proprietary 

trading desks. 

Please provide details on what, if any, analysis the OCC has 

made on the conflicts of interest and risks to institutions from proprietary trading wherever it may occur, and particularly that 

which occurs on market-making desks and in other business units 

of a firm, such as securitization-structured product underwriting 

and merchant banking. 

For example, the U.S. Permanent Subcommittee on Investigations found that large, conflicted proprietary trading activities of 

one firm occurred on its mortgage desks, which were non- standalone proprietary trading desks. How does the OCC identify those 

conflicts and risks now and what new forms of oversight are you 

contemplating putting in place to ensure the statutory intent of 

section 619 is implemented? 

A.11. Response not provided. 

68 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

STATEMENT SUBMITTED BY THE AMERICAN BANKERS ASSOCIATION 

Chairman Brown, Ranking Member Corker, and Members of the Subcommittee, 

the American Bankers Association appreciates the opportunity to submit this statement for the record on ways to enhance safety and soundness in the aftermath of 

the financial crisis. The ABA represents banks of all sizes and charters and is the 

voice of the Nation’s $13 trillion banking industry and its two million employees. 

The topic of this hearing is very important. In an effort to deal with the aftermath 

of the financial crisis, the response by Congress and the regulators has been to drive 

out all the risk from the system in the name of safety and soundness. This has 

meant that good loans that could and should be made are left unfunded. The pendulum has swung too far in favor of tighter regulation, micromanagement, and second-guessing. This has made the daily efforts of banks to make credit and financial 

services available much more difficult. Combined with hundreds of new regulations 

expected from the Dodd-Frank Act, these pressures are slowly but surely strangling 

traditional community banks, handicapping their ability to meet the credit needs of 

communities across the country. 

Congress must be vigilant in overseeing regulatory actions that unnecessarily restrict loans to creditworthy borrowers. Holding oversight hearings like this one is 

critical to ensure that banks are allowed to do what they do best—namely, meet the 

credit needs of their communities. 

For banks to be successful and meet the needs of their customers, they need to 

be profitable. There is no better assurance of safety and soundness than a healthy, 

profitable industry. Once again, Congress and the regulators have acted to reduce 

sources of income, made it much harder to raise capital, and threaten to drive some 

banks completely out of business lines, such as acting as municipal advisors or making residential mortgage loans. 

One of those very important sources of income that will be significantly diminished is a direct result of the Durbin Amendment in the Dodd-Frank Act that imposes severe restrictions on interchange prices. The ABA and the thousands of 

banks we represent were deeply disappointed with the outcome of Senate vote last 

week. Failure to approve the bipartisan amendment sponsored by Senators Tester 

(D–Mont.), Corker (R–Tenn.), and others to address the serious concerns over the 

interchange amendment marks a dark day for every bank that issues debit cards 

and for consumers that have come to rely on them. 

American consumers will now have to pay more for basic banking services, while 

big-box retailers go off and count their unjustified profits. Community banks—the 

backbone of local communities—will suffer the most. They will see a reduction in 

a key source of revenue that allows them to offer low-cost banking services to everyday consumers and supports lending and fraud protection measures. Key banking 

regulators—including Federal Reserve Board Chairman Ben Bernanke and FDIC 

Chairwoman Sheila Bair—have unequivocally stated that small banks will be 

harmed by the implementation of the Durbin Amendment. While a majority of Senators supported the Tester/Corker amendment, it is simply unconscionable that the 

Senate will not complete the work and protect community banks from this destructive effect. 

It is within the Federal Reserve’s power to mitigate the disastrous consequences 

that are sure to come from this policy initiative, and we urge the Fed to take all 

necessary action to do so. 

The entire banking industry thanks Senators Tester and Corker—and the other 

52 senators that stood up for debit card customers—for their extraordinary effort 

to address this serious problem in a constructive and deliberate way. 

The remainder of this statement focuses on several key issues: 

• Driving all the risk out of the system means slower economic and job growth; 

• Access to New Capital for Community Banks is Problematic; and 

• Restrictions may drive banks out of some lines of business altogether. 

I. Driving All the Risk out of the System Means Slower Economic and Job 

Growth 

ABA believes that it is a mistake for policy makers to apply the most restrictive 

approach to every bank. By swinging the pendulum too far in the direction of minimizing risk, the Dodd-Frank Act risks choking off important banking activity that 

can and should be done by banks—particularly by banks that had no hand in creating the financial crisis. It is important to keep that pendulum close to the center 

in order to encourage diversity and innovation. 

69 

The health of the banking industry and the economic strength of the Nation’s 

communities are closely interwoven. ABA strongly believes that our communities 

cannot reach their full potential without the local presence of a bank—a bank that 

understands the financial and credit needs of its citizens, businesses, and Government. This model will collapse under the massive weight of new rules and regulations. The vast majority of banks never made an exotic mortgage loan or took on 

excessive risks. They had nothing to do with the events that led to the financial crisis and are as much victims of the devastation as the rest of the economy. These 

banks are the survivors of the problems, yet they are the ones that pay the price 

for the mess that others created. 

Managing this mountain of regulation will be a significant challenge for a bank 

of any size. For the median-sized bank with only 37 employees this burden will be 

overwhelming. The new rules create more pressure to hire additional compliance 

staff, not customer-facing staff. They mean more money spent on outside lawyers 

to manage the risk of compliance errors and litigation. They mean more money to 

hire consulting firms to assist with the implementation of all of the changes, and 

more money to hire outside auditors to verify there are no compliance errors. They 

mean more risk of regulatory scrutiny, which can include penalties and fines. All 

of these expenditures take away precious resources that could be better used serving 

the bank’s community. 

The consequences are real. Costs are rising, access to capital is limited, and revenue sources have been severely cut. It means that fewer loans get made. It means 

a weaker economy. It means slower job growth. With the regulatory overreaction, 

piles of new laws, and uncertainty about Government’s role in the day-to-day business of banking, meeting local community needs is difficult at best. Without quick 

and bold action to relieve regulatory burden we will witness an appalling contraction of the banking industry. 

II. Access to New Capital for Community Banks Is Problematic 

Banks have to be profitable and provide a reasonable return to investors. If they 

do not, capital quickly flows to other industries that have higher returns. Capital 

is critical as it is the foundation upon which all lending is built. Having sufficient 

capital is critical to support lending and to absorb losses when loans are not repaid. 

In fact, $1 worth of capital supports up to $10 in loans. Most banks entered this 

economic downturn with a great deal of capital, but the downward spiral of the 

economy has created losses and stressed capital levels. Not surprisingly, when the 

economy is weak, new sources of capital are scarce. 

The timing of the Dodd-Frank limitations on sources of capital could not have 

been worse, as banks struggle to replace capital used to absorb losses brought on 

by the recession. While the market for trust preferred securities (which had been 

an important source of capital for many community banks) is moribund at the moment, the industry needs the flexibility to raise capital through various means in 

order to meet increasing demands for capital. Moreover, the lack of readily available 

capital comes at a time when restrictions on interchange and higher operating expenses from Dodd-Frank have already made building capital through retained earnings more difficult. 

These limitations are bad enough on their own, but the consequences are exacerbated by bank regulators piling on new requests for even greater levels of capital. 

Many community banks have told us that regulators are pressing banks to increase 

capital-to-assets ratios by as much as 4 to 6 percentage points—50 to 75 percent— 

above minimum standards. For many banks, it seems like whatever level of capital 

they have, it is not enough to satisfy the regulators. This is excess capital not able 

to be redeployed into the market for economic growth. 

Thus, to maintain or increase capital-to-assets levels demanded by the regulators, 

these banks have been forced to limit, or even reduce, their lending. The result: the 

banking industry becomes smaller while loans become more expensive and harder 

to get. 

While more capital certainly can improve safety and soundness, it ignores the fundamental fact that banks are in the business of taking risk—every loan made runs 

the risk of not being repaid. Ever-increasing demands for more capital are dragging 

down credit availability at the worst possible time for our Nation’s recovery. Moreover, it works at cross purposes with banks’ need for the strong and sustainable 

earnings that will be the key to addressing asset quality challenges. Therefore, anything that relieves the increasing regulatory demands for more capital will help 

banks make the loans that are needed for our Nation’s recovery. 

70 

III. Regulatory Risk and Uncertainty Are Rising, Reducing Incentive To 

Lend 

Businesses—including banks—cannot operate in an environment of uncertainty. 

Unfortunately, Dodd-Frank increases uncertainty for banks, and as a consequence, 

raises credit risks, raises litigation risks and costs (for even minor compliance 

issues), leads to less hiring or even a reduction in staff, makes hedging risks more 

difficult and costly, and restricts new business outreach. All of this translates into 

less willingness to make loans. In fact, banks’ biggest risk has become regulatory 

risk. Four examples help to illustrate this increase in regulatory risk and uncertainty: 

First, the nature and extent of rules from the Consumer Financial Protection Bureau are unknown, but uncertainty about the potential actions creates potential litigation risk as actions taken today may conflict with the changes in rules devised 

by the Bureau. The expectation of significant new disclosures, for example, translates into less willingness to lend (and therefore less credit extended overall), and 

higher costs to borrowers that still have access to credit to cover the added risks 

and expenses assumed by banks. 

A second important example of uncertainty and unease created by Dodd-Frank 

arises from the provisions regarding preemption. Congress explicitly preserved in 

the Dodd-Frank Act the test for preemption articulated by the United States Supreme Court for deciding when a State law is preempted by the Federal laws that 

govern national banks’ activities. Nevertheless, any mention of the preemption 

standard in a statute is likely to generate lawsuits from those who argue that the 

standard somehow has changed. The Dodd-Frank Act preemption provisions will affect all banks, including State-chartered banks and thrifts that benefit from 

wildcard statutes. State attorneys general will have greater authority to enforce 

rules and regulations, specifically including those promulgated by the Consumer Financial Protection Bureau. The potential changes and risk of litigation necessarily 

reduce the willingness of banks to lend to any business or individual with less than 

a stellar credit history. 

Third, Government involvement in price controls—such as the Durbin Amendment on interchange fees—sets a dangerous precedent, suggesting that financial institutions may be subject to future, unknowable price controls on other financial 

products and services, undermining important free-market principles. Banks have 

always accepted the operational, reputational, and financial risk associated with developing new products and services and making them available to millions of consumers. Now financial institutions risk losing their investments of billions of dollars 

into improvements of existing products and services, and the creation of new ones, 

through Government price controls. Why would any business invest in an innovative 

product knowing the Government ex post facto will interfere by imposing price controls? The Durbin Amendment serves as a strong disincentive for innovation and investment by financial institutions in other emerging payment systems and financial 

products and services. In the end, it is the American public who suffers. 

The fourth uncertainty relates to the implementation of the swap rules. Banks do 

not know yet how the swaps exchanges will operate, what impact the clearing requirements will have on banks’ ability to customize swaps, or even which banks and 

transactions will be subject to each of the new rules. For example, while other end 

users will be exempt from complex and costly clearing requirements, we are waiting 

to find out if our community banks will receive the same treatment. If not, then 

these banks might not be able to use swaps and the end result would be reduced 

lending, increased risk for banks, and higher costs for customers if banks cannot 

hedge the risk. 

We urge Congress to actively oversee the Commodity Futures Trading Commission (CFTC) and SEC as they implement the new swaps requirements to be sure 

there are no adverse affects on lending or competition for U.S. banks. We also encourage Congress to enact legislation explicitly granting small banks the same exemption from swaps clearing requirements that is available to other end users. 

IV. Restrictions May Drive Banks Out of Some Lines of Business Altogether 

Safety and soundness is best protected when banks are able to meet the credit 

needs of their customers. This is what is so disturbing about the implementation 

of some rules under Dodd-Frank that would effectively drive banks out of lines of 

businesses altogether. This not only hurts the customers, but also means less income—and less diversified sources of income—that forms the base of financial 

health for any bank. New rules on registration as municipal advisors and on mortgage lending are two particularly problematic provisions. 

71 

Proposed SEC municipal advisor rules could limit banking options for State and 

local governments. 

ABA believes that Dodd-Frank intended to establish a regulatory scheme for unregulated persons providing advice to municipalities with respect to municipal derivatives, guaranteed investment contracts, investment strategies or the issuance of 

municipal securities. Most community banks do not deal in bonds or securities. But 

banks do offer public sector customers banking services and are regulated closely 

by several Government agencies. 

The Securities and Exchange Commission has proposed a very broad definition of 

‘‘investment strategies’’ that would cover traditional bank products and services 

such as deposit accounts, cash management products and loans to municipalities. 

This means that community banks would have to register as municipal advisors and 

be subject to a whole new layer of regulation on bank products for no meaningful 

public purpose. The result of this duplicative and costly regulation is that banks 

may decide not to provide banking services to their local municipalities—forcing 

these local and State entities to look outside of their community for the services 

they need. This proposal flies in the face of the President’s initiative to streamline 

Federal oversight and avoid new regulations that impede innovation, diminish U.S. 

competitiveness, and restrain job creation and economic expansion. 

We urge Congress to oversee this implementation and ensure that the rule addresses unregulated parties and that neither Section 975 of Dodd-Frank nor its implementing regulation reaches through to traditional bank products and services. 

New proposed mortgage rules likely to drive many community banks out of mortgage 

lending. 

ABA has grave concerns that the risk retention proposal issued by the regulators 

will drive many banks from mortgage lending and shut many borrowers out of the 

credit market entirely. Responding to widespread objections from consumer groups, 

banks, and Senators and Congressman, the regulators extended the comment period 

from June 10th to August 1st. While more time for commenting on such a far reaching regulatory proposal is welcome, what is really necessary is for the rule to be 

withdrawn in its current form and substantially reconsidered. 

It is true that the proposal’s immediate impact is muted by the fact that loans 

sold to Fannie Mae and Freddie Mac while they are in conservatorship escape risk 

retention. However, once the rule’s requirements are imposed broadly on the market 

(should they be adopted) they would likely shut out many borrowers entirely and 

act to destabilize the housing market once again. Since it is also the stated goal of 

both the Congress and the Administration to end the conservatorship of Fannie and 

Freddie, it is important that risk retention requirements be rational and nondisruptive when they are applied broadly to the market. The rule as proposed does not 

meet those tests. 

Therefore, ABA urges Congress to ensure that the regulators revise the risk retention regulation before it is imposed on the mortgage market broadly. Specifically 

we recommend: 

Exemption from risk retention provisions must reflect changes in the market 

already imposed through other legislative and regulatory change. 

In the Dodd-Frank Act, Congress determined that some form of risk retention was 

desirable to ensure that participants in a mortgage securitization transaction had 

so-called ‘‘skin in the game.’’ The goal was to create incentives for originators to assure proper underwriting (e.g., ability to repay) and incentives to control default risk 

for participants beyond the origination stage. There have already been dramatic 

changes to the regulations governing mortgages. The result is that mortgage loans 

with lower risk characteristics—which include most mortgage loans being made by 

community banks today—should be exempted from the risk retention requirements—regardless of whether sold to Fannie Mae and Freddie Mac or to private 

securitizers. 

Exempting such ‘‘qualified residential mortgage’’ loans (QRM) is important to ensure the stability and recovery of the mortgage market and also to avoid capital requirements not necessary to address systemic issues. However, the QRM as proposed is very narrow and many high-quality loans posing little risk will end up 

being excluded. This will inevitably mean that fewer borrowers will qualify for loans 

to purchase or refinance a home. Instead, the QRM definition should more closely 

align with the proposed QM definition promulgated by the Federal Reserve Board. 

The QM definition (as proposed) focuses on a borrower’s ability to repay and allows 

originators to measure that ability with traditional underwriting tools. The proposed 

QRM rule, in contrast, takes most underwriting decisions away from originators in 

favor of rigid loan to value and other targets. 

72 

For example, for the loan to qualify for QRM status, borrowers must make at 

least a 20 percent downpayment—and at least 25 percent if the mortgage is a refinancing (and 30 percent if it is a cash-out refinance). 

Certainly loans with lower loan-to-value (LTV) ratios are likely to have lower default rates, and we agree that this is one of a number of characteristics to be considered. However, the LTV should not be the only characteristic for eligibility as a 

‘‘Qualified Residential Mortgage,’’ and it should not be considered in isolation. Setting the QRM cutoff at a specific LTV without regard to other loan characteristics 

or features, including credit enhancements such as private mortgage insurance, will 

lead to an unnecessary restriction of credit. To illustrate the severity of the proposal, even with private mortgage insurance, loans with less than 20 percent down 

will not qualify for the QRM. 

ABA strongly believes that creating a narrow definition of QRM is an inappropriate method for achieving the desired underwriting reforms intended by DoddFrank. 

The Risk Retention Requirements as proposed will inhibit the return of private 

capital to the marketplace and will make ending the conservatorship of 

Fannie Mae and Freddie Mac more difficult. 

The proposal presented by the regulators will make it vastly more difficult to end 

the conservatorship of Fannie and Freddie and to shrink FHA back to a more rational portion of the mortgage market. As noted above, under the proposed rule, 

loans with a Federal guarantee are exempt from risk retention—which includes 

loans sold to Fannie Mae and Freddie Mac while they are in conservatorship and 

backed by the Federal Government. FHA loans (as well as other federally insured 

and guaranteed loan programs) are also exempt. Since almost 100 percent of new 

loans today being sold are bought by Fannie and Freddie or insured by FHA—and 

as long as these GSEs can buy loans without risk retention—it will be dramatically 

more difficult for private securitizers to compete. In fact, the economic incentives of 

the proposed risk retention strongly favor sales of mortgages to the GSEs in conservatorship and not to private securitizers. Thus, this proposal does not foster the 

growth of private label securitizations that would reduce the role of Government in 

backing loans. 

Equally important is the fact that the conservatorship situation is unsustainable 

over the long term. That means that eventually, these highly narrow and restrictive 

rules would apply to a much, much larger segment of the mortgage market. That 

means that fewer borrowers will qualify for these QRM mortgage loans and the risk 

retention rules make it less likely that community banks will underwrite nonQRM—but prudent and safe—loans. Some community banks may stop providing 

mortgages altogether as the requirements and compliance costs make such a service 

unreasonable without considerable volume. Driving community banks from the 

mortgage marketplace would be counterproductive as they have proven to be responsible underwriters that have served their borrowers and communities well. Instead 

of exempting the GSEs from risk retention, the QRM should also factor in the underwriting requirements of the GSEs. If a loan meets those requirements (which we 

anticipate will evolve to conform with any new QM definition) and is thus eligible 

for purchase by the GSEs, it should also be exempt from risk retention requirements. More closely conforming the QM, QRM, and GSE standards will set the foundation for a coherent and sustainable secondary mortgage market. 

The imposition of risk retention requirements to improve underwriting of mortgage loans is a significant change to the operation of the mortgage markets and 

must not be undertaken lightly. ABA urges Congress to exercise its oversight authority to assure that rules adopted are consistent with the intent of the statute and 

will not have adverse consequences for the housing market and mortgage credit 

availability. 

Conclusion 

Safety and soundness is best protected by created an environment where banks 

can make good business decisions and take prudent risks. Unfortunately, the pendulum has shifted too far in favor of driving out risk entirely and constant secondguessing of banks’ decisions. 

Ultimately, it is consumers that bear the consequences of Government imposed 

restrictions. The loss of interchange income will certainly mean higher costs of using 

debit cards for consumers. Greater mortgage restrictions and the lack of certainty 

on safe harbors for qualified mortgages means that community banks may no longer 

make mortgage loans or certainly not as many. Higher compliance costs mean more 

time and effort devoted to Government regulations and less time for our communities. Increased expenses often translate into layoffs within the bank. 

73 

This all makes it harder to meet the needs of our communities. Jobs and local 

economic growth will slow as these impediments inevitably reduce the credit that 

can be provided and the cost of credit that is supplied. Fewer loans mean fewer jobs. 

Access to credit will be limited, leaving many promising ideas from entrepreneurs 

without funding. Capital moves to other industries, further limiting the ability of 

banks to grow. Since banks and communities grow together, the restrictions that 

limit one necessarily limit the other. 

Lack of earning potential, regulatory fatigue, lack of access to capital, limited resources to compete, inability to enhance shareholder value, and return on investment, all push community banks to sell. The Dodd-Frank Act drives all of these in 

the wrong direction and is leading to consolidations. The consequences for local communities are real. 

The regulatory burden from Dodd-Frank and the excessive regulatory secondguessing must be addressed in order to give all banks a fighting chance to maintain 

long-term viability and meet the needs of local communities everywhere.