United States General Accounting Office

GAO Report to Congressional Committees

November 1996 BANK AND THRIFT

REGULATION

Implementation of

FDICIA’s Prompt

Regulatory Action

Provisions

G O A

years

1921 - 1996

GAO/GGD-97-18

GAO United States

General Accounting Office

Washington, D.C. 20548

General Government Division

B-260107 

November 21, 1996

The Honorable Alfonse M. D’Amato

Chairman

The Honorable Paul S. Sarbanes

Ranking Minority Member

Committee on Banking, Housing, and

 Urban Affairs

United States Senate

The Honorable James A. Leach

Chairman

The Honorable Henry B. Gonzalez

Ranking Minority Member

Committee on Banking and Financial

 Services

House of Representatives

This report summarizes the results of our self-initiated review of the implementation of the

Federal Deposit Insurance Corporation Improvement Act of 1991’s (FDICIA) Prompt Regulatory

Action provisions, as amended. Our review focused on the Federal Reserve System’s and the

Office of the Comptroller of the Currency’s efforts to implement the provisions and the impact

of the provisions on federal oversight of depository institutions.

This report also discusses other initiatives, contained in FDICIA or self-initiated by the regulators,

that are intended to improve the supervision and early identification of institutions with

safety-and-soundness problems. No recommendations or matters for congressional

consideration are presented in this report because it is too early to assess many of the more

recent initiatives that the regulators are still implementing or testing to improve federal

oversight of depository institutions.

We are sending copies of this report to the Chairman of the Board of Governors of the Federal

Reserve System, the Comptroller of the Currency, the Chairman of the Federal Deposit

Insurance Corporation, the Acting Director of the Office of Thrift Supervision, and the Secretary

of the Treasury. We will also make copies available to others on request.

This report was prepared under the direction of Kane Wong, Assistant Director, Financial

Institutions and Markets Issues. Other major contributors are listed in appendix VII. If you have

any questions, please call me on (202) 512-8678.

James L. Bothwell

Director, Financial Institutions

 and Markets Issues
Executive Summary

Purpose The thrift and banking crisis of the 1980s caused deposit insurance fund

losses estimated at over $125 billion.1

 One of the many factors contributing

to the size of the federal losses was weakness in federal regulatory

oversight. Federal regulators were criticized for not taking prompt and

forceful action to minimize or prevent losses to the insurance funds due to

bank and thrift failures. The Federal Deposit Insurance Corporation

Improvement Act of 1991 (FDICIA) was enacted to make fundamental

changes in federal oversight of depository institutions. FDICIA’s Prompt

Regulatory Action provisions created two new sections in the Federal

Deposit Insurance Act—sections 38 and 39—which mandate that

regulators establish a two-part regulatory framework to improve

safeguards for the deposit insurance funds. The first part focuses on

capital levels of depository institutions, and the second part focuses on

other measures of an institution’s safety and soundness.

Since the passage of FDICIA, the financial condition of banks and thrifts has

improved, and Congress has taken some actions and considered other

actions to expand bank powers and activities. To keep Congress informed

about changes in the safeguards of federal deposit insurance funds, this

report assesses the progress and results of the federal regulators’

implementation of FDICIA’s Prompt Regulatory Action provisions, as

amended. Specifically, this report assesses (1) the regulators’

implementation of sections 38 and 39 of the Federal Deposit Insurance Act

as of September 1996 and (2) the impact of the two sections on federal

oversight of the banking industry.

Background Section 38 of the Federal Deposit Insurance Act requires regulators to

categorize depository institutions into five categories on the basis of their

capital levels and to take increasingly severe supervisory actions as an

institution’s capital level deteriorates. The section requires regulators to

define criteria for four of the five categories, which are identified as

well-capitalized, adequately capitalized, undercapitalized, and significantly

undercapitalized. It also requires the regulators to set the threshold for the

fifth category, which is identified as critically undercapitalized, at no less

than 2 percent of tangible equity capital. The section also establishes a

system of mandatory supervisory actions that are to be triggered by an

institution’s capital levels. For example, regulators are required to obtain

capital restoration plans from undercapitalized institutions, and the

1

The $125 billion represents the estimated direct cost to the federal deposit insurance funds for closing

or assisting in the merger of thrifts and banks that failed from 1980 to 1990. For additional information

on the estimated cost of resolving the savings and loan crisis, see Financial Audit: Resolution Trust

Corporation’s 1995 and 1994 Financial Statements (GAO/AIMD-96-123, July 2, 1996).

Page 2 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Executive Summary

regulators are required to close critically undercapitalized institutions

within a 90-day period.2

 In addition, section 38 restricts depository

institutions in the three lowest capital categories from engaging in certain

activities that could increase the risk of losses to the federal deposit

insurance funds.

Section 39 directs regulatory attention to the noncapital areas of an

institution’s activities as they pertain to safety and soundness. The section

requires regulators to develop and implement safety-and-soundness

standards in three areas: (1) operations and management; (2) asset quality,

earnings, and stock valuation; and (3) compensation. Initially, the

standards for asset quality and earnings were to be quantitative. Section 39

also initially required regulators to take specific regulatory actions against

institutions not meeting prescribed safety-and-soundness standards, such

as imposing growth restrictions or requiring the institution to increase its

capital position. The Riegle Community Development and Regulatory

Improvement Act of 1994 amended section 39 by eliminating the

requirement for quantitative standards and allowing regulators greater

discretion in setting standards as well as in determining whether to take

action against institutions that fail to meet the standards. The amendments

were enacted in response to concerns about the potential regulatory

burden on banks and thrifts associated with section 39.

Four federal regulators oversee federally insured banks and thrifts. The

Federal Reserve System (FRS) regulates state-chartered banks that are

members of FRS (member banks) and all bank-holding companies; the

Federal Deposit Insurance Corporation (FDIC) regulates state-chartered,

nonmember banks; the Department of the Treasury’s Office of the

Comptroller of the Currency (OCC) regulates nationally chartered banks;

and Treasury’s Office of Thrift Supervision (OTS) regulates all federally

insured thrifts, regardless of charter type.

GAO’s review of the implementation and use of section 38 was confined to

OCC and FRS. As part of this review, GAO analyzed the supervisory actions

taken on a sample of 61 banks that were undercapitalized for section 38

purposes. This sample provided coverage of 68 percent of the

OCC-regulated banks and 56 percent of the FRS-regulated banks that were

undercapitalized during the period December 1992 through

December 1994, according to financial data obtained from FDIC. GAO relied

2

FDICIA allows an exception to the 90-day closure rule if both the primary regulator and the Federal

Deposit Insurance Corporation concur and document why taking some other action would better

achieve section 38’s purpose, which is to resolve the problems of insured depository institutions at the

least possible long-term loss to the deposit insurance funds.

Page 3 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Executive Summary

on similar reviews of OTS and FDIC, which were performed by the

regulators’ respective Offices of Inspector General (OIG), to assess their

implementation of section 38. The two OIGs did not assess the

implementation of section 39 or the impact of sections 38 and 39 on

federal oversight of the thrift and bank industries. In its review of section

39 implementation, GAO did not sample cases because, at the time of its

review, the regulators had not exercised their section 39 powers.

Results in Brief Regulators have taken the required steps to implement FDICIA’s Prompt

Regulatory Action provisions but have had to use the additional

enforcement powers granted by the provisions against a relatively small

number of depository institutions. The improved financial condition of

banks and thrifts has allowed them to build their capital levels to the point

where only a few institutions were considered undercapitalized according

to section 38 standards. On average, less than 1 percent of all banks and

thrifts were classified as undercapitalized between December 1992 and

December 1995. For the 61 undercapitalized banks in GAO’s sample, OCC

and FRS generally took prescribed regulatory actions. For example, the two

regulators closed or merged all but 2 of the 25 critically undercapitalized

banks in GAO’s sample within the required 90-day time frame. As of

September 1996, regulators had not used their section 39 enforcement

authority. The final two safety-and-soundness standards—asset quality and

earnings—required to fully implement section 39 became effective on

October 1, 1996. Regulators issued the other required

safety-and-soundness standards (dealing with operations and management

and compensation) in July 1995, and those standards became effective in

August 1995.

As amended and implemented to date, the Prompt Regulatory Action

provisions strengthen federal oversight to a degree. But the provisions

may not fully address one significant weakness that existed in the 1980s as

noted by GAO and others—i.e., the failure of regulators to take strong,

forceful enforcement actions early enough to prevent or minimize losses

to the deposit insurance funds.3

Effective regulatory use of section 38 standards and enforcement actions

should help prevent capital-deficient depository institutions from engaging

in certain risky practices and conditions that contributed to the losses

suffered by the insurance funds in the 1980s. Nonetheless, most troubled

3

Deposit Insurance: A Strategy for Reform (GAO/GGD-91-26, Mar. 4, 1991) and Bank Supervision:

Prompt and Forceful Regulatory Actions Needed (GAO/GGD-91-69, Apr. 15, 1991).

Page 4 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Executive Summary

institutions experienced problems in other areas, such as asset quality and

management, long before their capital became adversely affected. Section

39 was intended to increase the likelihood that regulators would take

action to address safety-and-soundness problems before they result in the

deterioration of capital. However, the guidelines and regulations issued to

date by the regulators to implement section 39 do not (1) establish clear,

objective criteria for what would be considered to be unsafe and unsound

practices or conditions or (2) link the identification of such conditions to

specific mandatory enforcement actions. Other provisions in FDICIA and

initiatives recently announced by regulators should help in the early

identification of depository institutions with safety-and-soundness

problems. Ultimately, the success of these provisions and initiatives will

be determined by the regulators’ willingness to use their enforcement

powers, including sections 38 and 39, early enough to prevent or minimize

losses to the deposit insurance funds.

Principal Findings

Few Institutions Have

Been Subject to

Enforcement Actions

Under Section 38

The overall financial condition of banks and thrifts has improved since the

1991 passage of FDICIA. Banks and thrifts reported record profit and capital

levels from 1992 to 1995. As a result, the number of institutions considered

undercapitalized according to section 38 capital standards has steadily

declined since 1991. As of December 1995, a total of 29 federally insured

banks and thrifts, or one-quarter of 1 percent of the total number (11,970),

were considered undercapitalized according to section 38 capital

standards.

OCC and FRS generally took the prescribed enforcement actions on the 61

undercapitalized banks in GAO’s sample. The two regulators notified the

banks of their undercapitalized status and corresponding restrictions. In

addition, OCC and FRS typically obtained capital restoration plans from the

banks, reviewed them within the prescribed 60-day time frame, and

required modifications for some plans before granting approval. Moreover,

the regulators generally closed those institutions that were rated critically

undercapitalized within the 90-day time frame specified by section 38. The

FDIC OIG reported similar conclusions regarding FDIC’s compliance with

section 38 provisions. As of September 1996, the Treasury OIG was in the

process of finalizing its report on OTS’ compliance with section 38 time

frames for the receipt and review of capital restoration plans.

Page 5 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Executive Summary

Neither FRS nor OCC has used the additional enforcement tools provided by

section 38 to any great extent. These enforcement tools are the

reclassification of a bank’s capital category due to safety-and-soundness

reasons and actions, known as directives, which are used to require banks

to take specified corrective actions.

According to the regulators GAO interviewed, section 39 was not fully

implemented by FDICIA’s deadline of December 1, 1993, due to the

(1) difficulty of developing standards acceptable to all four regulators,

(2) concerns of regulators and depository institutions that the

safety-and-soundness standards could increase regulatory burden—the

cost of complying with federal regulations—on thrifts and banks, and

(3) knowledge that Congress was considering amending the section 39

requirements to increase regulatory discretion in implementing and

enforcing noncapital safety-and-soundness standards. The regulators

obtained public comments on three separate occasions in their efforts to

develop and issue the required safety-and-soundness standards. On

August 27, 1996, the regulators issued the safety-and-soundness standards

for asset quality and earnings, thereby allowing the full implementation of

section 39 as of October 1, 1996.

Effectiveness of Sections

38 and 39 Is Yet to Be

Determined

The capital standards implemented under section 38 have provided some

additional protection against losses to the insurance funds. Section 38

gave depository institutions a strong incentive to increase capital levels to

avoid the mandatory restrictions and supervisory actions associated with

being undercapitalized. Section 38 also allows regulators to promptly close

institutions when their tangible equity capital drops to 2 percent of their

total assets, thereby preventing seriously troubled institutions from

compounding their losses.4

 In addition, capital-based enforcement

authority also serves as a useful supplement to regulators’ traditional

enforcement authority.

However, capital-based safeguards of insurance funds are inherently

limited because capital does not typically show a decline until an

institution has experienced substantial deterioration in other components

4

Section 133 of FDICIA amended the Federal Deposit Insurance Act to establish 12 factors that

regulators can use to close seriously troubled institutions to facilitate prompt regulatory action. One

factor allows regulators to close critically undercapitalized institutions, which the regulators have

defined as institutions with tangible equity capital ratios of 2 percent or less. Another factor allows

regulators to close undercapitalized institutions that have no reasonable prospect of becoming

adequately capitalized or that fail to (1) become adequately capitalized, (2) submit an acceptable

capital restoration plan, or (3) implement a capital restoration plan submitted and accepted under

section 38.

Page 6 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Executive Summary

of its operations and finances. Deterioration in an institution’s internal

controls, asset quality, and earnings can occur years before capital is

adversely affected. For example, of the 193 banks and thrifts designated by

regulators as being problem institutions as of December 31, 1995, only 29

(or about 15 percent) were classified as undercapitalized for section 38

purposes. Consequently, by the time seriously troubled institutions

become subject to section 38’s mandatory restrictions and enforcement

actions, there may be few options available to prevent or minimize losses

to the deposit insurance funds.

Section 39, as amended, does not appear to significantly change the wide

discretion that regulators have regarding the timing and severity of

enforcement actions taken against troubled institutions. In 1991, GAO

recommended that Congress and the regulators develop a “trip wire”

system that would be based on clear, objective criteria as to what would

constitute unsafe and unsound conditions or practices and what

regulatory actions would result if institutions violated the specified

criteria. In contrast, the guidelines and regulations developed to

implement the amended section 39 consist of general statements of sound

banking principles rather than specific measures of safety and soundness.

Furthermore, the guidelines and regulations do not require regulators to

take any specific action against institutions that fail to comply with the

standards.

Nevertheless, FDICIA contains a number of accounting, corporate

governance, and supervisory reforms that may result in greater

management accountability from depository institutions and could help

prevent safety-and-soundness problems from arising or, at least, allow

their earlier identification. For example, FDICIA requires the management of

large depository institutions to report annually on (1) the effectiveness of

the institution’s internal controls and (2) the institution’s compliance with

designated laws and regulations. Thus, regulators can use the results of

these assessments to enhance their ability to identify institutions that have

emerging or existing safety-and-soundness deficiencies. Regulators have

also acted to improve their oversight by revising risk-based capital

standards and their on-site examination procedures to better monitor and

control excessive bank risk-taking (see apps. I and II). The success of

these initiatives, coupled with the regulators’ willingness to use their

various enforcement authorities, including sections 38 and 39, will be

instrumental in determining whether losses to the deposit insurance funds

are prevented or minimized in any subsequent economic downturn.

Page 7 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Executive Summary

Recommendations GAO is not making any recommendations in this report.

Agency Comments

and GAO’s Evaluation

GAO requested comments on a draft of this report from the Office of the

Comptroller of the Currency, the Federal Reserve Board of Governors, the

Federal Deposit Insurance Corporation, and the Office of Thrift

Supervision. Their comments and GAO’s responses are discussed at the end

of chapter 3. The staffs of the Office of the Comptroller of the Currency

and Federal Deposit Insurance Corporation also provided technical

comments that were incorporated in this report where appropriate.

The Federal Reserve Board of Governors stated that it had no formal

comments but that the report appeared to accurately describe the FRS’

policies, procedures, and practices with respect to the implementation of

FDICIA’s Prompt Regulatory Action provisions, as amended.

Both the Office of the Comptroller of the Currency and the Office of Thrift

Supervision agreed with GAO’s conclusion that the implementation of

section 38 has produced positive benefits to the regulatory oversight of

depository institutions. In response to GAO’s concern that the section 39

safety-and-soundness standards adopted by the regulators may not always

result in early regulatory action, the Office of the Comptroller of the

Currency, Federal Deposit Insurance Corporation, and Office of Thrift

Supervision reiterated their endorsements of the regulatory discretion and

flexibility provided by section 39.

GAO does not disagree that there is a need for some degree of regulatory

discretion. Rather, GAO sees the issue as one of striking a proper balance

between the need for sufficient regulatory discretion to deal with

particular facts and circumstances and the need for certainty for the

banking industry about what constitutes unsafe or unsound conditions and

the supervisory actions that would result from those conditions. GAO notes

that the implementation of FDICIA along with recent regulatory initiatives

may help in the earlier detection of problems in federally insured

institutions. These initiatives along with regulators’ willingness to use their

enforcement authorities—including sections 38 and 39—will be

instrumental in preventing or minimizing potential losses to the deposit

insurance funds and in determining whether the proper balance between

discretion and certainty has been attained.

Page 8 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Page 9 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Contents

Executive Summary 2

Chapter 1 

Introduction

12

Background 12

Objectives, Scope, and Methodology 22

Chapter 2 

Few Institutions Have

Been Subject to

Enforcement Actions

Under Sections 38 and

39

25

Few Financial Institutions Have Been Undercapitalized Under

Section 38

25

Regulators Complied With the Basic Requirements of Section 38 28

Regulators Had Not Used Their Section 39 Enforcement

Authority

36

Chapter 3 

The Effectiveness of

Sections 38 and 39 Is

Yet to Be Determined

41

Section 38 Appears to Have Produced Some Benefits 41

Section 38’s Capital-Based Regulatory Approach Has Inherent

Limitations

43

Section 39 Safety-And-Soundness Standards Do Little to Increase

the Likelihood of Early Regulatory Action

49

Various Ongoing Initiatives May Result in Improved Regulatory

Oversight

52

Conclusions 55

Agency Comments and Our Evaluation 56

Appendixes Appendix I: Revisions to Risk-Based Capital Standards 58

Appendix II: New Examination Procedures and Rating System to

Better Monitor Bank Risk-Taking

62

Appendix III: Comments From the Office of the Comptroller of

the Currency

65

Appendix IV: Comments From the Federal Reserve Board 67

Appendix V: Comments From the Federal Deposit Insurance

Corporation

68

Appendix VI: Comments From the Office of Thrift Supervision 70

Appendix VII: Major Contributors to This Report 72

Tables Table 1.1: Annual Net Income of Federally Insured Banks and

Thrifts, 1991-95

21

Page 10 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Contents

Table 2.1: Summary of Four Section 38 Capital Categories and

Ratio Requirements

27

Table 2.2: Federally Insured Banks and Thrifts by Section 38

Capital Category, Year-End 1992-95

28

Table 2.3: Section 38 Capital Categories of the 61

Undercapitalized Banks We Reviewed

29

Table 2.4: Sampled Institutions’ Timeliness in Submitting Capital

Restoration Plans to Regulators

31

Table 2.5: OCC’s and FRS’ Timeliness in Reviewing Capital

Restoration Plans Submitted by Sampled Institutions

32

Table 2.6: Comparison of the Implementation of Key Section 38

Provisions by Regulator

36

Table 3.1: Number of Undercapitalized Institutions Versus

Problem Institutions, December 1992 to December 1995

45

Table 3.2: Number of Failed Banks and Losses Absorbed by the

Bank Insurance Fund, 1985-94

49

Table II.1: Risk Factors Used in OCC’s and FRS’ Risk-Based

Examination Procedures

63

Abbreviations

CDRI Reigle Community Development and Regulatory

Improvement Act of 1994

CRP capital restoration plan

FDIC Federal Deposit Insurance Corporation

FDICIA Federal Deposit Insurance Corporation Improvement Act of

1991

FFIEC Federal Financial Institutions Examination Council

FIRREA Financial Institutions Reform, Recovery, and Enforcement

Act of 1989

FSLIC Federal Savings and Loan Insurance Corporation

FRS Federal Reserve System

OCC Office of the Comptroller of the Currency

OIG Office of Inspector General

OTS Office of Thrift Supervision

SAIF Savings Association Insurance Fund

Page 11 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Chapter 1 

Introduction

In the 1980s and early 1990s, the solvency of the federal depository

insurance funds was threatened when hundreds of thrifts1

 and banks

failed. Taxpayers were forced to bailout the insurance fund for thrifts, and

the insurance fund for banks had a negative balance for the first time in its

history. This situation prompted concern and considerable debate about

the need to reform federal deposit insurance and regulatory oversight. In

response, Congress passed the Federal Deposit Insurance Corporation

Improvement Act of 1991 (FDICIA)2

 to, among other things, improve the

supervision and examination of depository institutions and to protect the

federal deposit insurance funds from further losses. Among its various

provisions, FDICIA added two new sections to the Federal Deposit

Insurance Act of 19503

—sections 38 and 39—referred to as the Prompt

Regulatory Action provisions. The Prompt Regulatory Action provisions

required federal regulators to institute a two-part system of regulatory

actions that would be triggered when an institution fails to meet minimum

capital levels or safety-and-soundness standards. Enactment of this

two-part system was intended to increase the likelihood that regulators

would respond promptly and forcefully to prevent or minimize losses to

the deposit insurance funds from failures.

Background The Federal Deposit Insurance Corporation (FDIC), Federal Reserve

System (FRS), and two agencies within the Department of the

Treasury—the Office of the Comptroller of the Currency (OCC) and the

Office of Thrift Supervision (OTS)—share responsibility for regulating and

supervising federally insured banks and thrifts in the United States.4 FDIC

regulates state-chartered banks that are not members of FRS; FRS regulates

state-chartered, member banks; OCC regulates nationally chartered banks;

and OTS regulates all federally insured thrifts, regardless of charter type.

The regulators carry out their oversight responsibilities primarily through

monitoring data filed by institutions, conducting periodic on-site

examinations, and taking actions to enforce federal safety-and-soundness

laws and regulations.

1

The term “thrifts” refers to savings and loan associations and savings banks.

2

FDICIA, Public Law 102-242, was passed on December 19, 1991.

3

The Federal Deposit Insurance Act of 1950 (P.L. 81-797) revised and consolidated earlier Federal

Deposit Insurance Corporation (FDIC) legislation into one act and embodies the basic authority for

the operation of FDIC.

4

State regulatory agencies share responsibility with federal agencies for regulating federally insured

banks and thrifts that are state chartered.

Page 12 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Chapter 1 

Introduction

Problems of Thrifts and

Banks From 1980 to 1990

From 1980 to 1990, record losses absorbed by the federal deposit

insurance funds highlighted the need for a new approach in federal

regulatory oversight. Sharply mounting thrift losses over the decade

bankrupted the Federal Savings and Loan Insurance Corporation (FSLIC),

which was the agency responsible for insuring thrifts until 1989, despite a

doubling of premiums and a special $10.8 billion recapitalization program.

During this period, a record 1,020 thrifts failed at a cost of about

$100 billion to the deposit insurance funds for thrifts. Banks also failed at

record rates. From 1980 to 1990, a total of 1,256 federally insured banks

were closed or received FDIC financial assistance. Estimated losses to the

bank insurance fund for resolving these banks was about $25 billion.

These losses resulted in the bank insurance fund’s incurring annual net

losses in 1988, 1989, and 1990 that jeopardized the fund’s solvency for the

first time since FDIC’s inception.

Industry analysts have recognized many factors as contributing to the high

level of thrift failures from 1980 to 1990. For example, thrifts faced

increased competition from nondepository institutions, such as

money-market funds and mortgage banks, as well as periods of inflation,

recession, and fluctuating interest rates during that period. High interest

rates and increased competition for deposits during the decade also

created a mismatch between interest revenues from the fixed rate

mortgages that constituted the bulk of the thrift industry’s assets and the

cost of borrowing funds in the marketplace. Increased powers granted to

thrifts in a period during which supervision did not keep pace has also

been cited by some analysts, including us, as contributing to the problems

of the industry.

Regulators and industry analysts have associated a number of factors with

the problems of banks during the 1980s. First, banks suffered losses

resulting from credit risk—risk of default on loans—in an environment of

prolonged economic expansion and increasingly volatile interest rates.

The decade began with crises in agricultural loans and loans to developing

nations. Next, unrepaid energy loans took a toll and led to the downfall of

several major banks, including Continental Illinois in Chicago and First

RepublicBank in Texas. As the decade came to a close, highly leveraged

transactions and the collapse of commercial real estate markets, in which

banks had been heavy lenders, depleted the capital structures of some

major East Coast and West Coast banks and led to their failures.

One factor we and others cited as contributing to the problems of both

thrifts and banks during this period was excessive forbearance by federal

Page 13 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Chapter 1 

Introduction

regulators. Regulators had wide discretion in choosing the severity and

timing of enforcement actions that they took against depository

institutions with unsafe and unsound practices. In addition, regulators had

a common philosophy of trying to work informally and cooperatively with

troubled institutions. In a 1991 report,5

 we found that this approach, in

combination with regulators’ wide discretion in the oversight of financial

institutions, had resulted in enforcement actions that were neither timely

nor forceful enough to (1) correct unsafe and unsound banking practices

or (2) prevent or minimize losses to the insurance funds. Regulators

themselves recognized that their supervisory practices in the 1980s failed

to adequately control risky practices that led to the numerous thrift and

bank failures.

Legislative Response to the

Thrift and Bank Crisis of

the 1980s

Congress passed two major laws to address the thrift and bank crisis of

the 1980s. The first, the Financial Institutions Reform, Recovery, and

Enforcement Act of 1989 (FIRREA),6

 was enacted primarily in response to

the immediate problems surrounding FSLIC’s bankruptcy and troubles in

the thrift industry. FIRREA created a new regulator for the thrift industry,

OTS, and a new insurance fund, the Savings Association Insurance Fund

(SAIF), to replace the bankrupt FSLIC. In addition, FIRREA increased the

enforcement authority of both bank and thrift regulators. For example,

FIRREA expanded the circumstances under which regulators could assess

civil money penalties and increased the maximum penalty to $1 million per

day.7 FIRREA also authorized FDIC to terminate a bank’s or thrift’s deposit

insurance on the basis of unsafe and unsound conditions.

The second major piece of legislation, FDICIA, contains several provisions

that were intended to collectively improve the supervision of federally

insured depository institutions. Specifically, FDICIA requires a number of

corporate governance and accounting reforms to (1) strengthen the

corporate governance of depository institutions, (2) improve the financial

reporting of depository institutions, and (3) help in the early identification

of emerging safety-and-soundness problems in depository institutions. In

addition, FDICIA contains provisions that were intended to improve how

regulators supervise depository institutions.

5

Bank Supervision: Prompt and Forceful Regulatory Actions Needed (GAO/GGD-91-69, Apr. 15, 1991).

6

FIRREA, Public Law 101-73, was effective on August 9, 1989.

7

The $1 million per day civil money penalty established by FIRREA can be assessed against an insured

institution or institution-affiliated party under the following conditions. The institution or party must

“knowingly” (1) engage in unlawful conduct or unsafe and unsound practices or (2) breach a fiduciary

duty. Furthermore, the institution or party must “knowingly or recklessly cause a substantial loss to

the institution or a substantial pecuniary gain or other benefit” to the party.

Page 14 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Chapter 1 

Introduction

Among the corporate governance and accounting reforms, FDICIA

establishes generally accepted accounting principles as the standard for all

reports and statements filed with the regulators. FDICIA also requires the

management and auditors of depository institutions to annually report on

their financial condition and management.8

 The report is to include

management’s assessment of (1) the effectiveness of the institution’s

internal controls and (2) the institution’s compliance with designated laws

and regulations. In addition, FDICIA requires the institution’s external

auditors to report separately on management’s assertions.9

 Furthermore,

FDICIA requires the institutions to have an independent audit committee

composed of outside independent directors.

Among the supervision provisions, FDICIA requires regulators to perform

annual on-site examinations of insured banks and thrifts (an 18-month

cycle was allowed for qualified smaller institutions with assets of less than

$100 million).10 FDICIA’s sections 131 and 132 added two new sections to

the Federal Deposit Insurance Act (sections 38 and 39) that require the

implementation of a “trip wire” approach to increase the likelihood that

regulators will address the problems of troubled institutions at an early

stage to prevent or minimize loss to the insurance funds.

Section 38 Provisions Section 38 creates a capital-based framework for bank and thrift oversight

that is based on the placement of financial institutions into one of five

capital categories. Capital was made the centerpiece of the framework

because it represents funds invested by an institution’s owners, such as

common and preferred stock, that can be used to absorb unexpected

losses before the institution becomes insolvent. Thus, capital was seen as

serving a vital role as a buffer between bank losses and the deposit

insurance system. Although section 38 does not in any way limit

regulators’ ability to take additional supervisory action, it requires federal

regulators to take specific actions against banks and thrifts that have

8

FDICIA contains an exemption from the annual reporting requirement for small depository

institutions, which it defined as those institutions with less than $150 million in total assets or a greater

amount if established by FDIC in regulations. FDIC issued regulations on June 2, 1993, that exempt

institutions with less than $500 million in total assets from the annual reporting requirement (see 58

Fed. Reg. 31335).

9

Section 2301(a) of the Economic Growth and Regulatory Paperwork Reduction Act of 1996 contained

in Title II, Subtitle C, of the Omnibus Consolidated Appropriations Act for Fiscal Year 1997 (P.L.

104-208, Sept. 30, 1996) repealed the requirement that an institution’s external auditors report on the

institution’s compliance with designated laws and regulations.

10Section 2221 of the Economic Growth and Regulatory Paperwork Reduction Act of 1996 allows

regulators to increase the maximum size of institutions allowed to be examined on an 18-month cycle

to a level of $250 million in total assets if regulators determine that the greater amount would be

consistent with the principles of safety and soundness.

Page 15 GAO/GGD-97-18 Prompt Regulatory Action Provisions
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Introduction

capital levels below minimum standards. The specified regulatory actions

are made increasingly severe as an institution’s capital drops to lower

levels.

Section 38 requires regulators to establish criteria for classifying

depository institutions into the following five capital categories:

well-capitalized, adequately capitalized, undercapitalized, significantly

undercapitalized, and critically undercapitalized. The section does not

place restrictions on institutions that meet or exceed the minimum capital

standards—that is, those that are well- or adequately capitalized—other

than prohibiting the institutions from paying dividends or management

fees that would drop them into the undercapitalized category.11

A depository institution that fails to meet minimum capital levels faces

several mandatory restrictions or actions under section 38. The mandatory

actions are intended to ensure a swift regulatory response that would

prevent further erosion of an institution’s capital. Specifically, section 38

requires an undercapitalized institution to

• submit a capital restoration plan detailing, among other things, how the

institution is going to become adequately capitalized;

• restrict its asset growth during any quarter so that its average total assets

for the quarter do not exceed the preceding quarter’s average total assets,

unless certain conditions are met; and

• receive prior regulatory approval for acquisitions, branching, and new

lines of business.

Section 38 allows regulators to take additional actions against an

undercapitalized institution, if deemed necessary. It also requires

regulators to closely monitor the institution’s condition and its compliance

with section 38’s requirements.

Section 38 requires regulators to take more forceful corrective measures

when institutions become significantly undercapitalized.12 Regulators must

take 1 or more of 10 specified actions, including (1) requiring the sale of

11Section 301 of FDICIA amended section 29 of the Federal Deposit Insurance Act to make a

distinction between well-capitalized and adequately capitalized institutions regarding brokered

deposits. Well-capitalized institutions can accept brokered deposits without restriction. Adequately

capitalized institutions can accept brokered deposits if they receive a waiver from FDIC. Section 301

also imposes certain interest rate restrictions for brokered deposits accepted by institutions that are

not well-capitalized.

12Section 38 requires regulators to treat undercapitalized institutions that fail to submit or implement a

capital restoration plan as significantly undercapitalized.

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Introduction

equity or debt or, under certain circumstances, requiring institutions to be

acquired by or merged with another institution; (2) restricting otherwise

allowable transactions with affiliates; and (3) restricting the interest rates

paid on deposits by the institution. Each of these three steps is to be

mandatory unless the regulator determines that taking such steps would

not further the purpose of section 38, which is to resolve the problems of

insured depository institutions at the least possible long-term loss to the

insurance fund. Other specific actions available to the regulators include

• imposing more stringent asset growth limitations than required for

undercapitalized institutions or requiring the institution to reduce its total

assets;

• requiring the institution, or its subsidiaries, to alter, reduce, or terminate

an activity that the regulator determines poses excessive risk to the

institution;

• improving management by (1) ordering a new election for the institution’s

board of directors, (2) dismissing directors or senior executive officers,

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

officers;

• prohibiting the acceptance, including renewal and rollover, of deposits

from correspondent banks;

• requiring prior approval for capital distributions from holding companies

having control of the institution; and

• requiring divestiture by (1) the institution of any subsidiary that the

regulator determines poses a significant risk to the institution, (2) the

parent company of any nondepository affiliate that regulators determine

poses a significant risk to the institution, and/or (3) any controlling

company of the institution if the regulator determines that divestiture

would improve the institution’s financial condition and future prospects.

Regulators can also require any other action that they determine would

better resolve the problems of the institution with the least possible

long-term loss to the insurance funds. Finally, section 38 prohibits

significantly undercapitalized institutions from paying bonuses to or

increasing the compensation of senior executive officers without prior

regulatory approval.

Section 38 requires more stringent action to be taken against critically

undercapitalized institutions. After an institution becomes critically

undercapitalized, regulators have a 90-day period in which they must

either place the institution into receivership or conservatorship or take

other action that would better prevent or minimize long-term losses to the

Page 17 GAO/GGD-97-18 Prompt Regulatory Action Provisions
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Introduction

insurance fund.13 In either case, regulators must obtain FDIC concurrence

with their actions. Section 38 also prohibits critically undercapitalized

depository institutions from doing any of the following without FDIC’s prior

written approval:

• entering into any material transaction (such as investments, expansions,

acquisitions, and asset sales), other than in the usual course of business;

• extending credit for any highly leveraged transaction;

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

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

order;

• making any material change in accounting methods;

• engaging in any covered transaction;14

• paying excessive compensation or bonuses; or

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

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

exceeding the prevailing rates of interest on insured deposits in the

institution’s normal market area.

In addition, section 38 prohibits a critically undercapitalized institution

from making any payment of principal or interest on the institution’s

subordinated debt beginning 60 days after becoming critically

undercapitalized.15

Finally, section 38 permits regulators to, in effect, downgrade an

institution by one capital level if regulators determine that the institution

is in an unsafe and unsound condition or that it is engaging in an unsafe

13Any determination to take other action in lieu of receivership or conservatorship for a critically

undercapitalized institution is effective for no more than 90 days. The regulator is then required to

place the institution into receivership (or conservatorship) or make a new determination to take other

action. Each new determination is subject to the same 90-day restriction. If the institution is critically

undercapitalized, on average, during the calendar quarter beginning 270 days after the date on which

the institution first became critically undercapitalized, the regulator is required to appoint a receiver

for the institution. Section 38 contains an exception to this requirement if, among other things, the

regulator and chairperson of the FDIC Board of Directors both certify that the institution is viable and

not expected to fail.

14The term “covered transactions” refers to the following transactions between a depository institution

and its affiliates: (1) a loan or extension of credit to the affiliate; (2) a purchase of or an investment in

securities issued by the affiliate; (3) a purchase of assets—including assets subject to an agreement to

repurchase from the affiliate—except such purchase of real and personal property that may be

specifically exempted by the Federal Reserve Board by order or regulation; (4) the acceptance of

securities issued by the affiliate as security for a loan or extension of credit to any person or company;

or (5) the issuance of a guarantee, acceptance, or letter of credit—including an endorsement or

standby letter of credit—on behalf of an affiliate. See section 23A(b)(7) of the Federal Reserve Act, 12

U.S.C. section 371c(b)(7).

15An exception to the prohibition on making payments on subordinated debt can be made by FDIC on

the basis of conditions specified in section 38(h)(2)(B).

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Introduction

and unsound practice. For example, regulators can treat an adequately

capitalized institution as undercapitalized if the institution received a less

than satisfactory rating in its most recent examination report for asset

quality, management, earnings, or liquidity. This downgrading would then

allow regulators to require the institution’s compliance with those

restrictions applicable to undercapitalized institutions, such as limits on

the institution’s growth. Thus, section 38 allows regulators to take

enforcement actions against an institution that presents a danger to the

insurance fund by virtue of a factor other than its capital level. In addition

to the specific provisions of section 38, another section of FDICIA provides

FDIC with the authority to appoint a conservator or receiver for

undercapitalized institutions that meet certain criteria.16

Section 39 Provisions To limit deposit insurance losses caused by factors other than inadequate

capital, section 39 directs each regulator to establish standards defining

safety and soundness in three overall areas: (1) operations and

management; (2) asset quality, earnings, and stock valuation; and

(3) compensation. Section 39 originally made the safety-and-soundness

standards applicable to both insured depository institutions and their

holding companies, but the reference to holding companies was deleted in

1994.

The section originally required regulators to prescribe

safety-and-soundness standards through the use of regulations. For the

operations and management standards, section 39 did not provide specific

requirements other than requiring regulators to prescribe standards on

internal controls, internal audit systems, loan documentation, credit

underwriting, interest rate exposure, and asset growth. For asset quality,

earnings, and—to the extent feasible—stock valuation, the section initially

required regulators to establish quantitative standards. (See the next

section for a discussion of amendments made to section 39’s original

provisions.) Under compensation standards, regulators were to prescribe,

among other things, standards specifying when compensation, fees, or

benefits to executive officers, employees, directors, or principal

shareholders would be considered excessive or could lead to material

financial loss.

16FDICIA’s section 133 amended section 11(c)(5) of the Federal Deposit Insurance Act to add

additional grounds for the appointment of a conservator or receiver for troubled institutions. Among

the 12 factors listed, one factor provides for the appointment of a receiver or conservator for

institutions that are undercapitalized under section 38 and that (1) have no reasonable prospect of

becoming adequately capitalized, (2) fail to become adequately capitalized when required to do so by

the regulator, (3) fail to submit an acceptable capital restoration plan within the required time frames,

or (4) materially fail to implement a capital restoration plan submitted and accepted under section 38.

Page 19 GAO/GGD-97-18 Prompt Regulatory Action Provisions
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Introduction

Section 39 initially contained a number of provisions concerning the

failure to meet the regulators’ prescribed safety-and-soundness standards.

One key provision of the section directed regulators to require a corrective

action plan from institutions or holding companies that fail to meet any of

the standards. Such plans were to specify the steps an institution or a

holding company was taking or intended to take to correct the deficiency.

Section 39 directed the regulators to establish specific deadlines for

submission and review of the plans. If an institution or a holding company

failed to submit or implement the plan, regulators were mandated to issue

an order requiring the institution or holding company to correct the

deficiency and to take one or more of the following remedial actions as

considered appropriate:

• restrict the institution’s or holding company’s asset growth,

• require the institution or holding company to increase its ratio of tangible

equity to assets,

• restrict interest rates paid on deposits, and/or

• require the institution or holding company to take any other action that

the regulator determines would prevent or minimize losses to the

insurance fund.

Section 39 also initially required regulators to take at least one of the first

three previously mentioned remedial actions against institutions that

(1) fail to meet any of the operational and/or asset quality standards listed

in FDICIA, (2) have not corrected the deficiency, and (3) either commenced

operations or experienced a change in control within the preceding 24

months or experienced extraordinary growth during the prior 18 months

of failing to meet the standards.

Riegle Community

Development and Regulatory

Improvement Act of 1994

Amended Section 39’s

Provisions

The Riegle Community Development and Regulatory Improvement Act of

1994 (CDRI)17 was passed on September 23, 1994, and contains more than

50 provisions that were intended to reduce bank regulatory burden and

paperwork requirements. Among its provisions, CDRI amended some of

section 39’s requirements to provide regulators with greater flexibility and

to respond to concerns that section 39 would subject depository

institutions to undue “micromanagement” by the regulators. The CDRI

amendments allow regulators to issue the standards in the form of

guidelines instead of regulations. If guidelines are used, the amendments

give the regulators the discretion to decide whether a corrective action

plan will be required from institutions that are found not to be in

compliance with the standards. Finally, the amendments eliminate the

17Public Law 103-325.

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Chapter 1 

Introduction

requirement that regulators issue quantitative standards for asset quality

and earnings and exclude holding companies from the scope of the

standards.

CDRI did not change section 39’s original provisions regarding the content

and review of any plan required as a result of noncompliance with section

39’s safety-and-soundness standards. Thus, regulators still are required to

issue regulations governing the contents of the plan, time frames for the

submission and review of the plans, and enforcement actions applicable to

the failure to submit or implement a required plan.18

Condition of the Bank and

Thrift Industries Has

Improved

Since the passage of FDICIA in 1991, the financial condition of the bank and

thrift industries has improved substantially. As shown in table 1.1, the net

income of banks more than doubled between 1991 and 1995, reaching a

record high of $48.8 billion in 1995.

Table 1.1: Annual Net Income of

Federally Insured Banks and Thrifts,

1991-95 (Constant 1995 dollars)

Dollars in billions

Year

Net income of

banks

Net income of

thrifts

1995 $48.8 $7.6

1994 45.7 6.6

1993 45.2 7.1

1992 34.4 7.2

1991 19.8 1.0

Source: FDIC-published statistics.

Table 1.1 also shows that the net income of thrifts grew dramatically in

1992 from the 1991 level, decreased slightly in 1993 and 1994, and grew to

a record $7.6 billion in 1995. In the period from 1992 through 1995, the

number of bank and thrift failures declined from their 1980 to 1990 levels.

For example, 6 banks failed in 1995, compared with 169 bank failures in

1990.

The low number of bank failures in recent years has allowed the bank

insurance fund to rebuild its reserve level. After falling to a record low of

negative $7 billion in 1991, the fund grew to over $25 billion in 1995. The

18Under section 39, regulators are required to issue regulations establishing reasonable deadlines for

the submission of the plan (generally not later than 30 days after the entity fails to meet a standard)

and for acting on it (generally not later than 30 days after the plan is submitted).

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Introduction

recapitalization of the bank insurance fund allowed FDIC to reduce the

deposit insurance assessment rate paid by commercial banks twice in the

latter part of 1995. As a result, commercial banks are paying the lowest

average assessment rate in history.

Despite the improved performance of the thrift industry, the thrift

insurance fund remained undercapitalized as of December 1995. FDICIA

required FDIC to increase the bank and thrift insurance funds’ reserve

balances to at least 1.25 percent of the estimated insured deposits of

insured institutions within 15 years of enactment of a recapitalization

schedule.19 FDIC achieved this reserve ratio for the bank insurance fund on

May 31, 1995. However, SAIF is not expected to achieve its required reserve

ratio until 2002, according to FDIC. Thus, insurance fund premiums paid by

thrifts remain significantly higher than those paid by commercial banks.

Objectives, Scope,

and Methodology

The principal objective of this review was to assess the progress and

results of the federal regulators’ implementation of FDICIA’s Prompt

Regulatory Action provisions. Specifically, we assessed (1) the efforts of

federal regulators to implement sections 38 and 39 and (2) the impact of

sections 38 and 39 on federal oversight of the bank and thrift industries.

To assess the federal regulators’ efforts to implement sections 38 and 39,

we compared the legislative provisions with the implementing regulations

and guidelines developed and issued by the regulators. In addition, we

asked for and reviewed additional guidance developed by OCC and FRS. We

concentrated our assessment on OCC and FRS because the FDIC and

Treasury Offices of the Inspector General (OIG), respectively, had

performed similar reviews of FDIC’s and OTS’ implementation of section 38.

To the extent possible, we used the results of the FDIC OIG effort to

compare and contrast with the results of our review of OCC’s and FRS’

implementation of section 38. We did not include the Treasury OIG’s results

because the OIG was in the process of finalizing its evaluation. However,

the OIG reviews did not assess FDIC’s or OTS’ implementation of section 39.

We also assessed OCC’s and FRS’ implementation of section 38 by analyzing

the supervisory actions used on the 61 banks that were undercapitalized

(including those that were significantly and critically undercapitalized) for

section 38 purposes. We identified the 61 banks using financial data (call

19This requirement was subsequently amended by the Resolution Trust Corporation Completion Act,

Public Law 103-204. This amendment allows FDIC to extend the 15-year recapitalization schedule for

SAIF if FDIC determines that the extension will, over time, maximize the amount of semiannual

assessments received by SAIF, net of insurance losses incurred by the fund.

Page 22 GAO/GGD-97-18 Prompt Regulatory Action Provisions
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Introduction

reports)20 obtained from FDIC for the quarters ending December 1992

through December 1994. In the case of OCC, we looked at all of the 52

undercapitalized banks that were located in OCC’s Western, Southwest, and

Northeast districts. These data provided us with coverage of 68 percent of

all OCC-regulated banks that were undercapitalized during that period. For

FRS, we looked at all nine undercapitalized banks under the jurisdiction of

FRS’ Atlanta, Dallas, and San Francisco district banks. Doing so resulted in

a coverage of 56 percent of all FRS-regulated banks that were

undercapitalized during that period. While our results are not projectable

to all undercapitalized banks under OCC’s and FRS’ jurisdiction, our results

are representative of the OCC and FRS locations that we visited.

As part of our assessment of (1) OCC’s and FRS’ efforts to implement

sections 38 and 39 and (2) the impact of the sections on regulatory

oversight, we interviewed OCC and FRS officials in the previously

mentioned locations as well as in Washington, D.C. We obtained the

officials’ views on the legislative intent underlying sections 38 and 39 and

the evolution of the final regulations and guidelines. We also had

discussions with the officials about regulatory actions, both under their

traditional enforcement and section 38 authority, taken against the 61

banks that we reviewed.21 Additionally, we interviewed FDIC and OTS

officials to obtain information on the interagency process used to develop

the safety-and-soundness standards required to implement section 39.

To assess the impact of sections 38 and 39 on the regulatory oversight of

banks and thrifts, we used the 61 banks that we determined were

undercapitalized for section 38 purposes to evaluate OCC’s and FRS’ use of

their section 38 authority (reclassification and directives) versus the use of

traditional enforcement tools. In addition, we reviewed OCC’s and FRS’

internal guidance and policies regarding the use of section 38 versus their

other enforcement tools. We also obtained and analyzed information on

the number of banks that the regulators had determined were

undercapitalized for section 38 purposes versus the number of banks they

20Call reports are statements of a bank’s financial condition and income that are submitted to federal

regulators. Thrifts submit a Thrift Financial Report, which contains similar information to a call report.

Both banks and thrifts prepare and submit the reports on a quarterly basis.

21Regulators have a variety of actions prescribed by law and regulations that they can take against

depository institutions. Traditional enforcement actions include (1) formal written agreements

between regulators and bankers; (2) orders to cease and desist unsafe practices and/or violations;

(3) assessments of civil money penalties; and (4) orders of removal, prohibition, or suspension of

individuals from bank operations. (See 18 U.S.C. 1818.) In addition, regulators can issue directives.

Directives are orders issued by regulators to insured institutions that fail to satisfy minimum capital

standards, which require the institutions to take one or more actions to achieve required minimum

capital levels. (See 57 Fed. Reg. 44891, Sept. 29, 1992.)

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Introduction

had identified as being “problem” banks.22 We analyzed various articles

and economic literature issued on (1) the impact of sections 38 and 39 on

the regulatory process and (2) the implications of a capital-based

regulatory approach in general. Additionally, we used OIG and our prior

report results and recommendations to assess the content of the

implementing regulations and guidelines as well as the likely impact of

section 38 on the regulatory process.

We did our work from November 1994 to September 1996 in accordance

with generally accepted government auditing standards. We provided a

draft of this report to the Federal Reserve Board, the Comptroller of the

Currency, the Federal Deposit Insurance Corporation, and the Office of

Thrift Supervision for their review and comment. A summary of the

agencies’ comments and our evaluation are included at the end of chapter

3. The agencies’ comment letters are reprinted in appendixes III to VI. Staff

of OCC and FDIC also provided additional technical comments on the draft

report, which were incorporated as appropriate.

22Federal regulators assign a composite rating to each financial institution on the basis of an evaluation

of financial and operational criteria. The rating is based on a scale from 1 to 5 in ascending order of

supervisory concern. Problem institutions are those with financial, operational, or managerial

weaknesses that threaten the institutions’ continued financial viability. Depending on the degree of

risk and supervisory concern, the institutions are rated either “4” or “5.”

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Few Institutions Have Been Subject to

Enforcement Actions Under Sections 38 and

39

Regulators have taken steps to implement FDICIA’s Prompt Regulatory

Action provisions. However, the financial condition of banks and thrifts

has improved since the passage of FDICIA in 1991 because relatively few

institutions have been considered undercapitalized under section 38 as of

September 1996. Our review of a sample of 61 undercapitalized banks

found that OCC and FRS have generally met section 38 requirements

regarding the identification of undercapitalized institutions, the receipt

and review of capital restoration plans, and the closure of critically

undercapitalized institutions. Our finding was consistent with the FDIC

OIG’s conclusions regarding FDIC’s implementation of section 38. All three

regulators (OCC, FRS, and FDIC) had virtually no experience in using their

section 38 reclassification authority and had used their section 38

authority to take enforcement actions on a relatively small number of

institutions.

As of September 1996, none of the regulators had used section 39

enforcement powers. All but two of the safety-and-soundness standards

required for the implementation of section 39 became effective in

August 1995. The remaining two standards—asset quality and

earnings—became effective on October 1, 1996, allowing for the full

implementation of section 39. The regulators explained that they missed

the December 1993 statutory deadline for the implementation of section 39

due to (1) the complication of developing standards on an interagency

basis, (2) the concern of ensuring that the standards did not unnecessarily

add to the existing regulatory burden of depository institutions, and

(3) the knowledge that Congress was considering amending section 39’s

requirements governing the standards.

Few Financial

Institutions Have

Been

Undercapitalized

Under Section 38

Regulations issued by the four regulators to implement section 38

requirements are intended to ensure that prompt regulatory action is taken

whenever an institution’s capital condition poses a threat to federal

deposit insurance funds. Banks and thrifts have increased their capital

levels since the passage of FDICIA so that relatively few financial

institutions have been subject to section 38 regulatory actions in the 3

years that the regulations were in effect. Between December 1992—the

effective date of the regulations—and December 1995, the number and

total assets of institutions that were undercapitalized had decreased from

about 2 percent in 1992 to less than one-quarter of 1 percent of all banks

and thrifts by 1995.

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39

The regulators jointly developed the implementing regulations for section

38 and based the criteria for the five capital categories on international

capital standards and section 38 provisions. The four regulators

specifically based the benchmarks for an adequately capitalized institution

on the Basle Committee1

 requirement, which stipulates that an adequately

capitalized international bank must have at least 8 percent total risk-based

capital and 4 percent tier 1 capital.2

 For the definition of a critically

undercapitalized institution, the regulators adopted section 38’s

requirement of a tangible equity ratio of at least 2 percent of total assets.

The regulators based the criteria for the remaining three capital categories

on these two benchmarks.

As shown in table 2.1, three capital ratios are used to determine if an

institution is well-capitalized, adequately capitalized, undercapitalized, or

significantly undercapitalized. A well-capitalized or adequately capitalized

institution must meet or exceed all three capital ratios for its capital

category. To be deemed undercapitalized or significantly undercapitalized,

an institution need only fall below one of the ratios listed for its capital

category. Although not shown in the table, a fourth ratio—tangible

equity—is used to categorize an institution as critically undercapitalized.

Any institution that has a 2-percent or less tangible equity ratio is

considered critically undercapitalized, regardless of its other capital ratios.

1

The Basle Committee is made of representatives from Belgium, Canada, France, Germany, Italy,

Japan, Luxembourg, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United

States. The chief purpose of the committee has been “to close gaps in the supervisory net and to

improve supervisory understanding and the quality of banking supervision worldwide.” The committee

issued its final version of capital standards for international banks on July 15, 1988, under the title

International Convergence of Capital Measure and Capital Standards.

2

The total risk-based capital ratio consists of the sum of tier 1 and tier 2 capital divided by

risk-weighted assets. Tier 1 capital consists primarily of tangible equity capital—equity capital plus

cumulative preferred stock (including related surplus)—minus all intangible assets, except for some

amount of purchased mortgage servicing rights. Tier 2 capital includes subordinated debt, loan loss

reserves (both subject to maximum limits), and certain other instruments. Risk-weighted assets are

calculated using a risk weighing to each asset, on the basis of the asset’s relative default risk. These

weights range from 0 percent for assets, such as cash and U.S. Treasury securities, to 100 percent for

most loans.

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Enforcement Actions Under Sections 38 and

39

Table 2.1: Summary of Four Section 38

Capital Categories and Ratio

Requirements

Capital ratio

Capital category Total risk-based Tier 1 risk-based Leverage

Well-capitalizeda 10 percent or more

and

6 percent or more

and

5 percent or more

Adequately

capitalized

8 percent or more

and

4 percent or more

and

4 percent or more

Undercapitalized Less than 8 percent

or

Less than 4 percent

or

Less than 4 percentb

Significantly

undercapitalized

Less than 6 percent

or

Less than 3 percent

or

Less than 3 percent

Note: Only the tangible equity ratio is used to determine whether an institution is critically

undercapitalized. Institutions with a tangible equity ratio of 2 percent or less are considered to be

critically undercapitalized.

aAn institution cannot be considered to be well-capitalized if it is subject to a formal regulatory

enforcement action that requires the institution to meet and maintain a specific capital level.

bThe leverage ratio can be as low as 3 percent if the institution has a regulator-assigned

composite rating of 1. Regulators are to assign a composite rating of 1 only to institutions

considered to be sound in almost every aspect of operations, condition, and performance.

Source: Interagency regulations issued on September 29, 1992 (57 Fed. Reg. 44866).

So far, relatively few financial institutions have been categorized as

undercapitalized and, thus, subject to section 38 regulatory actions. This

situation was due, in part, to the improved financial condition of the bank

and thrift industries. The implementation of section 38 also provided

institutions with strong incentives to increase their capital levels to avoid

the mandatory restrictions and supervisory actions associated with being

undercapitalized. As shown in table 2.2, the number of financial

institutions whose reported financial data indicated undercapitalization,

based on section 38 implementing regulations, steadily declined between

December 1992 and December 1995. The beginning of the decline

coincided with the December 1992 implementation of section 38.

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39

Table 2.2: Federally Insured Banks and Thrifts by Section 38 Capital Category, Year-End 1992-95

December 1992 December 1993 December 1994 December 1995

Federally insured banks and thrifts

Capital category Number Percent Number Percent Number Percent Number Percent

Well-capitalized 12,990 93.8 12,873 97.4 12,328 97.8 11,783 98.4

Adequately capitalized 609 4.4 275 2.1 224 1.8 158 1.3

Undercapitalized 109 0.8 32 0.2 27 0.2 21 0.2

Significantly undercapitalized 83 0.6 24 0.2 14 0.1 5 0.0

Critically undercapitalized 60 0.4 16 0.1 9 0.1 3 0.0

Total 13,851 100.0 13,220 100.0 12,602 100.0 11,970 100.0

Note: Percentages may not total 100 percent due to rounding.

Source: FDIC.

Data reported by financial institutions indicated that 252 banks and thrifts,

or about 2 percent of those institutions, were undercapitalized in

December 1992, including those that were significantly and critically

undercapitalized. As of December 1995, only 29 banks and thrifts, or about

one-quarter of 1 percent of all banks and thrifts, fell into the

undercapitalized categories.

Regulators Complied

With the Basic

Requirements of

Section 38

Our review of regulatory actions at 61 sample banks indicated that OCC and

FRS complied with the basic requirements of section 38 and its

implementing regulations. Specifically, OCC and FRS categorized the banks

in accordance with section 38 criteria and notified undercapitalized banks

of the restrictions and regulatory actions associated with their capital

category. In addition, OCC and FRS typically obtained and reviewed the

required capital restoration plans within the time frames specified by

section 38. Moreover, the two regulators generally took action to close the

critically undercapitalized banks as required by section 38. Both regulators

had limited experience with issuing section 38 directives or using their

reclassification authority. The FDIC OIG reported similar results regarding

FDIC’s implementation of section 38.

OCC and FRS Classified

Banks in Accordance With

Section 38 Requirements

OCC and FRS correctly identified and categorized the 61 sampled banks

using criteria specified in section 38 legislation and implementing

regulations. While primarily relying on call reports, they also used the

on-site examination process to identify undercapitalized banks. The

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regulators then sent notices to those banks to inform the banks of their

undercapitalized status and the associated section 38 mandatory

restrictions, requirements, and regulatory responses.

In the jurisdictions of the offices that we visited,3 OCC and FRS identified a

total of 61 banks as being undercapitalized at some point from

December 1992 through December 1994. The two regulators identified 60

banks as undercapitalized on the basis of the call report data reported to

the regulators on a quarterly basis. FRS identified an additional bank as

being undercapitalized on the basis of the results of an on-site

safety-and-soundness examination. Table 2.3 shows the distribution of the

banks in our sample by regulator and section 38 capital category.

Table 2.3: Section 38 Capital

Categories of the 61 Undercapitalized

Banks We Reviewed

Number of

banks

identified by:

Capital category OCC FRS

Total number

of banks

Status of banks as of December

1995

Undercapitalized 18 2 20 4 merged, 1 voluntarily liquidated,

5 remained problem banks,a 10

improved

Significantly

undercapitalized

11 5 16 4 merged, 1 voluntarily liquidated,

6 remained problem banks,a 5

improved

Critically

undercapitalized

23 2 25 18 failed, 1 merged, 1 remained a

problem bank,a 5 improved

Total/Status 52 9 61 18 failed, 9 merged, 2

voluntarily liquidated, 12

remained problem banks,a 20

improved

aProblem banks have one or more of the following attributes: (1) the banks have a

regulator-assigned composite rating of 4 or 5, (2) the banks are under a formal enforcement

agreement because of safety-and-soundness problems, and/or (3) the banks continue to be

undercapitalized according to section 38 implementing regulations.

Source: GAO analysis of OCC and FRS files.

OCC and FRS sent the required notices to the management of the 61 banks in

our sample informing them of their banks’ undercapitalized status. The

notification letters advised the banks of the mandatory requirements and

restrictions associated with their section 38 capital category. For

significantly and critically undercapitalized banks, the notification letters

also pointed out the additional mandatory and discretionary regulatory

3

We visited the OCC and FRS offices located in San Francisco and Dallas. In addition, we performed

work in OCC’s New York/Boston office and FRS’ Atlanta office.

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responses or actions associated with their section 38 capital

categorization.

Capital Restoration Plan

Requirements Were

Generally Met

OCC and FRS generally met section 38 requirements governing capital

restoration plans (CRP). Section 38 requires banks to prepare a CRP within

45 days of becoming undercapitalized and allows regulators 60 days to

review the CRP. For the 61 banks that we reviewed, OCC and FRS were

generally successful in getting banks to submit the plans on time and in

meeting the required time frames for reviewing and approving or rejecting

the plans.

Section 38 provisions require that CRPs prepared by undercapitalized

institutions contain certain elements. Specifically, the section requires that

CRPs specify

• the steps that the institution will take to become adequately capitalized,

• the levels of capital the institution will attain during each year the plan will

be in effect,

• how the institution will comply with the restrictions or requirements

applicable to its undercapitalization capital category, and

• the types and levels of activities in which the institution will engage.

Section 38 prohibits regulators from accepting a CRP unless it (1) contains

the previously mentioned required elements, (2) is based on realistic

assumptions and is otherwise likely to succeed, and (3) would not

appreciably increase the institution’s riskiness. Holding companies are

required to guarantee the institution’s compliance with the CRP and to

provide adequate assurance of performance.

Although the notification letters sent to the 61 undercapitalized banks in

our review indicated that a CRP was required, only 44 banks submitted a

CRP. Of the 17 banks that did not submit CRPs, 15 experienced conditions

within the first few months of becoming undercapitalized that, according

to the regulator, precluded the need for a CRP. Specifically, nine failed, two

merged with other banks, one was voluntarily liquidated, and three

became adequately capitalized.

OCC chose not to pursue obtaining CRPs from the remaining two banks. In

one case, OCC deferred its enforcement efforts pending the results of an

ongoing investigation by the Federal Bureau of Investigation and local

enforcement authorities into potential criminal activity by the bank’s

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management. In the second case, OCC issued a section 38 directive instead

of formally enforcing the requirement that the bank submit a CRP to

achieve corrective action in a more timely fashion.

OCC and FRS were generally successful in getting the 44 institutions that

submitted CRPs to meet the 45-day requirement. As shown in table 2.4, 10

banks exceeded the 45-day requirement, but most had submitted CRPs

within 55 days.

Table 2.4: Sampled Institutions’

Timeliness in Submitting Capital

Restoration Plans to Regulators

Number of CRPs

submitted to:

Time frame for the receipt of the CRP OCC FRS

Received in 45 days or less 26 7

Received between 46 and 55 days 4 2

Received after 55 days 4 0

Unable to determinea 1 0

Total 35 9

aWe were unable to calculate the time frame for submission of one CRP because critical data

were not available in OCC’s files.

Source: GAO analysis of OCC and FRS files.

OCC and FRS were typically successful in meeting the 60-day time frame for

reviewing the 44 CRPs submitted by the banks in our sample. As shown in

table 2.5, the regulators met the 60-day requirement on all but one

applicable case where data were available to make a determination.

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Table 2.5: OCC’s and FRS’ Timeliness

in Reviewing Capital Restoration Plans

Submitted by Sampled Institutions

Number of CRPs reviewed by:

Time frame for the review of the CRP OCC FRS

Reviewed in 60 days or less 30 9

Reviewed in 75 days 1 0

Not applicablea 3 0

Unable to determineb 1 0

Total 35 9

aAccording to the regulators, the review of CRPs was “not applicable” for three banks because

(1) one improved to the adequately capitalized level within 60 days of submitting its CRP,

(2) another failed within 60 days of submitting a CRP, and (3) the last was undergoing a change

in ownership that, if successful, would have resulted in the bank’s becoming well- or adequately

capitalized.

bWe were unable to calculate the time frames for the review of one CRP due to the lack of

available documentation in OCC’s files.

Source: GAO analysis of OCC and FRS files.

Of the 44 CRPs submitted by the banks that we looked at, OCC and FRS

rejected 30 of the CRPs as inadequate and required those banks to revise

and resubmit them. The regulators used the criteria specified in section 38

legislation to determine whether a CRP was acceptable. Ultimately, the

regulators approved 29 of the CRPs submitted by the undercapitalized

banks that we reviewed. Of the 15 banks whose CRPs were not approved,

10 ultimately failed. One of the 15 banks merged with another bank, and

the remaining 4 banks obtained enough capital to eliminate the need for a

CRP.

OCC and FRS Closed

Critically Undercapitalized

Banks Within the Required

Time Frame

As required by section 38, OCC and FRS have generally taken action to close

critically undercapitalized banks within a specified time frame. Under

section 38, regulators are required to close critically undercapitalized

institutions within 90 days of the institutions’ becoming critically

undercapitalized unless the regulator and FDIC concur that other actions

would better protect the insurance funds from losses.

As previously shown in table 2.3, there were 25 critically undercapitalized

banks in our sample. OCC and FRS closed 17 of these banks because they

were critically undercapitalized.4

 Fifteen of the 17 banks were closed

within the prescribed 90-day period. In the case of the two banks that were

closed after the 90-day deadline had expired, regulators approved the

4

An additional bank ultimately failed, but this occurred after the bank had received a capital injection,

which put it into the adequately capitalized category for section 38 purposes.

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delay to allow FDIC more preparation time for the orderly closure of the

banks. For the remaining 8 critically undercapitalized banks in our sample,

1 merged and the other 7 improved their capital position above the

critically undercapitalized level before the end of the 90-day period.

Few Institutions Were

Subject to Section 38

Enforcement Actions

From December 1992 to September 1996, OCC and FRS used their section 38

authority to initiate directives against 8 of the 61 banks in our sample.

Section 38 requires regulators to take specific regulatory actions against

significantly undercapitalized institutions and to make the use of these

actions discretionary for other undercapitalized institutions. In those

instances in which section 38 directives were used, both OCC and FRS

complied with the governing requirements of section 38 legislation and

implementing regulations.

As previously discussed in chapter 1, section 38 mandates regulators to

take at least 1 of 10 specified actions against significantly undercapitalized

institutions.5

 The section also provides regulators with discretionary

authority to take any of the 10 specified actions that they consider

appropriate against undercapitalized institutions.

OCC used directives against a relatively small number of the banks in our

sample. Of the 52 OCC-regulated banks we reviewed, 16 were significantly

undercapitalized at some time between December 1992 and

December 1994, according to their call report data.6

 Thus, unless the status

of the banks changed, OCC would have been expected to have initiated a

directive against the 16 banks to take the enforcement actions mandated

by section 38. However, OCC only initiated directives against five of these

banks. Seven of the remaining 11 banks either failed, merged, or improved

their capital status within 90 days of becoming significantly

undercapitalized, thus eliminating the need for OCC to issue a directive. OCC

officials told us that directives were not initiated against the remaining

four significantly undercapitalized banks because they were already

subject to formal enforcement actions that OCC believed were similar to

5

Of the 10 specific actions authorized, FDICIA established the presumption that the regulator take the

following three actions unless the regulator determines that the actions would not further the purpose

of section 38: (1) require recapitalization through the sale of stocks or obligations or require that the

institution be acquired by or combined with another institution, (2) restrict transactions with affiliates,

and (3) restrict interest rates paid by the institution. These mandatory action requirements also apply

to an undercapitalized institution that fails either to submit an acceptable CRP or implement one

accepted by the regulator.

6

The 16 OCC-regulated significantly undercapitalized banks that we looked at included 5 banks that

subsequently became critically undercapitalized.

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those that would be covered by directives. Thus, initiating a directive

would have duplicated the existing, ongoing enforcement actions.

FRS initiated directives against three of the seven7 FRS-regulated banks in

our sample that were categorized as significantly undercapitalized at some

point between December 1992 and December 1994.8

 According to FRS, the

need for it to issue directives was precluded for three significantly

undercapitalized banks because they improved their capital status, merged

with another institution, or were voluntarily liquidated shortly after

becoming significantly undercapitalized. FRS did not initiate a directive

against the remaining significantly undercapitalized bank because the

applicable corrective actions were already under way in connection with

existing federal and state enforcement actions and in connection with the

bank’s CRP.

OCC and FRS Reclassified

Two Banks

From December 1992 to September 1996, OCC and FRS used their

reclassification authority in two instances. Section 38 authorizes bank

regulators under certain circumstances to downgrade, or treat as if

downgraded, an institution’s capital category if (1) it is in an unsafe or

unsound condition or (2) it is deemed by the regulator to be engaging in an

unsafe or unsound practice. Reclassifying an institution to the next lower

capital category allows regulators to subject the institution to more

stringent restrictions and sanctions.9

According to OCC officials, OCC would use its section 38 reclassification

authority only if its traditional enforcement actions had not been

successful in correcting a bank’s problems. OCC officials told us that they

prefer to use their traditional enforcement authority for several reasons.

One reason was the broader range of options that OCC’s traditional

enforcement actions provide both in the areas covered by the enforcement

action as well as in the degree of severity of the action. Another reason

that OCC prefers to use its traditional enforcement actions is the bilateral

nature of these actions. According to OCC officials, traditional enforcement

actions, such as a formal written agreement between the regulator and an

7

The seven FRS-regulated significantly undercapitalized banks that we looked at included two banks

that subsequently became critically undercapitalized.

8

Of the three directives FRS initiated, one was never issued because the bank complied with all of the

provisions contained in the Notice of Intent to Issue a Directive, and the directive was not needed.

Section 38 implementing regulations require the regulator to notify the institution before issuing a

directive to give the institution time to comment on the proposed action.

9

Section 38 does not provide for regulators to reclassify or treat a significantly undercapitalized

institution as critically undercapitalized.

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institution, may achieve greater acceptance by the institution for taking

corrective action than the unilateral nature of section 38 reclassifications

and/or directives. However, OCC officials said that reclassification under

section 38 can sometimes allow them to initiate certain actions faster (i.e.,

through directives) than would be possible using their traditional

enforcement actions.

In the one case involving OCC reclassification, the agency reclassified a

bank from adequately capitalized to undercapitalized because (1) OCC

believed the bank was operating in an unsafe and unsound condition that

would impair its capital levels and (2) the bank had not complied with

earlier OCC enforcement actions. The reclassification allowed OCC to

initiate a directive that, among other requirements, mandated the dismissal

of a senior bank official and a director who OCC believed were responsible

for the bank’s deteriorated condition. Despite OCC’s use of its

reclassification authority and a section 38 directive, the bank’s condition

deteriorated further until it failed 8 months later.

FRS has an internal policy that requires all problem banks, which it defined

as banks with a composite rating of 4 or 5, to be considered operating in

an unsafe and unsound condition and, thus, candidates for reclassification.

Between December 1992 and December 1994, 58 banks10 had a

FRS-assigned composite rating of 4 or 5. In its only use of its

reclassification authority, FRS reclassified a well-capitalized bank to

adequately capitalized because of continuous deterioration in the bank’s

asset quality, earnings, and liquidity. This bank’s capital levels

subsequently deteriorated to the point where it was considered

significantly undercapitalized. The bank has since improved its capital to

the well-capitalized category and is no longer considered to be a problem

institution by FRS.

OIG Reported Similar

Section 38 Compliance by

FDIC

In September 1994, the FDIC OIG reported that FDIC had generally complied

with the provisions of section 38 and its implementing regulations.11 Table

2.6 compares the three regulators’ implementation of specific section 38

provisions.

10The 58 banks reviewed exclude composite-rated 4 or 5 banks whose capital ratios indicated that they

were already considered undercapitalized according to section 38 standards.

11Audit of FDIC’s Implementation of the Prompt Corrective Action Provisions of FDICIA (Sept. 23,

1994).

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Table 2.6: Comparison of the

Implementation of Key Section 38

Provisions by Regulator

(Percent)

Regulator

CRPs received

within 45 days

CRPs reviewed

within 60 days

Institutions

receiving

directivesa

Number of

reclassifications

OCCb 75 86 10 1

FRSb 77 100 33 1

FDICc 73 74 30 0

aThe percentage is calculated on the basis of the total number of institutions reviewed by GAO or

the OIG.

bInformation is based on GAO’s analysis of 52 OCC-regulated banks and 9 FRS-regulated banks

as of February 1996.

cInformation is based on the FDIC OIG’s analysis of 43 FDIC-regulated banks as of July 1994.

Source: FDIC OIG and GAO.

Regulators Had Not

Used Their Section 39

Enforcement

Authority

As of September 1996, regulators had not used their section 39

enforcement authority against an institution. In July 1995, regulators

issued final guidelines and regulations to implement parts of section 39.

Specifically, the regulators issued standards governing operations and

management and compensation. They also issued requirements for

submission and review of compliance plans.12 The regulators issued the

remaining standards required for the full implementation of section

39—asset quality and earnings—in August 1996.13

FDICIA had established a deadline of December 1, 1993, for the

implementation of section 39. Regulators said they were unable to meet

that deadline because of (1) the difficulty of jointly developing the

standards, (2) the concerns of regulators and financial institutions that the

implementation of section 39 could increase existing regulatory burden for

banks and thrifts, and (3) the knowledge that Congress was considering

amending the section 39 requirements to provide regulators with greater

flexibility and discretion in their implementation of the section.

1260 Fed. Reg. 35673 (July 10, 1995).

1361 Fed. Reg. 43948 (Aug. 27, 1996).

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Interagency Process and

Concerns About

Regulatory Burden

Complicated the

Development of Required

Standards

According to the regulators, developing and issuing safety-and-soundness

standards was complicated by the interagency process and by concerns

about the potential regulatory burden associated with the standards.

Unlike the process for promulgating capital standards under section 38,

which used the Basle Accord as a reference point, the regulators had no

generally accepted standards to use as the basis for the

safety-and-soundness standards. In addition, the regulators told us that the

legislative history for section 39 did not provide specific guidance on the

standards envisioned by Congress. Furthermore, the regulators wanted to

ensure that the section 39 standards did not increase the bank and thrift

industries’ regulatory burden without a corresponding benefit to the

federal deposit insurance funds and taxpayers.

OCC and FRS officials said that the lack of generally agreed upon standards

for the areas covered by section 39 contributed to delays in developing

and issuing the section’s standards. They explained that regulators

consider numerous variables in assessing an institution’s safety and

soundness. As a result, developing standards on an interagency basis for

areas such as internal controls and interest rate exposure was difficult.

According to the officials, the various regulators had different viewpoints

as to how specific or general the standards should be.

On July 15, 1992, the regulators issued a joint solicitation of comments on

the section 39 safety-and-soundness standards.14 In soliciting the views of

the banking industry on the form and content of the standards, the

regulators said that they were concerned with “establishing unrealistic and

overly burdensome standards that unnecessarily raise costs within the

regulated community.” The four regulators collectively received over 400

comment letters, primarily from banks and thrifts.15 According to the

regulators, the comments strongly favored adopting general standards,

rather than specific standards, to avoid regulatory “micromanagement.”

The regulators considered the public comments in developing the

proposed standards that were published on November 18, 1993.16 The

regulators proposed standards for the following three areas required by

section 39: (1) operations and management, (2) asset quality and earnings,

and (3) compensation. According to the notice of proposed rulemaking,

1457 Fed. Reg. 31336.

15The 400 comment letters received by the regulators included multiple copies of some of the comment

letters that were sent to more than one regulator.

1658 Fed. Reg. 60802.

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regulators proposed general standards, rather than detailed or quantitative

standards, to “avoid dictating how institutions are to be managed and

operated.”

However, as required by section 39 before its amendment in 1994, the

regulators proposed two quantitative standards—a maximum ratio of

classified assets-to-capital17 and a formula to determine minimum earnings

sufficient to absorb losses without impairing capital. Section 39 also

required the regulators to set, if feasible, a minimum ratio of

market-to-book value for publicly traded shares of insured institutions as a

third quantitative standard. The regulators determined that issuing such a

standard was technically feasible, but they concluded that it was not a

reasonable means of achieving the objectives of the Prompt Regulatory

Action provisions. The regulators explained that an institution’s stock

value can be affected by factors that are not necessarily indicative of an

institution’s condition, such as the performance of the general stock

market and industry conditions. As a result, the regulators believed that a

market-to-book value ratio would not be an operationally reliable indicator

of safety and soundness. Therefore, the regulators ultimately decided

against proposing a market-to-book value ratio as a third quantitative

standard.

The proposed regulations also described procedures for supervisory

actions that were consistent with those contained in the section 39

legislation for institutions failing to comply with standards. Specifically,

the proposed regulations required institutions to prepare and submit a

compliance plan within 30 days of being notified by the regulator of their

noncompliance. The plan was to include a description of the steps the

institution intended to take to correct the deficiency. Regulators would

then have 30 days to review the plan. In addition, the proposed regulations

specified enforcement actions regulators would take if an institution failed

to submit an acceptable compliance plan or failed to implement the plan.

The regulators collectively received 133 comment letters, primarily from

financial institutions, in response to the November 18, 1993, notice of

proposed rulemaking. According to the four regulators, those who

commented generally found the agencies’ proposed standards, including

the two quantitative standards, acceptable. However, some of those who

commented criticized the proposed quantitative standards as inflexible

and overly simplistic.

17Classified assets are loans and other assets that are at risk to some degree. Such assets fail to meet

acceptable credit standards and are reported separately in bank call reports and thrift financial

reports.

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Consideration of

Legislative Amendments to

Section 39 Contributed to

Additional Delays in Its

Implementation

OCC and FRS officials attributed further delays in implementing section 39

to their knowledge that in the period from late 1993 to mid-1994, Congress

was considering legislation that would amend section 39’s requirements.

Congress was considering amending section 39 to reduce the

administrative requirements for insured depository institutions consistent

with safe-and-sound banking practices. After CDRI was passed in

September 1994, regulators needed additional time to revise the standards

they proposed in November 1993 to take advantage of the additional

flexibility provided by the section 39 amendments.

On July 10, 1995, the regulators published final and proposed guidelines

and regulations to implement section 39, as amended. The final guidelines

covered

• operational and managerial standards, including internal controls,

information systems, internal audit systems, loan documentation, credit

underwriting, interest rate exposure, and asset growth, and

• compensation standards.18

The final guidelines were effective in August 1995. Along with the final

guidelines, regulators proposed new standards for asset quality and

earnings. The final standards for asset quality and earnings were issued on

August 27, 1996, with an effective date of October 1, 1996.

The final standards contained in the guidelines are less prescriptive on the

institutions than those proposed in November 1993. For example, under

internal controls and information systems, the guidelines specified that the

“institution should [in lieu of shall] have internal controls and information

systems, that are appropriate to the size of the bank and the nature and

scope of its activities.” [Underscoring supplied.] In addition, the regulators

used the additional flexibility provided by CDRI to eliminate the two

previously proposed quantitative standards for classified assets and

earnings. According to the regulators, the use of general rather than

specific standards was supported by the overwhelming number of

commenters responding to the regulators’ request for comments on the

section 39 safety-and-soundness standards. Moreover, the use of

guidelines instead of regulations gives the regulators flexibility in deciding

whether to require a compliance plan from an institution found to be in

noncompliance with the standards.

18In these guidelines, the regulators did not establish stock valuation standards for publicly traded

institutions because they believed such standards would not be appropriate given that institutions do

not have direct control over the marketplace’s evaluation of their stocks’ value.

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The regulators issued regulations addressing the (1) required content of

compliance plans, (2) time frames governing the preparation and review of

a plan, and (3) regulatory actions applicable to the failure to submit or

comply with a plan. The compliance plan regulations were issued jointly

on July 10, 1995, with the section 39 guidelines governing the operational,

managerial, and compensation standards. Both the guidelines and

regulations became effective in August 1995.

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Yet to Be Determined

FDICIA’s Prompt Regulatory Action provisions granted additional

enforcement tools to regulators and provided more consistency in the

treatment of capital-deficient institutions. However, sections 38 and 39, as

implemented, raise questions about whether regulators will act early and

forcefully enough to prevent or minimize losses to the insurance funds.

Section 38 does not require regulators to take action until an institution’s

capital drops below the adequately capitalized level. However, depository

institutions typically experience problems in other areas, such as asset

quality and management, long before these problems result in impaired

capital levels. Moreover, regulators have wide discretion governing the

application of section 39 because the guidelines and regulations

implementing section 39, as amended, do not (1) establish clear and

specific definitions of unsound conditions and practices or (2) link such

conditions or practices to specific mandatory regulatory actions.

Other initiatives that have been undertaken as a result of FDICIA, as well as

the regulators’ recognition of the need to be more proactive in preventing

unsafe and unsound practices, may help increase the likelihood that

sections 38 and 39 will be used to provide prompt and corrective

regulatory action. FDICIA’s corporate governance and accounting reform

provisions were designed to improve management accountability and

facilitate early warning of safety-and-soundness problems. In addition,

FDICIA requires regulators to revise the risk-based capital standards to

ensure that reported capital accurately reflected the institution’s risk of

operations. Regulators have also announced new initiatives to improve

monitoring and control of bank risk-taking, but these initiatives have not

been fully implemented or tested. The success of these initiatives, coupled

with the regulators’ willingness to use their various enforcement

authorities, including sections 38 and 39, will be instrumental in

determining whether losses to the insurance funds are prevented or

minimized in the future.

Section 38 Appears to

Have Produced Some

Benefits

Available evidence suggests that the implementation of the section 38

capital standards between 1992 and 1995, along with other factors, has

benefited the bank and thrift industries and may have helped improve

federal oversight. Specifically, the section 38 standards (1) provide

financial institutions with incentives to raise equity capital, (2) should help

regulators prevent seriously troubled institutions from taking actions that

could compound their losses, and (3) should help ensure more timely

closure of near-insolvent institutions. In addition, regulatory officials have

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stated that section 38 serves as an important supplemental enforcement

tool.

According to the regulators and banking industry analysts, section 38

provides depository institutions with strong incentives to raise additional

equity capital. These officials explained that financial institutions were

concerned about the potential ramifications of becoming undercapitalized,

and the institutions raised additional equity capital to avoid potential

sanctions. Once the implementing regulations were issued, depository

institutions had clear benchmarks as to the levels of capital they needed to

achieve to avoid mandatory regulatory intervention. Since the

implementation of section 38, thanks in part to record industry profits, the

capital levels of banks and thrifts have reached their highest levels since

the 1960s.

Another benefit of the section 38 capital standards is that they should help

prevent certain practices and conditions that rapidly eroded the capital of

troubled institutions from 1980 to 1990 and contributed to deposit

insurance fund losses. For example, section 38 standards impose growth

restrictions to prevent undercapitalized and significantly undercapitalized

institutions from trying to “grow” their way out of financial difficulty. As a

result, it should be more difficult for these institutions to rapidly expand

their asset portfolios and increase potential insurance fund losses, as

many thrifts did during the 1980s. Section 38 also requires regulators to

prohibit undercapitalized institutions from depleting their remaining

capital by paying dividends.

OCC and FRS officials told us that another benefit of section 38 is the

mandatory closure rule for critically undercapitalized institutions. These

officials explained that before the implementation of section 38, regulators

typically waited until an institution had 0-percent equity capital before

closing it as insolvent. The officials also said that under section 38, they

now have a clear legal mandate for closing problem institutions at

2-percent tangible equity capital, which should provide the insurance

funds with a greater cushion against losses.

Regulatory officials we contacted also said that section 38 serves as a

useful supplement to their traditional enforcement authority. For example,

OCC officials said that section 38 directives allow for the prompt removal of

bank officials when the agency believes such officials are responsible for

the bank’s financial and operational deterioration. OCC officials said that

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The Effectiveness of Sections 38 and 39 Is

Yet to Be Determined

before FDICIA, removing such individuals took longer, sometimes up to

several months.

Section 38’s

Capital-Based

Regulatory Approach

Has Inherent

Limitations

Although the capital-based regulatory approach strengthens federal

oversight in several ways, by itself it has significant limitations as a

mechanism to provide early intervention to safeguard the insurance funds.

Capital is a lagging indicator of a financial institution’s deterioration.

Troubled institutions may already have irreversible financial and

operational problems that would inevitably result in substantial insurance

fund losses by the time their capital deteriorates to the point where

mandatory enforcement actions are triggered under section 38. In

addition, troubled institutions often fail to report accurate information on

their true financial conditions. As a result, many troubled institutions that

have serious safety-and-soundness problems may not be subject to section

38 regulatory actions.

Capital Is a Lagging

Indicator of Financial and

Operational Deterioration

Capital has been a traditional focus for regulatory oversight because it is a

reasonably obvious and accepted measure of financial health. However,

our work over the years has shown that, although capital is an important

focus for oversight, it does not typically begin to decline until an

institution has experienced substantial deterioration in other components

of its operations and finances.1

 It is not unusual for an institution’s internal

controls, asset quality, and earnings to deteriorate for months, or even

years, before conditions require that capital be used to absorb losses. As a

result, regulatory actions, such as requirements for capital restoration

plans or growth limits, may have only marginal effects because of the

extent of deterioration that may have already occurred.

Reported Capital Levels Do

Not Always Accurately

Reflect Institutions’

Financial Troubles

Relating regulatory actions to capital alone has another inherent limitation

in that reported capital levels do not always accurately reflect troubled

institutions’ actual financial conditions. Troubled institutions have little

incentive to report the true level of problem assets or to establish adequate

reserves for potential losses. As a result, some institutions’ reported

capital levels were often artificially high. The reporting of inaccurate

capital levels was evident from 1980 to 1990 as many of the troubled

institutions, which reported some level of capital before failing, ultimately

generated substantial losses to the insurance fund. Thus, capital-driven

regulatory responses would likely have had limited effectiveness since the

1

Deposit Insurance: A Strategy for Reform (GAO/GGD-91-26, Mar. 4, 1991) and GAO/GGD-91-69.

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institutions were already functionally insolvent. As illustrated by the

following example, troubled institutions’ reported capital levels can

plummet rapidly in times of economic downturn.

Problems Experienced by

Regulators in the 1980s With

New England Banks

In the 1980s, many New England banks, with average equity capital ratio

levels exceeding the regulatory minimum requirements then in existence,

were engaged in aggressive high-risk commercial real estate lending.

These banks frequently ignored basic risk diversification principles by

committing a substantial percentage of their lending portfolios to

construction, multifamily housing, and commercial real estate lending—in

some cases as high as 50 percent.2

 This practice tied their future financial

health to those industries.

When the New England economy fell into recession in the late 1980s and

early 1990s, many of the poorly managed banks in the region experienced

a deterioration in their asset quality, earnings, and liquidity well before

their capital levels declined. For example, once regulators recognized the

recession’s effect on the Bank of New England3

 portfolios, examiners

required the bank to adversely classify4

 an increasing number of

loans—especially commercial real estate loans whose repayment was

questionable due to the economic downturn. As the level of classified

loans increased, the examiners required the Bank of New England to

establish reserves for potential loan losses, which reduced the bank’s

earnings. Subsequently, the bank suffered continued earnings

deterioration and had to use its capital to absorb those losses.

The Bank of New England’s managers and regulators had few options for

maintaining solvency and, ultimately, for minimizing insurance fund

losses. The available options included reducing the institution’s inventory

of classified loans by selling assets, raising capital through public

offerings, or selling the institution to a healthy buyer. The managers’ and

regulator’s ability to carry out these strategies was constrained by the

region’s economic downturn, since few investors were willing to purchase

the assets of problem banks or to inject new capital into them without

some form of financial assistance from FDIC. Ultimately, the bank failed,

2

Many banks in other parts of the country, including Texas and California, also had overconcentrated

portfolios in commercial real estate and energy investments.

3

The Bank of New England was one of the largest bank failures during the period from 1986 to 1994

both in terms of the size of the bank ($22.4 billion in total assets) and the loss to the insurance fund

($841 million).

4

Adversely classified loans are put into one of three categories to reflect their risk classification:

(1) substandard, where some loss is probable unless corrective actions are taken; (2) doubtful, where

repayment in full is questionable; and (3) loss, where a complete write-off of the loan is expected.

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resulting in a loss to the bank insurance fund of $841 million. Other failed

banks in the New England area followed a similar pattern, resulting in

substantial losses to the insurance fund.

Most Troubled Institutions

Were Not Subject to

Section 38 Capital

Standards

Another reason that section 38, used alone, is a limited mechanism to

protect deposit insurance funds, is that most troubled institutions do not

fall into undercapitalized categories, including some that ultimately fail.

Consequently, regulators overseeing even the most troubled institutions

generally would not be compelled to initiate mandatory enforcement

actions under section 38.

We reviewed data compiled by FDIC that showed that many severely

troubled institutions in the period from December 1992 to December 1995

did not fall into section 38’s undercapitalized categories. Therefore, these

institutions were not subject to the section’s mandatory enforcement

actions. On a quarterly basis, FDIC reports on the number of “problem”

institutions. These institutions have regulator-assigned composite ratings

of 4 or 5 because they typically have severe asset quality, liquidity, and

earnings problems that make them potential candidates for failure. These

institutions are also typically subject to more intensive oversight,

including more frequent examinations by regulators and more frequent

required reporting by the institutions on their financial conditions.

As of December 31, 1995, 193 banks and thrifts were on FDIC’s problem

institution list. However, only 29 institutions were categorized as

undercapitalized under section 38 criteria. We made similar comparisons

for 1992 through 1995 and found that only 15 to 24 percent of the problem

institutions were categorized as undercapitalized under section 38 criteria

(see table 3.1).

Table 3.1: Number of Undercapitalized

Institutions Versus Problem

Institutions, December 1992 to

December 1995

Year-ending

Number of

undercapitalized

institutions

Number of problem

institutions

Undercapitalized

institutions as a

percentage of

problem institutions

December 1995 29 193 15.0

December 1994 50 318 15.7

December 1993 72 572 12.6

December 1992 252 1,063 23.7

Source: GAO analysis of FDIC Quarterly Banking Profile Reports.

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Moreover, a recent study assessed the effectiveness of the current section

38 capital standards in identifying problem institutions and mandating

enforcement actions by applying the section 38 standards to the troubled

banks of an earlier period.5

 The study concluded that the majority of banks

that experienced financial problems between 1984 and 1989 would not

have been subject to the capital-based enforcement actions of section 38,

if they had been in effect. For example, the study found that 54 percent of

the banks that failed within the subsequent 2 years would have been

considered to be well- or adequately capitalized between 1984 and 1989.

Thus, even if the section 38 standards had been in place in the 1980s, these

troubled banks would not have been subject to section 38’s mandatory

restrictions and supervisory actions.

The study attributed the limitations that the current section 38 standards

have in identifying troubled financial institutions to weaknesses in the

risk-based capital ratio used by the regulators. Specifically, the study

stated that the risk-based ratio does not (1) account for the fact that many

banks do not adequately reserve for potential loan losses or (2) assign an

adequate risk weight to cover the level of adversely classified assets that a

bank may have on its books. Although the regulators are in the process of

revising the risk-based capital standards, the revisions announced as of

September 1996 do not address the two previously mentioned factors. The

regulators’ efforts to revise the risk-based capital standards are discussed

later in this chapter and in appendix I.

Mechanics National Bank’s

Failure Illustrates

Limitations of Capital

Standards

The 1994 failure of one of the banks reviewed by the Treasury OIG,

Mechanics National Bank of Paramount, California, illustrated some of the

limitations of section 38 capital standards.6

 The Treasury OIG found that

despite OCC’s aggressive use of section 38 enforcement actions, OCC did not

reverse the bank’s decline or prevent material loss to the bank insurance

fund. The bank’s failure also demonstrated that severely troubled banks

may not be subject to section 38’s restrictions and mandatory enforcement

actions for a substantial period.

5

D.S. Jones and K.K. King, The Implementation of Prompt Corrective Action (Journal of Banking and

Finance, June 1995).

6

Office of Inspector General, U.S. Department of the Treasury, Material Loss Review Under FDIA:

Mechanics National Bank of Paramount, California (Sept. 29, 1995). Under the Federal Deposit

Insurance Act as amended by FDICIA section 38(k), the Inspectors General for the responsible

regulatory agencies are required to issue reports on bank failures that cause “material losses” to the

insurance fund. Among other requirements, these reports are to determine the cause of each bank’s

failure and to assess the regulator’s oversight of that bank.

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According to the Treasury OIG report, the Mechanics National Bank

pursued an aggressive growth strategy between 1988 and 1991 that

contributed substantially to its failure. The bank concentrated its loan

portfolio in risky service station loans and speculative construction and

development projects. Under a Small Business Administration lending

program, the bank also developed a significant portfolio of loans that was

poorly underwritten and inadequately documented. In 1990, a downturn in

the California economy generated a substantial deterioration in the bank’s

loan portfolio. In 1991, OCC issued a cease-and-desist order against the

bank that required substantial improvements in the bank’s operations and

financial condition. Despite the cease-and-desist order, the bank’s asset

quality and earnings continued to deteriorate over the next several years.

The Treasury OIG report said that when section 38 capital standards

became effective in December 1992, the Mechanics National Bank had a

ratio of classified assets-to-capital of about 309 percent and had

experienced losses of $4.3 million during 1992. OCC had just completed an

examination of the bank in December 1992, which concluded that the

bank was likely to fail. At that time, despite apparent asset quality and

earnings problems, the bank’s capital had not deteriorated to the point

where it was undercapitalized according to section 38 criteria. The bank’s

capital ratios fell within the adequately capitalized category. The bank

continued to be categorized as adequately capitalized during the first and

second quarters of 1993, despite its high levels of classified assets and

mounting losses. In July 1993, OCC reclassified the bank to the

undercapitalized level. On January 10, 1994, OCC notified the bank that it

was critically undercapitalized because its total capital-to-asset ratio had

fallen below 2 percent. The regulators closed the bank in April 1994.

Although the Treasury OIG report criticized OCC’s supervision and

enforcement activities for the period between 1988 and 1991,7

 the report

found that the agency’s use of section 38 enforcement authority during

1993 and 1994 was appropriate. For example, the OIG report highlighted

OCC’s use of its section 38 reclassification authority to remove two

Mechanics National Bank officers who were thought to be largely

responsible for the bank’s problems. OCC also used its section 38 authority

to close the bank on April 1, 1994, within 90 days of the notification of its

critically undercapitalized status. Nevertheless, OCC’s enforcement actions

under section 38 were largely ineffective in minimizing the losses that

7

For example, the Treasury OIG report found that OCC did not comprehensively examine the

Mechanics National Bank between 1989 and 1990. The OIG report also stated that OCC failed to

adequately enforce the cease-and-desist order that was signed in 1991 because the bank continued to

make poorly underwritten loans.

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were already embedded in the bank’s loan portfolio before it fell to the

undercapitalized level. The bank’s estimated loss to the insurance fund of

$37 million represented 22 percent of the bank’s total assets of

$167 million.

The Bank Insurance Fund

Continues to Absorb

Losses Despite the

Implementation of Section

38

The impact of section 38’s implementation on minimizing losses to the

insurance funds is difficult to assess. Between 1985 and 1989, losses to the

bank insurance fund ranged from approximately 12 to 23 percent of the

assets of failed banks with a 5-year weighted average of about 16 percent.

As we reported in 1991,8

 this high rate of losses indicated that regulators

were not (1) taking forceful actions that effectively prevented dissipation

of assets or (2) closing institutions when they still had some residual

value.

There have been some signs of improvement since the 1985-to-1989 period

as illustrated in table 3.2. During the first 2 full years that section 38 was in

effect, 1993 and 1994, the rates of loss were 17 and 10 percent,

respectively, for a weighted average of 15 percent. While these loss rates

are still significant, it is too early to assess section 38’s long-term

effectiveness in reducing losses to the insurance funds compared with

preceding years. However, it does suggest that the implementation of

section 38 alone is likely to provide only limited assurance that bank

failures will not have significant effects on the insurance funds.

8

GAO/GGD-91-26.

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Table 3.2: Number of Failed Banks and

Losses Absorbed by the Bank

Insurance Fund, 1985-94

(Dollars in millions)

Year

Number of

failed banks

Total assets of

failed banks

Estimated bank

insurance fund

loss

Percentage loss

of total assets

1985 120 $8,735 $1,008 11.5

1986 145 7,663 1,725 22.5

1987 203 9,234 2,021 21.9

1988 221 52,620 6,872 13.1

1989 207 29,395 6,123 20.8

1990 169 15,705 2,813 17.9

1991 127 63,198 6,269 9.9

1992 122 45,447 3,960 8.7

1993 41 3,524 584 16.6

1994 13 1,392 139 10.0

Source: FDIC.

Section 39

Safety-And-Soundness

Standards Do Little to

Increase the

Likelihood of Early

Regulatory Action

As discussed in chapter 2, the full implementation of section 39 began on

October 1, 1996. However, the guidelines and regulations developed by

regulators to implement section 39 do little to reduce the degree of

discretion regulators exercised from 1980 to 1990. In particular, the

safety-and-soundness standards contained in the guidelines are general in

nature and do not identify specific unsafe or unsound conditions and

practices even though the regulators have already established measures

that could have served as a basis for more specific requirements.

Moreover, the guidelines and regulations do not require regulators to take

corrective action against institutions that do not meet the standards for

safety and soundness.

Unsafe and Unsound

Conditions and Practices

Are Not Specifically

Defined

In two 1991 reports,9 we recommended that Congress and regulators

develop a formal, regulatory trip wire system that would require prompt

and forceful regulatory action tied to specific unsafe banking practices.

The trip wire system we envisioned would have been specific enough to

provide clear guidance about what actions should be taken to address

specified unsafe banking practices and when the actions should be taken.

The intent was to increase the likelihood that regulators would take

forceful action to stop risky practices before the capital of the bank begins

to fall and it is too late to do much about the condition of the bank or

9

GAO/GGD-91-26 and GAO/GGD-91-69.

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insurance fund losses. The trip wire system was also to consist of

objective criteria defining conditions that would trigger regulatory action.

In contrast, the safety-and-soundness standards, contained in the

guidelines developed to implement section 39, as amended, consist of

broad statements of sound banking principles that are subject to

considerable interpretation by the regulators. For example, the standards

for asset quality state that the institution should establish and maintain a

system to identify problem assets and prevent deterioration of those assets

in a manner commensurate with its size and the nature and scope of its

operations. Specifically, the guidelines direct institutions to do the

following:

• conduct periodic asset quality reviews to identify problem assets and

estimate the inherent losses of those assets,

• compare problem asset totals to capital and establish reserves that are

sufficient to absorb estimated losses,

• take appropriate corrective action to resolve problem assets,

• consider the size and potential risks of material asset concentrations, and

• provide periodic asset reports containing adequate information for

management and the board of directors to assess the level of asset risk.

Although the asset quality standards identify general controls and

processes the regulators expect institutions to have, the standards do not

provide specific, measurable criteria of unsafe conditions or practices that

would trigger mandatory enforcement actions. In our 1991 report on

deposit insurance reform,10 we suggested that the classified

assets-to-capital ratio could serve as an objective criterion because the

ratio is routinely used by bank examiners to identify deteriorating asset

quality. For example, we reported that the regulators become increasingly

concerned when a bank’s classified assets-to-capital ratio increased to

50 percent or more. Similarly, during the interagency process used to

develop the section 39 safety-and-soundness standards, FRS had proposed

that the regulators take mandatory enforcement actions when a bank’s

classified assets-to-capital ratio reached 75 to 100 percent. However, the

regulators decided not to include this requirement after CDRI provided

them with the option of omitting quantifiable measures of unsafe and

unsound conditions. Without such specific criteria, regulators will

continue to exercise wide discretion in determining whether a depository

institution’s asset quality deterioration is at a point where enforcement

actions are necessary.

10GAO/GGD-91-26.

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Similarly, the section 39-based loan documentation standards do not

establish specific criteria for regulators to use to assess an institution’s

safety and soundness. The regulators believed that general standards

provide an acceptable gauge against which compliance can be measured,

while at the same time allowing for differing approaches to loan

documentation. However, this approach to loan documentation standards

differs from the long-standing approach that the regulators have

established in their examination manuals. These standards contain

specific loan documentation requirements that examiners are to use in

assessing the safety and soundness of depository institutions. For

example, real-estate construction loan files are to include current financial

statements, inspection reports, and written appraisals. Since the section 39

standards do not contain similar documentation requirements, we believe

the standards are open to considerable interpretation and do little to limit

the wide discretion regulators have in determining whether banks have

adequate loan documentation practices.

Furthermore, the loan documentation standards do not provide or state a

specific level of noncompliance at which enforcement actions will be

required. Although it may be difficult to develop quantifiable criteria for

making such enforcement decisions, there are various regulatory “rules of

thumb” in place that we believe could serve as the basis for triggering

mandatory actions. For example, in its 1988 report on the reasons why

banks fail, OCC found that banks with loan documentation problems in 15

to 20 percent or more of their loan portfolios were typically operating in

an unsafe and unsound manner.11

Regulators Have

Discretion to Require

Section 39 Compliance

Plans, and Requirements

Are Not Specific

As discussed earlier, CDRI amended the section 39 mandate that regulators

require a depository institution to file a compliance plan if the institution

is found not to be in compliance with the standards. The new provision

allows regulators greater flexibility in deciding whether to impose such a

requirement. In the July 10, 1995, Notice of Final Rulemaking, the four

regulators (OCC, FRS, FDIC, and OTS) stated that they expect to require a

compliance plan from any institution with deficiencies severe enough to

threaten the safety and soundness of the institution. However, as

discussed in the previous section, regulators have not developed

quantifiable criteria or other specific guidance for measuring an

institution’s compliance with the section 39 safety-and-soundness

standards. Therefore, it is not clear how regulators would determine

11OCC, Bank Failures: An Evaluation of the Factors Contributing to the Failures of National Banks

(June 1988).

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whether an institution’s noncompliance with generally accepted

management principles is “severe” enough to warrant regulatory action.

In addition, the implementing regulations do not provide any specific

criteria for compliance plans beyond those contained in the section 39

legislation. The regulations merely state that compliance plans should

identify steps that the institution is to take to correct the identified

problems and the time by which the steps are to be taken. In contrast,

section 38 and its implementing regulations establish more specific criteria

for CRPs. For example, CRPs must specify capital levels that the institution

expects to achieve for each year the plans are in effect. In addition, CRPs

must show how the institution will comply with any restrictions on its

activities under section 38 and the types of businesses and activities in

which the institution will engage. Section 38 requires regulators to reject

any CRP unless it contains such information, is based on realistic economic

assumptions, and would not appreciably increase risk to the institutions.

In the absence of similar criteria, there is less assurance that the

compliance plans developed under section 39 will consistently result in

the prompt remediation of deficiencies.

Various Ongoing

Initiatives May Result

in Improved

Regulatory Oversight

FDICIA contained a number of reforms and provisions that were designed to

complement sections 38 and 39. FDICIA’s corporate governance and

accounting reform provisions directed depository institutions to improve

their corporate governance and the information they report to the

regulators. FDICIA also required regulators to revise their risk-based capital

standards to ensure that those standards take adequate account of interest

rate risk, concentrations of credit, and nontraditional activities. In

addition, regulators have stated that their oversight of depository

institutions has improved, and they are in the process of modifying their

examination approaches to emphasize the monitoring of risk-taking by

depository institutions. However, we did not evaluate the effectiveness of

these various initiatives because many had not been fully implemented or

tested.

FDICIA’s Corporate

Governance Requirements

Can Enhance Management

Accountability and

Regulatory Oversight

FDICIA placed a number of new requirements on depository institutions to

improve their corporate governance and the information they provide to

the regulators. As previously discussed, FDICIA requires all but small (total

assets of less than $500 million) depository institutions to submit annual

reports to the regulator on the institutions’ financial conditions and

management. The report is to include management’s assessment of (1) the

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effectiveness of the institution’s internal controls and (2) the institution’s

compliance with the laws and regulations designated by the regulator. In

addition, FDICIA required the institution’s external auditors to report

separately on these assertions made by management.12 Furthermore, FDICIA

requires depository institutions to have an independent audit committee

composed of outside directors who are independent of institutional

management.

As we reported in 1993,13 these new requirements have the potential to

significantly enhance the likelihood that regulators will identify emerging

problems in banks and thrifts earlier. For example, regulators can use the

result of an institution’s management assessments and external auditor’s

reviews to identify those areas with the greatest risk exposure. This

identification process should allow the regulators to improve the quality

and efficiency of their examinations. While these FDICIA requirements may

result in the early identification of troubled institutions, they do not ensure

that regulators will take consistent supervisory actions to address

safety-and-soundness problems before they adversely affect an

institution’s capital levels.

Regulators Are Revising

Their Risk-Based Capital

Standards

In response to FDICIA section 305 requirements, regulators have recently

undertaken revisions of the risk-based capital standards that they use to

implement provisions of section 38. Specifically, regulators have revised or

are revising the risk-based capital standards to cover risks associated with

concentrations of credit, nontraditional financial products, and interest

rate movements.14 As of September 1996, the revisions to the risk-based

capital standards announced by the regulators will not change the capital

ratios used for section 38 purposes. Instead, regulators plan to use the

examination process to identify institutions that have excessive and poorly

managed risk exposure, due to concentrations of credit, nontraditional

products, or interest rate risk. Regulators said that they will require such

12Section 2301(a) of the Economic Growth and Regulatory Paperwork Reduction Act of 1996 repealed

the requirement that an institution’s external auditors report on compliance with designated laws and

regulations.

13Bank and Thrift Regulation: Improvements Needed in Examination Quality and Regulatory Structure

(GAO/AFMD-93-15, Feb. 16, 1993).

14The term “concentrations of credit” refers to situations when an institution has a large portion of its

loan portfolio involving one borrower, industry, location, collateral, or loan type. Nontraditional

financial product risks are the risks associated with activities or products that have not customarily

been part of the banking business but that begin to be conducted as a result of developments in, for

example, technology or financial instruments. The term “interest rate movement” refers to the risk that

changes in market interest rates will have an adverse effect on an institution’s earnings and its

underlying economic value.

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institutions to hold greater levels of capital than those required of other

institutions. See appendix I for a more detailed discussion of section 305’s

requirements and the regulators’ planned revisions to risk-based capital

standards.

Other Regulatory

Initiatives May Improve

Depository Institution

Oversight

Regulators have stated that they have learned from their experiences in

the 1980s and that their approach to depository institution oversight has

changed. The regulators said that they have recognized the need to take

proactive steps to prevent institutions from engaging in unsafe and

unsound practices. For example, OCC, FRS, and FDIC are developing new

examination procedures to better monitor and control bank risk-taking

(see app. II). A July 1996 proposal to revise the rating system used by the

regulators also reflects the increased emphasis on evaluating an

institution’s risk exposure and the quality of its risk management systems.15

Efforts by the regulators to improve federal oversight through

examinations focused on risk management, along with the accounting and

corporate governance provisions of FDICIA, could help provide early

warning signals of potential safety-and-soundness problems. However,

whether this potential for earlier detection will be translated into

corrective action is subject to some question because the regulators still

have a great deal of discretion under section 39, as amended. Although the

section 38 capital standards appear to have played some role in

strengthening the condition of the banks and thrifts, other factors have

also contributed to this improvement, including lower interest rates and an

improving economy. Despite the apparently sound financial condition of

the bank and thrift industry, the possibility cannot be ruled out that the

current strong performance of the bank and thrift industry is masking

management problems or excessive risk-taking that is not being addressed

by regulators. For example, the financial press reported in November 1995

and March 1996 that delinquent consumer loans, such as credit card loans,

grew considerably during these years and that this growth was partially

attributed to lower credit standards.16 Whether the regulators are more

successful in detecting risk management problems and then taking the

1561 Fed. Reg. 37472 (July 18, 1996).

16The regulators have indicated that they are closely monitoring delinquencies by loan type. For

example, FDIC testified before the House Committee on Banking and Financial Services on

September 12, 1996, that consumer lending did not pose a significant risk to the deposit insurance

funds at this time and that it would continue to closely monitor industry trends in consumer loan

delinquencies and consumer loan portfolios at individual institutions.

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requisite corrective actions may not be fully known until another

downturn in the economy affects the bank and thrift industry.

Conclusions In 1991, Congress enacted FDICIA, in part, because of concerns that the

exercise of regulatory discretion during the 1980s did not adequately

protect the safety and soundness of the banking system or minimize

insurance fund losses. FDICIA’s Prompt Regulatory Action provisions were

originally enacted to limit regulatory discretion in key areas and to

mandate regulatory responses against financial institutions with

safety-and-soundness problems. The implementation of section 38 has

provided capital categories and mandated actions that regulators should

take if banks or thrifts fall into specific categories. However, section 39, as

amended, appears to leave regulatory discretion largely unchanged from

what existed before the passage of FDICIA.

Sections 38 and 39 provide regulators with additional enforcement tools

that they can use to obtain corrective action or close institutions with

serious capital deficiencies and/or safety-and-soundness problems. These

provisions include the enforcement tool that allows regulators to remove

bank officials believed to be the cause of the institution’s problems as well

as other actions intended to stop the institution from engaging in risky

practices. Moreover, section 38 appears to have encouraged institutions to

raise additional equity capital and should help prevent capital-deficient

institutions from compounding losses.

Despite such benefits, severely troubled institutions may not be subject to

mandatory restrictions and supervisory actions under section 38 due to its

reliance on capital as the basis for regulatory intervention. In addition,

section 39 does not require regulators to take actions against poorly

managed institutions that have not yet reached the point of capital

deterioration. Legislative and regulatory changes have resulted in the

guidelines’ taking the form of broad statements of general banking

principles rather than as specific measures of unsafe and unsound

conditions. Furthermore, regulators have not established criteria for

determining when a institution is in noncompliance with the guidelines.

The implementation of FDICIA’s other provisions and various initiatives

undertaken by the regulators to improve their examination process may

help to increase the likelihood that regulators will take prompt and

corrective regulatory action. FDICIA’s accounting and supervisory reforms

provide a structure to strengthen corporate governance and to facilitate

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Chapter 3 

The Effectiveness of Sections 38 and 39 Is

Yet to Be Determined

early warning of safety-and-soundness problems. In addition, regulators

have stated that their approach to supervision has changed since the

1980s, and they are developing new examination procedures to be more

proactive in monitoring and assessing bank risk-taking. However, we did

not evaluate the effectiveness of these initiatives because many of them

have not been fully implemented or tested. Therefore, at present, it is

difficult to determine if these initiatives will result in the earlier detection

of safety-and-soundness problems and, if so, whether regulators will take

strong and forceful actions early enough to prevent or minimize future

losses to the insurance funds due to failures.

Agency Comments

and Our Evaluation

In its comments on our report, OCC agreed with our conclusion that

sections 38 and 39 may not always result in prompt and corrective

regulatory action. Nonetheless, OCC believes that FDICIA’s combination of

section 38 mandatory restrictions and the regulatory discretion retained

under section 39 allows regulators to tailor their supervision to suit an

institution and its particular problems.

The Federal Reserve Board of Governors stated that it had no formal

comments but that the report appeared to accurately describe the Federal

Reserve’s policies, procedures, and practices with respect to the

implementation of FDICIA’s Prompt Regulatory Action provisions, as

amended.

OTS stated that section 38 effectively encourages institutions to avoid

becoming or remaining undercapitalized. OTS emphasized that the section

39 standards are untested, and it supported the flexibility built into section

39. OTS believes that existing discretionary supervisory and enforcement

tools are adequate to deal with most safety-and-soundness issues, apart

from capital.

FDIC also supported the discretionary and flexible nature of the section 39

safety-and-soundness standards. FDIC pointed out that the overwhelming

number of comments that the regulators received on the section 39

standards were in favor of general rather than specific standards. FDIC

stated that the section 39 standards adopted by the regulators minimize

regulatory burden while recognizing that there is more than one way to

operate in a safe-and-sound manner.

We do not disagree that there is a need for some degree of regulatory

discretion. Rather, we see the issue as one of striking a proper balance

Page 56 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Chapter 3 

The Effectiveness of Sections 38 and 39 Is

Yet to Be Determined

between the need for sufficient regulatory discretion to respond to

circumstances at a particular institution and the need for certainty for the

banking industry about what constitutes an unsafe or unsound condition

and what supervisory actions would be expected to result from those

conditions. The subjective nature of the standards continues the wide

discretion that regulators had in the 1980s over the timing and severity of

enforcement actions. Such discretion resulted in the regulators’ not always

taking strong actions early enough to address safety-and-soundness

problems before they depleted an institution’s capital. However, we note

that the implementation of FDICIA along with various regulatory initiatives

undertaken since the passage of FDICIA may help in the earlier detection of

institutions with safety-and-soundness problems. These initiatives, along

with the regulators’ willingness to use their various enforcement

authorities—including sections 38 and 39—to prevent or minimize

potential losses to the deposit insurance funds, will be instrumental in

determining whether the proper balance between discretion and certainty

has been attained.

Page 57 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Appendix I 

Revisions to Risk-Based Capital Standards

Section 305 of FDICIA requires regulators to review their risk-based capital

standards biennially to facilitate section 38’s ability to prevent or minimize

insurance fund losses. The section also requires regulators to revise the

risk-based capital standards to ensure that the standards take adequate

account of interest rate risk, concentrations of credit risk, and the risks of

nontraditional financial products. Regulators are required to revise the

risk-based capital standards to reflect the actual performance and risk of

loss on multifamily mortgages. Section 305 required regulators to issue

regulations prescribing the new standards no later than June 19, 1993. In

addition to the actions taken in response to section 305’s requirements,

regulators have revised their risk-based capital standards by adding a

market risk component in conformance with a recent amendment to the

Basle Committee’s capital standards for international banks.1

Capital Standards for

Credit Concentration

and Nontraditional

Product Risks

On December 15, 1994, regulators issued final rules on revised risk-based

capital standards to ensure that the standards account for credit

concentrations and nontraditional products risks.2

 Loan concentrations

pose substantial risks to depository institutions because problems with

one borrower, industry, location, collateral, or loan type could cause

substantial asset quality deterioration. Nontraditional product risks are

associated with activities that have not customarily been part of the

banking business (e.g., sophisticated financial instruments, such as

derivatives).

In the course of developing the final rule on credit concentrations,

regulators concluded that there is no generally accepted approach to

identifying and quantifying the magnitude of risk associated with

concentrations of credit. Therefore, regulators determined that it was not

currently feasible to include a formula-based calculation to quantify the

risk related to concentrations of credit. Instead, the final rule directs

examiners to assess each bank’s concentrations of credit and its ability to

manage those concentrations. Under the final rule, institutions found to

have excessive concentrations that are inadequately managed will be

required to hold capital in excess of the regulatory minimums established

by section 38.

1

The Basle Committee amendment defined market risk as the risk of losses in on- and

off-balance-sheet positions arising from movements in market prices. Specifically, the risks related to

(1) interest rate-related instruments and equities in the trading book and (2) foreign exchange risk and

commodities risk throughout the bank.

2

59 Fed. Reg. 64561.

Page 58 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Appendix I 

Revisions to Risk-Based Capital Standards

Like concentrations of credit, regulators did not issue quantitative

formulas or standards for nontraditional products risk. Under the final

rule, regulators will take into account the risks posed by nontraditional

activities during the examination process. The regulators explained that

the final rule recognized that the effect of a nontraditional activity on an

institution’s capital adequacy depends on the activity, the profile of the

institution, and the institution’s ability to monitor and control the risks

arising from that activity. Regulators may require higher minimum capital

ratios from those institutions found to have excessive risk due to

nontraditional banking activities. The regulators stated that they will

continue their efforts to incorporate nontraditional activities into

risk-based capital.

Interest Rate Risk

Capital Revisions

On August 2, 1995, regulators issued a final rule that amended their capital

guidelines for interest rate risk.3

 Interest rate risk is the risk that changes

to market interest rates will have an adverse effect on a bank’s earnings

and its underlying economic value. The final rule does not make explicit or

quantitative changes to risk-based capital standards. Instead, the final rule

directs examiners to consider, in their evaluation of a bank’s capital

adequacy, the exposure of the bank’s capital and economic value to

changes in interest rates.

The August 2, 1995, final rule did not adopt a measurement framework for

assessing the level of an institution’s interest rate exposure, nor did it

specify a formula for determining the amount of capital that would be

required. The intent of the regulators at that time was to implement an

explicit minimum capital charge for interest rate risk at a future date, after

the regulators and industry had gained more experience with a proposed

supervisory measure that the agencies issued for comment in August 1995.4

At that time, regulators sought comments on their proposed framework

for measuring and monitoring the level of interest rate risk at individual

banks. The proposed system would, on a standardized basis, measure the

risk of all banks not exempted from reporting additional information on

their call reports.5

 In addition, regulators proposed encouraging banks to

3

60 Fed. Reg. 39490.

4

60 Fed. Reg. 39495.

5

The only proposed exemption from the expanded reporting requirements was for banks with (1) total

assets under $300 million, (2) composite supervisory ratings of 1 or 2, and (3) moderate or low

holdings of assets with intermediate and long-term maturity or repricing characteristics.

Page 59 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Appendix I 

Revisions to Risk-Based Capital Standards

report the results of their own internal, interest rate risk measurement

systems on a voluntary and confidential basis. Examiners would then use

the information from both sources in their assessments of the bank’s

interest rate risk management and capital adequacy. The results would

also provide regulators with information on industry trends and patterns

that would better inform both present and future supervisory efforts

related to interest rate risk, such as the development of explicit minimum

risk-based capital requirements for interest rate risk.

On June 26, 1996,6

 the regulators issued a joint policy statement on interest

rate risk that did not incorporate the standardized measurement

framework proposed by the regulators in August 1995. According to the

regulators, the decision not to pursue a standardized measurement system

reflected (1) concerns about the burden, accuracy, and complexity of a

standardized measure and (2) the recognition that industry techniques for

measuring interest rate risk were continuing to evolve. Instead, the

June 1996 policy statement identified the key elements of sound interest

rate risk management and described the prudent principles and practices

for each of these elements. The regulators stated their intent to continue

to place significant emphasis on the level of an institution’s interest rate

risk exposure and the quality of its risk management process when

evaluating its capital adequacy.

Market Risk Measure OCC, FRS, and FDIC have issued a final rule amending their risk-based capital

standards to include market risk.7

 The final rule was intended to expand

the existing credit-based focus of the regulators’ risk-based capital

standards. The regulators took this action in response to the Basle

Committee’s January 1996 amendment to its capital standards for

international banks.8

 That amendment requires international banks to start

incorporating market risk in their risk-based capital by the end of 1997.

The final rule issued by the regulators requires an institution that meets

specific applicability criteria9

 to measure its exposure to market risk and

hold capital in support of that exposure by January 1, 1998. Specifically, an

6

61 Fed. Reg. 33166.

7

61 Fed. Reg. 47357 (Sept. 6, 1996).

8

Amendment to the Capital Accord to Incorporate Market Risks, Basle Committee on Banking

Supervision, January 1996.

9

Any bank or holding company whose trading activity equals 10 percent or more of its total assets, or

whose trading activity equals $1 billion or more is required to adjust its risk-based capital to account

for market risk.

Page 60 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Appendix I 

Revisions to Risk-Based Capital Standards

institution must adjust its risk-based capital ratio to take into account the

general market risk of all positions located in its trading accounts and of

foreign exchange and commodity positions whether they are on- or

off-balance sheet. Additionally, the institution must account for the

specific risk of debt and equity positions located in its trading account.

The final rule on market risk allows an institution to use its own internal

models to measure its exposure to market risk. However, the institution is

required to determine the capital charges for its specific risks using a

standardized approach methodology specified by the regulators. The

regulators will then use the adjusted risk-based capital ratio to determine

the institution’s capital category under section 38 as well as for other

statutory and regulatory purposes.

Page 61 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Appendix II 

New Examination Procedures and Rating

System to Better Monitor Bank Risk-Taking

OCC, FRS, and FDIC have announced or were developing new bank

examination policies and/or procedures to better monitor bank risk-taking.

The primary objective of the new banking examination procedures was to

identify potential areas of risk and concentrate regulatory resources on

those areas with the greatest potential risk. As of September 1996, these

initiatives had not been fully implemented. In addition, the Federal

Financial Institutions Examination Council (FFIEC)1

 issued a proposal in

July 1996 that would revise the supervisory rating system used by

regulators to, among other things, reflect changes that have occurred in

supervisory policies and procedures.

Risk-Based

Examination

Initiatives

As shown in table II.1, OCC’s initiative requires its examiners to separate

risk into nine categories, ranging from credit and interest rate risk to

compliance and reputation risk. Although similar in content, FRS’

risk-based examination approach divides bank risk into six categories.

Under both approaches, examiners rate each bank in each risk category,

as well as overall, and analyze how well each category is managed. The

risk rating of each institution would supplement and not replace

traditional examination approaches, which focus on assessing bank asset

quality, capital adequacy, and profitability. OCC and FRS developed the new

examination system, in part, to better respond to developments in the

financial services industry over recent years. For example, the new

examination system is intended to help OCC and FRS better monitor banks’

use of complex derivative financial products.

1

FFIEC is an interagency group of depository institution regulators (OCC, FDIC, FRS, OTS, and the

National Credit Union Association) that was formed in 1979 to maintain uniform standards for the

federal examination and supervision of federally insured depository institutions.

Page 62 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Appendix II 

New Examination Procedures and Rating

System to Better Monitor Bank Risk-Taking

Table II.1: Risk Factors Used in OCC’s

and FRS’ Risk-Based Examination

Procedures

Risk category used in regulators’

examination procedures

Risk category OCC FRS

Credit: risk that borrower will default yes yes

Liquidity: risk that bank will not meet its

obligation without selling assets at

below-market rates yes yes

Interest rate: risk from fluctuating interest rates yes no

Market: risk from shifts in interest rates and

foreign exchange rates no yes

Price: risk from changing values in a securities

portfolio yes no

Reputation: risk of bad publicity yes yes

Strategic: risk of making bad business

decisions yes no

Operational: risk of trouble from regular

business practices no yes

Transactions: risk from product delivery

problems yes no

Foreign Exchange: risk from changing

exchange rates yes no

Compliance (OCC)/Legal (FRS): risk of

violating laws or regulations yes yes

Source: OCC and FRS.

According to a senior FDIC official, FDIC was also developing a new

examination policy on assessing bank risks. He said that the policy is to be

based largely on a current policy statement, issued by FDIC in March 1994,

that provides guidance on examining and assessing the risks of financial

derivatives. In addition, FDIC was examining the new risk-based

examination procedures announced by OCC and FRS as possible models for

FDIC’s new examination policy on assessing bank risk. The official said he

was not certain when the new examination policy would be issued.

Proposed Supervisory

Rating System

Revisions

On July 18, 1996, FFIEC requested comments on proposed revisions to the

Uniform Financial Institutions Rating System, which is commonly referred

to as the CAMEL (Capital, Asset, Management, Earnings, and Liquidity)

rating system.2

 The proposed revisions reflected changes occurring in the

financial services industry and in supervisory policies and procedures

since the rating system was first adopted in 1979.

2

61 Fed. Reg. 37472.

Page 63 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Appendix II 

New Examination Procedures and Rating

System to Better Monitor Bank Risk-Taking

The proposed revisions included (1) the reformatting and clarification of

the existing component rating descriptions; (2) the addition of a sixth

rating component addressing sensitivity to market risks; (3) an increase in

emphasis on the quality of risk management processes in each of the

rating components, particularly in the management component; (4) the

addition of language in composite rating definitions to parallel the

proposed changes in component rating definitions; and (5) the explicit

identification of the risk types that are to be considered in assigning

component ratings. FFIEC established September 16, 1996, as the deadline

for receiving comments on its proposal.

Page 64 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Appendix III 

Comments From the Office of the

Comptroller of the Currency

See pp. 27 and 28.

Page 65 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Appendix III 

Comments From the Office of the

Comptroller of the Currency

Page 66 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Appendix IV 

Comments From the Federal Reserve Board

Page 67 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Appendix V 

Comments From the Federal Deposit

Insurance Corporation

Now on p. 6.

See pp. 6 and 19.

Page 68 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Appendix V 

Comments From the Federal Deposit

Insurance Corporation

Now on p. 6.

See p. 37.

Page 69 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Appendix VI 

Comments From the Office of Thrift

Supervision

Page 70 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Appendix VI 

Comments From the Office of Thrift

Supervision

Page 71 GAO/GGD-97-18 Prompt Regulatory Action Provisions
Appendix VII 

Major Contributors to This Report

General Government

Division, Washington,

D.C.

Thomas J. McCool, Associate Director

Mark Gillen, Assistant Director

James R. Black, Senior Evaluator

Wesley M. Phillips, Evaluator

Boston Field Office Kevin F. Murphy, Senior Evaluator

Dallas Field Office Ronald Haun, Senior Evaluator

San Francisco-Seattle

Field Office

Kane Wong, Assistant Director

Harry Medina, Evaluator-in-Charge

Bruce K. Engle, Evaluator

Gerhard C. Brostrom, Communications Analyst

(233448) Page 72 GAO/GGD-97-18 Prompt Regulatory Action Provisions
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