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S. HRG. 113–58 

LESSONS LEARNED FROM THE FINANCIAL CRISIS 

REGARDING COMMUNITY BANKS 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED THIRTEENTH CONGRESS 

FIRST SESSION 

ON 

EXAMINING THE MAJOR TRENDS AFFECTING COMMUNITY BANKS AND 

LESSONS LEARNED FROM COMMUNITY BANK FAILURES DURING THE 

FINANCIAL CRISIS 

JUNE 13, 2013 

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

( 

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

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

TIM JOHNSON, South Dakota, Chairman 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

KAY HAGAN, North Carolina 

JOE MANCHIN III, West Virginia 

ELIZABETH WARREN, Massachusetts 

HEIDI HEITKAMP, North Dakota 

MIKE CRAPO, Idaho 

RICHARD C. SHELBY, Alabama 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

TOM COBURN, Oklahoma 

DEAN HELLER, Nevada 

CHARLES YI, Staff Director 

GREGG RICHARD, Republican Staff Director 

LAURA SWANSON, Deputy Staff Director 

GLEN SEARS, Deputy Policy Director 

PHIL RUDD, Legislative Assistant 

GREG DEAN, Republican Chief Counsel 

JELENA MCWILLIAMS, Republican Senior Counsel 

DAWN RATLIFF, Chief Clerk 

KELLY WISMER, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

(II)

C O N T E N T S 

THURSDAY, JUNE 13, 2013 

Page 

Opening statement of Chairman Johnson ............................................................. 1 

Opening statements, comments, or prepared statements of: 

Senator Crapo ................................................................................................... 2 

WITNESSES 

Richard A. Brown, Chief Economist, Federal Deposit Insurance Corporation ... 3 

Prepared statement .......................................................................................... 18 

Responses to written questions of: 

Senator Crapo ............................................................................................ 46 

Jon T. Rymer, Inspector General, Federal Deposit Insurance Corporation ....... 5 

Prepared statement .......................................................................................... 21 

Responses to written questions of: 

Senator Crapo ............................................................................................ 48 

Lawrance L. Evans, Jr., Director, Financial Markets and Community Investment, Government Accountability Office ........................................................... 6 

Prepared statement .......................................................................................... 26 

Responses to written questions of: 

Senator Crapo ............................................................................................ 52 

(III)

(1) 

LESSONS LEARNED FROM THE FINANCIAL 

CRISIS REGARDING COMMUNITY BANKS 

THURSDAY, JUNE 13, 2013 

U.S. SENATE, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC. 

The Committee met at 10:27 a.m., in room SD–538, Dirksen Senate Office Building, Hon. Tim Johnson, Chairman of the Committee, presiding. 

OPENING STATEMENT OF CHAIRMAN TIM JOHNSON 

Chairman JOHNSON. I apologize for being a bit late, but the vote 

was called. Good morning. I call this hearing to order. 

Today we will discuss three recent studies on community banks: 

the GAO’s study, ‘‘Causes and Consequences of Recent Bank Failures’’; the FDIC Inspector General’s ‘‘Comprehensive Study on the 

Impact of the Failure of Insured Depository Institutions’’; and the 

‘‘FDIC Community Banking Study’’. 

Between January 2008 and December 2011, 414 insured U.S. 

banks failed. Of these, 353 were depository institutions with less 

than $1 billion in assets. Despite these failures, over 7,000 small 

financial institutions survived. We know that community banks did 

not cause the financial crisis, but many were casualties of the 

Great Recession that followed. 

Community banks entered the crisis with strong capital and, despite weakening earnings, most of them remained well capitalized 

through the crisis. However, some banks saw an increase in nonperforming loans and a decrease in income that strained their capital levels. 

I look forward to today’s witness testimony. The FDIC, the GAO, 

and FDIC IG have taken important steps to analyze the impact of 

the financial crisis on community banks, and specifically the GAO 

and IG studies looked at the factors that contributed to the bank 

failures during this period. All three studies have provided lessons 

learned from the crisis regarding community banks and have made 

recommendations that would strengthen the community bank 

model and improve regulation and supervision. 

Since community banks play such a vital role in so many cities 

and towns of all sizes, including many in my home State of South 

Dakota, it is important for this Committee to explore major trends 

affecting community banks and lessons learned from the financial 

crisis. It is my hope that this Committee can find consensus and 

ways to strengthen community banks and the communities they 

2 

serve without undermining safety and soundness regulation or consumer protection. 

Ranking Member Crapo, do you have an opening statement? 

OPENING STATEMENT OF SENATOR MIKE CRAPO 

Senator CRAPO. Yes, Mr. Chairman, and thank you. 

Today the Committee will hear about the lessons we have 

learned from the financial crisis regarding community banks. I 

want to thank the FDIC and the GAO for coming to testify pursuant to a statutory requirement to brief us on bank failures and 

their causes. 

This is a critical issue since small banks represent the lifeblood 

of many communities across America, and especially rural communities, in Idaho and elsewhere. In fact, the FDIC’s Community 

Banking Study, commissioned by Chairman Marty Gruenberg, 

shows that community banks hold the majority of banking deposits 

in rural counties, with one in five U.S. counties having no other 

banking presence. 

Banking used to be a community-based enterprise, relying on 

local knowledge and expertise to extend credit based on creditworthiness of the bank’s depositors. Many community banks continue to operate that way even today. 

Despite the many benefits of such relationship-based banking, 

the industry has become increasingly concentrated since the 1980s. 

The number of banking organizations has shrunk by nearly onethird from 1990 to 2006, and most of this contraction has involved 

small community banks whose numbers have now fallen by more 

than 3,000 during that time. 

The financial crisis of 2008 only exacerbated the consolidation 

trend. Between January 2008 and December 2011, 414 U.S. banks 

failed, according to the GAO. Of those, 85 percent, or 353 banks, 

had less than $1 billion in assets. Those banks often specialized in 

small business lending, so their failure has had a disproportionately large impact on small business lending and local employment. 

We must carefully examine what led to such a large number of 

small banks closing and the residual effect on local communities. 

We also need to be able to put this most recent crisis in perspective and examine how it compares to past community bank crises. 

While this hearing is focused on lessons learned from the most recent financial crisis, much can be learned from the postcrisis response as well. The regulatory framework that emerged out of 

Dodd-Frank has made it increasingly difficult for community banks 

to maintain and operate their business presence in many communities. Community banks are disproportionately affected by increased regulation because they are less able to absorb the additional cost. 

The majority of community banks today have $250 million or less 

in assets, according to the GAO, which often translates into a oneor two-person compliance department. Small institutions simply do 

not have the resources necessary to review and parse through thousands of pages of new rules. As a result, many community and 

small banks have identified Dodd-Frank as imposing overwhelming 

regulatory burdens on them or serving as barriers to entry. 

3 

As Federal Reserve Governor Duke outlined in a November 2012 

speech, ‘‘If the effect of a regulation is to make a traditional banking service so complicated or expensive that significant numbers of 

community banks believe they can no longer offer that service, it 

should raise red flags and spur policy makers to reassess whether 

the potential benefits of the regulation outweigh the potential loss 

of the community bank’s participation in that part of the market.’’ 

I believe we have reached that point, and I look forward to the 

testimony from our witnesses today. 

Thank you, Mr. Chairman. 

Chairman JOHNSON. Thank you, Senator Crapo. 

Are there any other Members who wish to make a brief opening 

statement? 

[No response.] 

Chairman JOHNSON. Thank you all. 

I want to remind my colleagues that the record will be open for 

the next 7 days for opening statements and any other materials 

you would like to submit. Now I will introduce our witnesses. 

Mr. Richard Brown is Chief Economist at the FDIC. 

The Honorable Jon T. Rymer is Inspector General of the FDIC. 

Mr. Lawrance L. Evans, Jr., is Director for Financial Markets 

and Community Investment at the GAO. 

I thank all of you for being here today. I would like to ask the 

witnesses to please keep their remarks to 5 minutes. Your full 

written statements will be included in the hearing record. 

Mr. Brown, you may begin your testimony. 

STATEMENT OF RICHARD A. BROWN, CHIEF ECONOMIST, 

FEDERAL DEPOSIT INSURANCE CORPORATION 

Mr. BROWN. Chairman Johnson, Ranking Member Crapo, and 

Members of the Committee, I appreciate the opportunity to testify 

on behalf of the FDIC regarding the FDIC Community Banking 

Study. This research effort was initiated in late 2011 to better understand the changes that have taken place among community 

banks over the past quarter century. This effort was motivated by 

our sense of the importance of community banks to small businesses and local economies in every part of the country and by our 

understanding that community banks have faced a number of challenges in the postcrisis financial environment. 

Our research confirms the crucial role that community banks 

play in our financial system. As defined by the study, community 

banks represent 95 percent of all U.S. banking organizations. They 

account for just 14 percent of U.S. banking assets but hold 46 percent of the industry’s small loans to farms and businesses. 

While their share of total deposits has declined over time, community banks still hold the majority of bank deposits in rural and 

other nonmetropolitan counties. Without community banks, many 

rural areas, small towns, and urban neighborhoods would have little or no physical access to mainstream banking services. The 

study identified 629 counties where the only banking offices are 

those operated by community banks. 

Our study examined the long-term trend of banking industry 

consolidation that has reduced the number of banks and thrifts by 

more than half since 1984. But the results cast doubt on the notion 

4 

that future consolidation will continue at this same pace or that 

the community banking model is in any way obsolete. 

Since 1984, more than 2,500 institutions have failed, with the 

vast majority failing in two crisis periods. To the extent that future 

crises can be avoided or mitigated, bank failures should contribute 

much less to future consolidation. About 80 percent of the consolidation that has taken place resulted from eliminating charters 

within bank holding companies or from voluntary mergers, and 

both of those trends were facilitated by the relaxation of geographic 

restrictions on banking that took place in the 1980s and the early 

1990s. 

But the pace of voluntary consolidation has slowed over the past 

15 years as the effects of these one-time changes were realized. 

The study also showed that community banks that grew prudently and that maintained diversified portfolios or otherwise stuck 

to their core lending competencies exhibited relatively strong and 

stable performance over time, including during the recent crisis. By 

comparison, institutions that pursued more aggressive growth 

strategies underperformed. 

The strongest performing lending groups across the entire study 

period were community banks specializing in agricultural lending, 

diversified banks with no single specialty, and consumer lending 

specialists. Agricultural specialists and diversified nonspecialists 

also failed at rates well below other community banks during the 

study period. Other types of institutions that pursued highergrowth strategies—frequently through commercial real estate or 

construction and development lending—encountered severe problems during real estate downturns and generally underperformed 

over the long run. 

Now, with regard to measuring the costs of regulatory compliance, the study noted that the financial data collected by regulators 

does not identify regulatory costs as a distinct category of noninterest expenses. As part of our study, the FDIC conducted interviews with a group of community banks to try to learn more about 

regulatory costs. Most participants stated that no single regulation 

or practice had a significant effect on their institution. Instead, 

most said that the strain on their organization came from the cumulative effects of a number of regulatory requirements that have 

built up over time. Several of those interviewed indicated that they 

have increased staff over the past 10 years to support their responsibilities in the area of regulatory compliance. Still, none of the 

interview participants said that they actively track the various 

costs associated with compliance, citing the difficulties associated 

with breaking out those costs separately. 

In summary, despite the challenges of the current operating environment, the study concluded that the community banking sector 

will remain a viable and vital component of the overall U.S. financial system for the foreseeable future. 

Thank you for the opportunity to testify, and I look forward to 

your questions. 

Chairman JOHNSON. Thank you, Mr. Brown. 

Mr. Rymer, please proceed. 

5 

STATEMENT OF JON T. RYMER, INSPECTOR GENERAL, 

FEDERAL DEPOSIT INSURANCE CORPORATION 

Mr. RYMER. Thank you, Chairman Johnson, Ranking Member 

Crapo, Senator Warren. Thank you for the opportunity to testify 

today on the lessons learned from the financial crisis. As you requested, I will focus my remarks on the study my office conducted 

on the impact of the failure of insured financial institutions. I will 

summarize the study’s overarching conclusions and general observations. In addition, I will highlight some of the work my office has 

completed over the last 5 years that could contribute to the Committee’s ‘‘lessons learned’’ discussion. 

The events leading to the financial crisis, and the subsequent efforts to resolve it, involved the dynamic interplay of laws, regulations, agency policies and practices with the real estate and financial markets. Banks expanded lending, fueling rapid growth in construction and real estate development. Many of the banks that 

failed did so because management relaxed underwriting standards 

and did not implement adequate oversight and control. 

For their part, many borrowers did not always have the capacity 

to repay loans and, in some cases, pursued many projects without 

considering all the risks involved. 

As for the regulators, while they generally fulfilled their responsibilities, most of the material loss reviews conducted by the three 

bank regulatory IGs found that the regulators could have provided 

earlier and greater supervisory attention to troubled banks and 

thrifts. 

Four general observations emerged from our study, and they are 

as follows: 

First, the FDIC’s resolution methods—including the shared loss 

agreements—were market driven. Often, failing banks had poor 

asset quality and little or no franchise value, and as a result did 

not attract sufficient interest from qualified bidders for the FDIC 

to sell the banks without a loss-share guarantee. The FDIC used 

these agreements to leave failed bank assets in the financial services industry, thereby supporting asset values and reducing losses 

to the Deposit Insurance Fund, or the DIF. 

Second, most community bank failures were the result of aggressive growth, asset concentrations, poor underwriting, deficient credit administration, and declining real estate values. 

Third, we found that examiners generally followed and implemented longstanding policies. However, they did not always document all of the examination steps they performed. 

And, fourth, the FDIC has investment-related policies in place to 

protect the DIF and to ensure the character and fitness of potential 

investors. 

In my remaining time, I would like to highlight some of the other 

work my office has completed related to the financial crisis. 

My office has conducted over 270 reviews of failed banks to determine the reason for the failure and, in many cases, to assess the 

FDIC’s supervisory performance as the primary Federal regulator 

of these banks. 

In addition to these reviews, we separately summarized the 

major causes, trends, and common characteristics of bank failures. 

In a December 2010 report, we examined the FDIC’s supervisory 

6 

actions taken up to that point in the crisis and offered recommendations geared to further enhance the FDIC’s supervisory 

program. 

Although our focus was primarily on failed banks, we have also 

looked to gain an understanding of why similarly situated banks 

did not fail. Our findings from an October 2012 report were not 

surprising as essentially they confirmed that planning, risk management, and strong leadership at both the bank management and 

board levels are the key ingredients to a successful bank. 

Finally, my office, along with the other two bank regulatory IGs, 

looked at the use and impact of prompt regulatory actions established in the FDI Act. In a September 2011 report, we found that 

prompt corrective actions occurred too late to rescue most troubled 

institutions. And while critically undercapitalized institutions were 

closed promptly, the losses to the DIF were still significant. 

In closing, the main lessons that should be learned from the 

work we did during the crisis is for the FDIC to remain vigilant 

in its supervisory activities in both good economic times and in 

bad. Focusing examination attention on key processes and risk 

management before an institution experiences financial and capital 

decline is the supervisory key to maintaining healthy banks. 

FDIC management must ensure that the lessons learned from 

the crisis become ingrained in its day-to-day operations in order to 

avoid a repeat of the last 5 years. We must all realize that these 

lessons will become more difficult to apply, or sustain, as the economy improves and banks return to profitability. 

This concludes my prepared statement. Thank you for the opportunity to be here today and join in this discussion. I look forward 

to answering your questions. 

Chairman JOHNSON. Thank you, Mr. Rymer. 

Mr. Evans, please proceed. 

STATEMENT OF LAWRANCE L. EVANS, JR., DIRECTOR, FINANCIAL MARKETS AND COMMUNITY INVESTMENT, GOVERNMENT ACCOUNTABILITY OFFICE 

Mr. EVANS. Chairman Johnson, Ranking Member Crapo, and 

Senator Warren, I am pleased to be here this morning to discuss 

our January 2013 report on bank failures. 

Between 2008 and 2011, 414 insured U.S. banks failed. Since 

then, there have been 67 additional failures. Examining failed institutions, especially in contrast to their nonfailing peers, provides 

an opportunity to glean lessons learned that may be useful for regulators and policy makers going forward. Whereas my written 

statement covers a number of issues, my oral remarks today will 

focus on the causes of community banks failures. 

As we detailed in our report, 72 percent of the failures were concentrated in 10 States—in the West, Midwest, and Southeast. Almost all the failures involved small and medium-size banks. As 

mentioned, 85 percent of the banks had less than $1 billion in assets at the time of failure. Our analysis of these failures revealed 

four key issues. 

First, the failures were associated with high concentrations in 

commercial real estate, particularly acquisition, development, and 

construction loans. These loans grew rapidly and exceeded the regVerDate Nov 24 2008 10:17 Oct 22, 2013 Jkt 048080 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\06-13 LESSONS LEARNED FROM THE FINANCIAL CRISIS REGARDIN
7 

ulatory thresholds for heightened scrutiny by a significant margin. 

ADC concentrations at failed banks grew from roughly 100 percent 

of total risk-based capital to nearly 260 percent in 2008. At the 

onset of the financial crisis, ADC loans made up 30 percent of the 

total loans at failed banks, roughly 20 percentage points higher 

than at their open peers. 

Second, ADC and CRE concentrations were often associated with 

aggressive growth, poor risk management, weak credit administration, and risky funding sources. In some cases, IG reviews noted 

that failed banks engaged in lending outside of their normal geographical trade areas where they had no experience. We found that 

28 percent of the failed banks had been chartered for less than 10 

years at the time of their failure. According to regulators, many of 

these were formed to take advantage of the commercial real estate 

boom but lacked the experience necessary to manage the risks associated with heavy concentrations. 

FDIC staff noted that in many cases these young failed banks departed sharply from the approved business plan originally filed 

with the FDIC. Our econometric analysis found that banks with 

higher ADC concentrations and greater use of broker deposits were 

more likely to fail, while banks with better asset quality and greater capital adequacy were less likely to fail over the 2008–11 period. 

Our model found that high concentrations of CRE loans unrelated to acquisition, development, and construction did not increase 

the likelihood of failure, of course, abstracting from extreme concentrations. 

Third, the majority of the assets held by failing banks were not 

subject to fair value accounting. In fact, less than 1 percent of the 

assets held by failed banks were subject to fair value accounting on 

a recurring basis. We found that the biggest contributors to credit 

losses at failed institutions were nonperforming loans recorded at 

historical costs. 

Significant declines in real estate values contributed to these 

losses because, as collateral-dependent loans suffered impairment, 

accounting rules required that they be written down to the value 

of the collateral. 

Last, loan loss reserves were not adequate to absorb credit losses, 

in part because the accounting model for estimating credit losses 

is based on historical loss rates or incurred losses. As a result, estimated losses were based on economic conditions that understated 

default risk. As the level of nonperforming loans began to rise during the crisis, banks were forced to increase loan loss allowances 

and raise capital when they were least able to do so. 

To address this issue, accounting standard setters have proposed 

a more forward-looking approach that focuses on expected losses 

and would, therefore, incorporate a broader range of credit information. If operationalized, an expected loss model could potentially reduce the cycle of losses and failures that emerged in the recent crisis and could also encourage prudent risk management practices. 

Federal Reserve staff noted that if management at failed banks 

were forced to recognize loan losses earlier, it may provided an incentive to limit concentrations and the types of loans that later resulted in significant losses. 

8 

Chairman Johnson, Ranking Member Crapo, and Members of the 

Committee, this concludes my opening statement. I will be happy 

to answer any questions you have. 

Chairman JOHNSON. Thank you, Mr. Evans, and thank you very 

much for your testimony. 

As we begin questions, I will ask the clerk to put 5 minutes on 

the clock for each Member. 

Mr. Evans and Mr. Rymer, with the vast majority of community 

banks that survived the financial crisis, what characteristics based 

on your research helped them survive? What lessons should community banks and regulators learn from those that failed? Mr. 

Rymer, let us begin with you. 

Mr. RYMER. Yes, sir, thank you. I think that is a great question 

to start with. We did do a study on that particular question a couple of years ago. We looked at banks that did have—I think all 

three of us have noted that concentrations in ADC—acquisition, development, and construction lending in commercial real estate— 

such concentrations, which had been a problem at many of the failures. We identified over 400 banks during the period of 2007 to 

2011 that had concentrations of 300 percent or more of capital in 

ADC loans. 

We looked at a particular group of those banks, 18 banks in that 

group that were high-performing or well-performing banks, either 

CAMELS—rated 1 or 2, and what we found in those banks was 

that the common characteristics were strong and engaged board 

leadership, strong management, a focus on local markets, strong 

core funding or local funding, and a focus on risk management and 

planning. 

So, in net, it is all the things that you would expect a well-run 

bank or a well-run business to do. I think the key is, in those community banks that are actively engaged in ADC lending, to recognize the risks associated with that business line and invest in the 

controls and management to manage that risk. 

Chairman JOHNSON. Mr. Evans. 

Mr. EVANS. So I will speak on net here because our findings were 

quite similar. We found that it was unhealthy concentrations in acquisition, development, and construction loans that were very important. And I think that underlies the core issues, which were 

poor risk management and aggressive growth. So I think, in this 

case—and we saw this across all banks, even the large institutions—we saw poor risk management, aggressive growth strategies, 

and weak credit administration practices. It just materialized a bit 

different for the small banks as opposed to their larger peers, and 

their larger peers were, of course, concentrated in nontraditional 

residential mortgage loans. And, of course, with the community 

banks, it was large and unhealthy concentrations in acquisition, 

development, and construction loans. 

Now, to build on the October 2012 report that the IG referred to, 

we also have some findings that are consistent with those findings. 

We found through our rigorous econometric analysis that CRE concentrations themselves, once you control for capital adequacy and 

asset quality, did not lead to an increased likelihood of failure. Of 

course, these were non-ADC portions of commercial real estate, so 

your strip malls and your gas stations and the like. That abstracts 

9 

again from very large and significant concentrations of, say, 600 

percent, something well beyond the regulatory thresholds that 

would trigger additional scrutiny. 

Chairman JOHNSON. Mr. Brown, have community banks fully recovered from the financial crisis? And how have community banks 

strengthened their balance sheets since the crisis? 

Mr. BROWN. Chairman Johnson, community banks have made 

significant progress in overcoming the challenges they faced in the 

crisis. They still have some way to go. As a group, as we have defined them in our study, they earned a pretax return on assets of 

1.06 percent in 2012. That is an update to our study. That is 3 

times more than their profitability in 2010, so that gives you a 

sense of the progress that they have made. 

But as our study documented, half of the loan portfolios of these 

institutions are real estate secured, and real estate is still in a difficult situation in many parts of the country. Problem loan levels 

remain elevated, and that is one of the reasons that loan growth 

remains slow. 

Now, the community banks were steady providers of credit during the depths of the crisis. I think the noncommunity banks 

showed much larger contractions in the credit that they provided. 

But community bank loans have grown slowly recently, largely because of the loans secured by nonfarm, nonresidential properties, 

in many cases where real estate serves as collateral for what otherwise is a commercial loans. So there are still some challenges that 

they face. 

Chairman JOHNSON. Senator Crapo. 

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

Mr. Evans, in December 2012, the FDIC issued a comprehensive 

report on community banks, and some of the findings of that report 

suggest that bank consolidation has very real consequences for the 

economy because community banks and small banks play such a 

vital role in the local source of credit. Yet some industry observers 

are estimating that nearly 2,000 banks will need to be acquired or 

to sell their assets in the aftermath of the crisis. Others speculate 

that 90 percent or more of small banks with less than $1 billion 

in assets are not likely to survive. 

First of all, did you agree with this assessment that the smaller 

banks still face a very serious potential of not surviving in large 

numbers? And what can the FDIC do given the causes that you 

have just identified and discussed with us of so much of the failure, 

what can the FDIC do to ensure that community banks, especially 

in rural areas, do survive? 

Mr. EVANS. Very important question, especially given the importance of community banks for local communities. 

I would say our work here is fairly limited that would allow me 

to answer this question. But I will note that as of the end of the 

first quarter of 2013, there were 612 banks on the problem bank 

list. So that indicates that there are still issues that need to be 

worked through. 

I think some of the issues with respect to community banks, 

where the examiners can play a more significant role, is determining what it really means when concentration thresholds are exceeded, and they say it requires additional scrutiny or heightened 

10 

scrutiny. What does that mean? Because it is really those significant concentrations that contributed to the problems that we saw 

across the board. 

And, again, just regulators in general, there are a number of 

issues we should be thinking about in terms of regulatory burden 

and right-sizing regulations. 

Senator CRAPO. I know you have studied the regulatory burden 

that our community banks or smaller banks have faced. Could you 

give us any—just comment on what your conclusions are with regard to whether we have too excessive a burden right now or 

whether we need to fine-tune the approach that we have taken? 

Mr. EVANS. Right. So, I mean, and this is an important issue. It 

is important to frame it appropriately, and I think there is a minimization problem that we are trying to solve, so we are trying to 

minimize regulatory burden on institutions, especially when some 

of the regulations were designed to impact the largest, most complex and internationally active institutions. 

So, clearly, there is a minimization problem that needs to be 

solved here, but there is a constraint, and that constraint is safety 

and soundness. So framing the debate in that way suggests that it 

is important for regulators to use their flexibility as granted by 

Dodd-Frank to offer exemptions and tier these regulations appropriately. 

Again, that having been said, safety and soundness is an important concern. Certain regulations are certainly appropriate for 

banks of all sizes. And so starting to have that dialog I think will 

be appropriate in determining where we can tier and right-size 

some of these regulations. 

Senator CRAPO. Thank you. 

Mr. Rymer, in the time I have got left, I would like to talk with 

you about the examination process just briefly. The FDIC has reviewed its examination rulemaking and guidance processes during 

2012, and as a result of that review, the FDIC has implemented 

a number of enhancements to its supervisory and rulemaking processes. 

What feedback, if any, have you received from your revisions 

from the institutions that are being supervised? How is this working? 

Mr. RYMER. Well, very little direct feedback from the industry. 

Those changes to the FDIC’s supervisory processes are very recent, 

but many of those changes I believe were responsive to some of the 

work we did in our 2009 and 2010 reports. 

The FDIC, in general, is focused on community bank examination, and I know this Committee is very interested in that issue. 

I know we received a letter from Chairman Johnson, I believe early 

last year, on that very topic. We have looked at examination frequency and examination consistency. It is my view that the FDIC 

is taking more of a risk-based approach to spending more examination time, frankly, on banks that may deserve it. There is an 

awareness in the agency that banks are in the business of banking, 

not in the business of complying with regulation, although regulation, as it has been noted, is critical to the business. 

Banking is a highly regulated industry. It does receive support 

in the sense of insured deposits from the FDIC, so the FDIC does 

11 

have a duty to protect those deposit insurance funds. But I think 

there is an acknowledgment within the FDIC through the more 

risk-focused examination process and its attention to the community banking industry through some of the work that Rich and his 

staff has done and then Chairman Gruenberg’s recently forming of 

a community bank advisory council. There seems to me to be a 

focus within the institutions, the FDIC, and the industry as a 

whole about the critical importance of the examination process. 

Senator CRAPO. Thank you. 

Chairman JOHNSON. Senator Warren. 

Senator WARREN. Thank you, Mr. Chairman, thank you, Ranking 

Member Crapo, for holding this hearing, and thank you all for 

being here. 

I believe we need banks of all sizes, including community banks. 

Community banks are important because they increase consumer 

choice, they promote competition, they counteract the concentration 

that we have with too-big-to-fail banks. 

But one of the principal benefits that community banks bring us 

is lending to small businesses, and I think the data show that disproportionately it is our community banks that are out there making these loans to small businesses. The smallest banks, those with $250 million or less in assets, account for only 4 percent of the assets in the banking industry. And 

yet they constitute 13.7 percent of all the business loans out there. 

So small businesses really count on these community banks. 

When I was working on the Congressional Oversight Panel during the crisis, we warned about the concentration in the banking 

industry and about the impact it would have on small business 

lending. And here we are 5 years out now, still worrying about concentration in the industry. 

So what I would like to do is just give you a chance here, Mr. 

Evans, if you could talk for just a minute about the GAO’s findings 

in your report about the impact that concentration in banking has 

on small business lending. 

Mr. EVANS. OK. So in this particular report, when we looked at 

concentration what we were trying to get at is whether the bank 

failures created the types of concentration concerns that would trigger potential anticompetitive effects. And so in this particular report, when we looked at it, we saw that the acquiring banks generally stepped in and limited concentration levels from going above 

that point where we would be concerned about anticompetitive effects. 

Senator WARREN. Well, let me push back, though, just a little bit 

on that, Mr. Evans, because part of the concern I have is not simply whether there is physically a bank outlet operated somewhere, 

but that community banks do more small business lending, and 

once they are swallowed up by big banks, whether they are swallowed up because they were failing or whether they were just 

bought up, whether they were gobbled up by the big banks, that 

what we see is that small businesses have much more trouble getting access to capital. 

Mr. EVANS. Right, and that is one of the things we really could 

not get at in the study, but we do point it out. We point out that 

the patterns of lending could change because of some of these acVerDate Nov 24 2008 10:17 Oct 22, 2013 Jkt 048080 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 L:\HEARINGS 2013\06-13 LESSONS LEARNED FROM THE FINANCIAL CRISIS REGARDIN
12 

quisitions. And those institutions and borrowers likely to be most 

hurt would be those that rely on their local community banks for 

small business loans. 

Senator WARREN. Good. Then let me just follow up on a question 

that Senator Crapo had put out on the table about how we maintain a strong environment for our community banks, because they 

are so important to the rest of our economy. 

You know, after the crisis, there was just nearly a panic about 

people who could not get access to credit. One of the responses, of 

course, was Dodd-Frank, but one of the concerns that I have is that 

in Dodd-Frank we now have a regulatory system that, while DoddFrank made some distinctions between large and small banks, 

small banks are still subject to many regulations that were written 

for the larger financial institutions. 

And so what I am concerned about is that we now have a regulatory system for which many parts of it are neutral on its face, 

but the impact on smaller financial institutions that cannot afford 

to hire an army of lawyers to go and interpret these rules turns 

out to be crushing. 

So the question I want to ask, and I hope we have time that I 

can ask it of all of you, is whether or not we are reaching a point 

where we should really think about a two-tiered regulatory system. 

Mr. Rymer, would you like to address that? 

Mr. RYMER. Yes, ma’am, to the extent I can. We have not, again, 

done a lot of work in that area in terms of post- Dodd-Frank. Our 

focus on Dodd-Frank will be—as we have some work planned—related to the effect of Dodd-Frank. We are planning work later this 

fall to look at whether examination efforts are coordinated between 

the CFPB and the primary Federal regulators as it relates to regulatory burden, and there are clear dividing lines between CFPB responsibilities in a bank and the primary Federal regulator. 

But I think the broader question that you are asking is what can 

the regulators do and potentially the Congress do to encourage or 

improve the health and sustainability of the community bank 

model. Frankly, I think whatever we can do to encourage profitability and encourage the types of positive behaviors in a community bank that make it successful. The key to community banking, 

frankly, is profitability. The majority of banks that have evaporated from the community bank landscape have done so through 

merger and acquisition, and that is because the folks that owned 

those banks chose to sell those banks, and perhaps in many cases 

those banks were not as profitable as they could have been. So I 

think enhanced profitability ultimately has got to be the focus. 

Senator WARREN. Although I am not sure we regulate that directly here in Washington. If I can just have a few more seconds, 

if that is all right, Mr. Chairman, I would really like to hear Mr. 

Brown’s comments on this since they are doing this at the FDIC. 

Have we reached a point where it is time to think about a two-tier 

regulatory system for our small banks? 

Mr. BROWN. Well, Senator, the issue that you bring up is a very 

important one, and I think it is addressed in the supervisory process by a risk-focused supervisory system that tries to scale the nature of the supervisory process to the risk and the complexity of institutions. And it is something where it is sort of hard to write 

13 

rules in advance and create thresholds that work for all cases. I 

think supervisors at the FDIC try very hard to make sure that the 

process is scaled to the risk and complexity of those institutions. 

I would just add that in the precrisis years there definitely was 

a performance gap between the larger noncommunity banks and 

community banks. The noncommunity banks grew much faster. 

They earned much more money. And, of course, they did so 

through—— 

Senator WARREN. I am sorry. Can we also add to that the noncommunity banks were the ones that took on all the risk and 

crashed the economy? 

Mr. BROWN. Yes, I was headed in that direction. 

Senator WARREN. Which sort of suggests that maybe they did not 

have proper oversight. 

Mr. BROWN. And I think the reforms in Title I and Title II of 

Dodd-Frank, ending too big to fail, is a very important element to 

leveling the playing field and making sure that the community 

banking sector stays vibrant in the years ahead. 

Senator WARREN. Thank you very much. 

Thank you for your indulgence, Mr. Chairman. 

Chairman JOHNSON. Senator Moran. 

Senator MORAN. Chairman, thank you. I appreciate the opportunity to visit with individuals from the FDIC. 

Most of my time in the Senate, which is short, certainly in the 

Banking Committee we have raised the topic of regulations of community banks, and I have raised that not just with the FDIC but 

other regulators. There is a pretty standard response to those questions about how we understand the value of community banks. We 

treat them differently. We have an advisory committee that we get 

input from. And yet the statistics and trends continue with additional consolidation. I see it in the numbers in Kansas. The number 

of banks is less than it was a year ago. And I heard it anecdotally, 

the continual conversation, and it makes sense to me that the increasing cost of regulation means that a bank has to be larger in 

order to cover the costs of those regulations. Fixed costs matter. 

I remember a banker telling me that an examiner was in the 

bank and suggested that they hire two more people in the bank to 

comply with rules and regulations. The bank employs eight people. 

Two people is a significant increase in the number of people working there. Increasing employment would be a good thing, but not 

if you cannot afford to do that. 

And so our bankers’ options, particularly as the economy becomes 

more difficult, their options generally are find some other bank interested in buying them. And I think there is a significant consequence to rural America in the absence of community financial 

institutions, the ability to—the relationship banking remains important to my farmers, ranchers, small business men and women. 

And my concern or complaint is that—I do not want to be pejorative and say we continue to provide lip service to this issue, but 

I cannot ever find any evidence that we are really doing anything 

differently in regard to the regulatory environment that community 

financial institutions face. 

Maybe you could satisfy me with the suggestion that we have a 

different examining standard, we have different criteria when our 

14 

examiners are in the bank, we have a different set—we have eliminated—give me an example of regulations that we have eliminated 

or modified because of the size and scope of the bank. And, again, 

I would portray this, at least in my view, that all of this is in the 

context of financial institutions that are not too big to fail and that 

have little consequence—significant consequence in a community or 

to shareholders, but little consequence systemically to the economy. 

Can you assure me that the conversations that I have had with 

individuals who regulate banks and are responsible for those regulations over the last 21⁄2 years have done more than tell me they 

understand my problem and have done something about it? 

Mr. BROWN. Senator, your question on consolidation is a very 

good one, and I do want to put it in perspective, that after—— 

Senator MORAN. My other questions are not? 

[Laughter.] 

Mr. BROWN. They are all very useful. 

After two-and-a-half decades of consolidation that we followed in 

our study, 95 percent of banking organizations in 2011 were community banks, and we saw the biggest decline among very small 

community banks. The number under $25 million actually declined 

by 96 percent, much less consolidation at slightly larger size 

groups. 

In fact, the number of charters with assets between $100 million 

and $1 billion increased by 19 percent over the study period, and 

that is where 65 percent of community banks currently operate. 

We did studies of economies of scale. How much do average costs 

fall as asset size increases? For some lines of business, like commercial real estate lending, there were some economies of scale, but 

most of them are realized at an asset size of $100 to $300 million. 

So, you know, the idea that you have to be a $2 or $3 billion bank 

to do business, I am not sure that the numbers square up with 

that. 

That said, we also understand that the overhead expenses of 

community banks are very sensitive to regulatory costs and staffing 

for regulatory purposes. The FDIC has undertaken a number of 

steps—you described them—to try to mitigate those costs, provide 

services that are valuable to the banks in terms of meeting those 

regulatory requirements. 

Senator MORAN. That answer is different than the other answers 

I have received over the last 21⁄2 years. What are the specific examples of modifications that the FDIC has made to accommodate— 

and I guess let me further indicate to you that I understand—if 

this was a matter of bank consolidation because of normal free 

market economic principles about size of scale economies, that to 

me is a different issue for us than one that is driven by the regulatory environment and the fixed costs or the costs associated with 

meeting those requirements. 

I do not know whether your study demonstrates what—is there 

an explanation for why those costs increase and the economies of 

scale—I guess to further indicate that a $25 million bank is important to me and to a community in Kansas, and when you assure 

me that things get better at $100 million and above, I mean, I am 

pleased to know that, but there are a lot of banks in Kansas that 

fall between that $25 million and that $100 million that are very 

15 

important certainly to the people who work there, who own that 

bank, but more importantly, to the community that they serve. 

Mr. BROWN. Well, understood, and I think those economies of 

scale that I referred to, the decline in average cost includes both 

regulatory and nonregulatory costs. The fact is we do not have the 

data to break down overhead expenses between those two categories, so we can only look at overall overhead costs. But for the 

community banking sector the last 3 years, those overhead costs as 

a percent of assets have been stable at 2.9 percent of average assets. And so we are not seeing large increases in overall overhead 

expenses. 

We do understand, though, the need on the part of the FDIC to 

provide technical assistance. We have created a Web-based preexam tool to make sure that information requests are synchronized 

and very clear with the bank being examined. We have created a 

regulatory calendar that reminds institutions of when the comment 

periods and what the compliance periods are. And we have created 

a series of videos on our Directors Resource Center that provide 

very detailed technical information about how to comply with the 

various standards coming down the pike so consultants are not 

needed to explain that. So we think those can be helpful in terms 

of helping to navigate. 

Senator MORAN. Thank you very much. My time has expired. I 

would only point out that what the FDIC does is critical in this 

arena. You are at least one of the few, if not the one regulator that 

the bank cannot escape. As we have seen in our State and elsewhere in the country, as banks have rechartered to become State 

institutions to alter this regulatory environment, they are never 

going to get away from you. And what you do matters to the success not just of my banks, but the communities that they serve. 

Thank you. 

Chairman JOHNSON. Senator Heitkamp. 

Senator HEITKAMP. You are going to hear a recurring theme 

here. Thank you, Mr. Chairman, and thank you for this hearing. 

You are going to hear a recurring theme in all of this. We are deeply concerned in a very nonpartisan way with the viability and the 

continuing operation of small community banks. And our overall 

concern is that we are now in an era where we create an atmosphere too big to fail and what the net result is too small to succeed. 

And I would suggest, Mr. Evans—and without having any dialog 

behind this—that, in fact, when you say you look at overall overhead costs and they have not increased, I would suggest to you that 

is because banks are doing things that—are not doing things that 

they have done in the past because they do not want to get in trouble. And one of those issues that is very critical in North Dakota 

is housing. Our small community banks have always been a huge 

part of financing residential development, and we are seeing a 

huge retraction from that responsibility to the community, not as 

a matter of choice but as a matter of—we do not know that we can 

comply. We do not know that we have the capacity to comply with 

what is coming at us. 

And so where I listened to the discussion that you had today 

about, you know, we are listening, we are moving, I had a conversation with the Chairman and suggested that he needs to listen 

16 

directly to the small community banks. And I am grateful to report 

that he, in fact, will be coming out to North Dakota to do 

roundtables with our small community banks in North Dakota to 

address these issues. 

But I want to take this in a little different direction. You know, 

there is postcrisis research regarding community banks showing 

that public benefits provided in the crisis and in the recovery 

stages after the crisis actually minimized the direct effect. Having 

a good relationship with your bank gave you the ability to continue 

to get the capital that you needed, the operating loans that you 

needed. 

You know, their central role—and, you know, I know you guys 

deal with numbers, but a lot of this in little towns in North Dakota, in Hankinson, North Dakota, it is about relationships. They 

have a generation-generation-generation relationship with their depositors. They have done operating loans for years, and now they 

are terrified to do them. And, you know, that may be drive, in fact, 

by reality or it may be driven by just the fear of what is coming 

down. 

And so I cannot impress upon this panel enough that we are 

deeply concerned about consolidation. We think it is being driven 

by regulation—I do think it is being driven by regulation. And we 

want to know whether this will reach the top runs in terms of evaluating what we can do to stop consolidation on the lower level and 

continue the viability of small community banks. I will start with 

you, Mr. Evans. 

Mr. EVANS. So the re-occurring theme here I think is important 

because it speaks to the need to minimize, where appropriate, burdens on community banks. And so I would take this time to plug 

some of the work we have done on Dodd-Frank where we have 

made recommendations to the regulators to strengthen their prospective analysis before they write these rules, as well as the retrospective analysis, because we have heard from community bankers 

that it is the cumulative burden of these regulations—‘‘death by a 

thousand cuts,’’ as it is often referred to—that raises the most significant concern. And so retrospective analysis there would be extremely important because this will allow us to really assess the 

impact of various regulations. 

And we have also asked the regulators to start to plan and think 

about the data they need to collect in order to do this assessment, 

because we do need to understand the impact of regulations and 

exemptions on stability, efficiency, and competitiveness. 

Mr. BROWN. I think one thing to keep in mind is that the forces 

of consolidation include, potentially, regulation going forward, but 

in the past they also have included bank failures. We had more 

than 2,500 bank failures during the study period that led to consolidation. And I think that the safety and soundness of the industry is one of the important factors, obviously, in determining the 

future pace of consolidation. 

I think one of the other things that we have observed is that the 

banks that came through the crisis in pretty good shape are generally pretty conservatively run. They generally have high supervisory ratings. They have the types of governance qualities that 

17 

Mr. Rymer described in his statement and generally comply with 

the regulatory requirements as they are. 

And so I know that the cost of the change in regulation is disconcerting for many. We are trying to help them work through 

that. We think that communication is absolutely critical to making 

sure there are no surprises and making sure that there is an agreement between supervisors and banks as to how the regulations are 

going to work going forward. 

Senator HEITKAMP. Mr. Chairman, if I could just take—just 

make one more point, which is enforcement versus regulation. 

There is not a kid that you grew up with who does not like being 

lumped in when their older siblings do something wrong and they 

all get punished, right? And so, you know, we are in an atmosphere—in North Dakota, no bank failures, but yet my banks are 

suffering the consequences of what happened. And I would suggest 

to you that the lack of enforcement of existing regulations before 

Dodd-Frank is a critical component to bank failures, and the reaction has been to regulate, and some would argue excessively, in response to that, which is one-size-fits-all, we are going to punish you 

all equally regardless of your appropriate conservative management of your financial institution. 

And so be very careful, because I am going to judge things very 

carefully on regulatory versus enforcement, and what I would suggest to you may have failed is enforcement, but what we got was 

regulation. 

Chairman JOHNSON. Senator Crapo will make a statement. 

Senator CRAPO. Thank you, Mr. Chairman. Before we wrap up, 

I just wanted to make a very brief summary statement, and to the 

panel, again, thank you for coming and for the work you are doing 

on this critical issue. I think every Senator who has been at the 

hearing here today has raised the same issue set with you. We are 

concerned about whether we have it right in law and in regulation 

and implementation in terms of the regulatory system that we are 

applying to our smaller and community banks, whether it is a 

question of whether we need to move to a two-tier system or 

whether we need to do other reforms at the congressional level, at 

the policy level, or whether we need to be more aggressive at making the appropriate distinctions in the regulatory, implementation, 

and the examination process, or what have you. 

I would just encourage you to help us answer this question correctly, to do the kind of analysis and studies that gets to the answers to some of the questions that we do not have answers to yet, 

and to work with us to help identify the proper structure and system that we need to have in place to create the best safety and 

soundness and the best profitability for our strong community bank 

system. 

Thank you. 

Chairman JOHNSON. I want to thank our witnesses for their testimony today as well as their continued focus on efforts to strengthen the community bank system. 

This hearing is adjourned. 

[Whereupon, at 11:24 a.m., the hearing was adjourned.] 

[Prepared statements and responses to written questions supplied for the record follow:] 

18 

1FDIC Community Banking Study, December 2012, http://www.fdic.gov/regulations/resources/cbi/study.html. 

PREPARED STATEMENT OF RICHARD A. BROWN 

CHIEF ECONOMIST, FEDERAL DEPOSIT INSURANCE CORPORATION

JUNE 13, 2013 

Chairman Johnson, Ranking Member Crapo, and Members of the Committee, we 

appreciate the opportunity to testify on behalf of the Federal Deposit Insurance Corporation (FDIC) regarding the state of community banking and to describe the findings of the FDIC Community Banking Study (the Study), a comprehensive review 

based on 27 years of data on community banks. 1

As the Committee is well aware, the recent financial crisis has proved challenging 

for all financial institutions. The FDIC’s problem bank list peaked at 888 institutions in 2011. Since January 2008, 481 insured depository institutions have failed, 

with banks under $1 billion making up 419 of those failures. Fortunately, the pace 

of failures has declined significantly since 2010, a trend we expect to continue. 

Given the challenges that community banks, in particular, have faced in recent 

years, the FDIC launched a ‘‘Community Banking Initiative’’ (Initiative) last year 

to refocus our efforts to communicate with community banks and to better understand their concerns. The knowledge gathered through this Initiative will help to 

ensure that our supervisory actions are grounded in the recognition of the important 

role that community banks play in our economy. A key product of the Initiative was 

our FDIC Community Banking Study, published last December, which is discussed 

in more detail below. 

In my testimony, I describe some key lessons from the failures of certain community banks during the recent crisis identified by the FDIC Community Banking 

Study. Consistent with the studies performed under P.L. 112-88 by the FDIC Office 

of Inspector General (OIG) and Government Accountability Office (GAO), the Study 

found three primary factors that contributed to bank failures in the recent crisis, 

namely: (1) rapid growth; (2) excessive concentrations in commercial real estate 

lending (especially acquisition and development lending); and (3) funding through 

highly volatile deposits. By contrast, community banks that followed a traditional, 

conservative business plan of prudent growth, careful underwriting, and stable deposit funding overwhelmingly were able to survive the recent crisis. 

FDIC Community Banking Study 

In December 2012, the FDIC released the FDIC Community Banking Study, a 

comprehensive review of the U.S. community banking sector covering 27 years of 

data. The Study set out to explore some of the important trends that have shaped 

the operating environment for community banks over this period, including: longterm industry consolidation; the geographic footprint of community banks; their 

comparative financial performance overall and by lending specialty group; efficiency 

and economies of scale; and access to capital. This research was based on a new definition of community bank that goes beyond the asset size of institutions to also account for the types of lending and deposit gathering activities and the limited geographic scope that are characteristic of community banks. 

Specifically, where most previous studies have defined community banks strictly 

in terms of asset size (typically including banks with assets less than $1 billion), 

our study introduced a definition that takes into account a focus on lending, reliance 

on core deposit funding, and a limited geographic scope of operations. Applying 

these criteria for the baseline year of 2010 had the effect of excluding 92 banking 

organizations with assets less than $1 billion while including 330 banking organizations with assets greater than $1 billion. Importantly, the 330 community banks 

over $1 billion in size held $623 billion in total assets—approximately one-third of 

the community bank total. While these institutions would have been excluded under 

many size-based definitions, we found that they operated in a similar fashion to 

smaller community banks. It is important to note that the purpose of this definition 

is research and analysis; it is not intended to substitute for size-based thresholds 

that are currently embedded in statute, regulation, and supervisory practice. 

Our research confirms the crucial role that community banks play in the American financial system. As defined by the Study, community banks represented 95 

percent of all U.S. banking organizations in 2011. These institutions accounted for 

just 14 percent of the U.S. banking assets in our Nation, but held 46 percent of all 

the small loans to businesses and farms made by FDIC-insured institutions. While 

their share of total deposits has declined over time, community banks still hold the 

19 

2The 3,238 U.S. counties in 2010 included 694 micropolitan counties centered on an urban 

core with population between 10,000 and 50,000 people, and 1,376 rural counties with populations less than 10,000 people. 

majority of bank deposits in rural and micropolitan counties. 2 The Study showed 

that in 629 U.S. counties (or almost one-fifth of all U.S. counties), the only banking 

offices operated by FDIC-insured institutions at year-end 2011 were those operated 

by community banks. Without community banks, many rural areas, small towns 

and urban neighborhoods would have little or no physical access to mainstream 

banking services. 

Our Study took an in-depth look at the long-term trend of banking industry consolidation that has reduced the number of federally insured banks and thrifts from 

17,901 in 1984 to 7,357 in 2011. All of this net consolidation can be accounted for 

by an even larger decline in the number of institutions with assets less than $100 

million. But a closer look casts significant doubt on the notion that future consolidation will continue at this same pace, or that the community banking model is in 

any way obsolete. 

More than 2,500 institutions have failed since 1984, with the vast majority failing 

in the crisis periods of the 1980s, early 1990s, and the period since 2007. To the 

extent that future crises can be avoided or mitigated, bank failures should contribute much less to future consolidation. In addition, about one third of the consolidation that has taken place since 1984 is the result of charter consolidation within 

bank holding companies, while just under half is the result of voluntary mergers. 

But both of these trends were greatly facilitated by the gradual relaxation of restrictions on intrastate branching at the State level in the 1980s and early 1990s, as 

well as the rising trend of interstate branching that followed enactment of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. The pace of voluntary consolidation has indeed slowed over the past 15 years as the effects of these 

one-time changes were realized. Finally, the Study questions whether the rapid 

precrisis growth of some of the Nation’s largest banks, which occurred largely as a 

result of mergers and acquisitions and growth in retail lending, can continue at the 

same pace going forward. Some of the precrisis cost savings realized by large banks 

have proven to be unsustainable in the postcrisis period, and a return to precrisis 

rates of growth in consumer and mortgage lending appears, for now anyway, to be 

a questionable assumption. 

The Study finds that community banks that grew prudently and that maintained 

diversified portfolios or otherwise stuck to their core lending competencies during 

the Study period exhibited relatively strong and stable performance over time. The 

strongest performing lending groups across the entire Study period were community 

banks specializing in agricultural lending, diversified banks with no single specialty, 

and consumer lending specialists, although the latter group had shrunk to fewer 

than one percent of community banks by 2011. Agricultural specialists and diversified nonspecialists also failed at rates well below other community banks during the 

Study period. Other types of institutions that pursued higher-growth strategies— 

frequently through commercial real estate or construction and development lending—encountered severe problems during real estate downturns and generally 

underperformed over the long run. 

Moreover, the Study finds that economies of scale play a limited role in the viability of community banks. While average costs are found to be higher for very small 

community banks, most economies of scale are largely realized by the time an institution reaches $100 million to $300 million in size, depending on the lending specialty. These results comport well with the experience of banking industry consolidation during our Study period (1984–2011), in which the number of bank and thrift 

charters with assets less than $25 million declined by 96 percent, while the number 

of charters with assets between $100 million and $1 billion grew by 19 percent. 

With regard to measuring the costs associated with regulatory compliance, the 

Study noted that the financial data collected by regulators does not identify regulatory costs as a distinct category of expenses. In light of the limitations of the data 

and the importance of this topic in our discussions with community bankers, as part 

of our Study the FDIC conducted interviews with a group of community banks to 

try to learn more about regulatory costs. As described in Appendix B of the Study, 

most interview participants stated that no single regulation or practice had a significant effect on their institution. Instead, most stated that the strain on their organization came from the cumulative effects of all the regulatory requirements that 

have built up over time. Many of the interview participants indicated that they have 

increased staff over the past 10 years to support the enhanced responsibility associated with regulatory compliance. Still, none of the interview participants indicated 

that they actively track the various costs associated with regulatory compliance, beVerDate Nov 24 2008 10:17 Oct 22, 2013 Jkt 048080 PO 00000 Frm 00023 Fmt 6621 Sfmt 6621 L:\HEARINGS 2013\06-13 LESSONS LEARNED FROM THE FINANCIAL CRISIS REGARDIN
20 

cause it is too time-consuming, too costly, and so interwoven into their operations 

that it would be difficult to break out these specific costs. These responses point to 

the challenges of achieving a greater degree of quantification in studying this important topic. 

In summary, the Study finds that, despite the challenges of the current operating 

environment, the community banking sector remains a viable and vital component 

of the overall U.S. financial system. It identifies a number of issues for future research, including the role of commercial real estate lending at community banks, 

their use of new technologies, and how additional information might be obtained on 

regulatory compliance costs. 

Examination and Rulemaking Review 

In addition to the comprehensive study on community banks, the FDIC also reviewed its examination, rulemaking, and guidance processes during 2012 with a 

goal of identifying ways to make the supervisory process more efficient, consistent, 

and transparent, while maintaining safe and sound banking practices. This review 

was informed by a February 2012 FDIC conference on the challenges and opportunities facing community banks, a series of six roundtable discussions with community 

bankers around the Nation, and by ongoing discussions with the FDIC’s Advisory 

Committee on Community Banking. 

Based on concerns raised in these discussions, the FDIC has implemented a number of enhancements to our supervisory and rulemaking processes. First, the FDIC 

has restructured the pre-exam process to better scope examinations, define expectations, and improve efficiency. Second, the FDIC is taking steps to improve communication with banks under our supervision. Using Web-based tools, the FDIC created a regulatory calendar that alerts stakeholders to critical information as well 

as comment and compliance deadlines relating to new or amended Federal banking 

laws, regulations, and supervisory guidance. The calendar includes notices of proposed, interim, and final rulemakings, and provides information about banker teleconferences and other important events related to changes in laws, regulations, and 

supervisory guidance. The FDIC also is actively taking steps to provide bankers 

with additional insights on proposed or changing rules, regulations, and guidance 

through regional meetings and outreach. Further, we clarify and communicate 

whether specific rules, regulations, and guidance apply to the operations of community banks through the use of statements of applicability in our Financial Institution Letters. 

Finally, the FDIC has instituted a number of outreach and technical assistance 

efforts, including increased direct communication between examinations, increased 

opportunities to attend training workshops and symposiums, and conference calls 

and training videos on complex topics of interest to community bankers. In April, 

the FDIC issued six videos designed to provide new bank directors with information 

to prepare them for their fiduciary role in overseeing the bank. A second installment, to be released very soon, is a virtual version of the FDIC’s Directors’ College 

Program that regional offices deliver throughout the year. A third installment, expected to be released by year-end will provide more in-depth coverage of important 

supervisory topics and focus on management’s responsibilities. The FDIC plans to 

continue its review of examination and rulemaking processes, and continues to explore new initiatives to provide technical assistance to community banks. 

Conclusion 

The recent financial crisis has proved challenging for financial institutions in general and for community banks in particular. Analyses of bank failures during the 

crisis by the FDIC, the FDIC OIG, and the GAO point to some common risk factors 

for institutions that failed during the recent crisis, including rapid growth, concentrations in high-risk loans, and funding through volatile deposits. In contrast, 

community banks that followed traditional, conservative business models overwhelmingly survived the recent crisis. The FDIC’s extensive study of community 

banking over a 27-year period shows that while these institutions face a number of 

challenges, they will remain a viable and vital component of the overall U.S. financial system in the years ahead. 

21 

PREPARED STATEMENT OF JON T. RYMER 

INSPECTOR GENERAL, FEDERAL DEPOSIT INSURANCE CORPORATION

JUNE 13, 2013 

Chairman Johnson, Ranking Member Crapo, and Members of the Committee: 

Thank you for the opportunity to testify in today’s hearing on the lessons learned 

from the financial crisis related to community banks. As you requested, I will focus 

on the broad and comprehensive study, required by Public Law 112-88, that the 

Federal Deposit Insurance Corporation (FDIC) Office of Inspector General (OIG) 

conducted on the impact of the failure of insured depository institutions during the 

recent financial crisis. Specifically, I will summarize the study’s general observations, findings, conclusions, and recommendations contained in the report, Comprehensive Study on the Impact of the Failure of Insured Depository Institutions (Report No. EVAL-13-002, dated January 3, 2013). In addition, I will highlight some 

of the work my office has completed over the last 5 years that could contribute to 

the Committee’s ‘‘lessons learned’’ discussion. 

The OIG is an independent office within the FDIC, established to conduct audits, 

investigations, and other reviews to prevent and detect waste, fraud, and abuse relating to the programs and operations of the FDIC, and to improve the efficiency 

and effectiveness of those programs and operations. I was appointed as the Inspector General of the FDIC by President Bush, and confirmed by the Senate in June 

2006. 

Through its audits, evaluations, and other reviews, my office provides oversight 

of FDIC programs and operations. Our work is either required by law or self-initiated based on our assessment of various risks confronting the FDIC. Our audits, 

evaluations, and other reviews assess such areas as program effectiveness, adequacy 

of internal controls, and compliance with statutory requirements and corporate policies and procedures. We perform our work using internally available resources, supplemented by contracts with independent public accounting firms when expertise in 

a particular area is needed or when internal resources are not available. Our work, 

as well as that of our contractors, is performed in accordance with standards applicable to Federal audit, evaluation, and investigative entities. 

Before I discuss the study’s high-level observations and resulting recommendations, and to provide helpful context, I will briefly describe the regulatory framework and the individual regulator responsibilities for overseeing insured depository 

institutions and resolving those institutions when they fail. 

Regulatory Framework and Regulator Responsibilities 

In the wake of the savings and loan and banking crisis of the 1980s, the Congress 

passed two laws that drove the closure and resolution decisions we witnessed in this 

most recent crisis. These laws were the Financial Institutions Reform, Recovery, 

and Enforcement Act of 1989 and the FDIC Improvement Act of 1991. Taken together, these laws amended the Federal Deposit Insurance (FDI) Act to require, 

among other things, that (1) institutions maintain minimum capital levels and the 

chartering regulator promptly close critically undercapitalized institutions through 

prompt corrective action provisions, (2) the FDIC resolve banks in the least costly 

manner, and (3) the FDIC maximize recoveries from failed institutions. The FDI Act 

also placed requirements on how the regulators examine institutions, including establishing minimum examination frequency requirements, requiring the agencies to 

establish standards for safety and soundness, and requiring the agencies to establish appraisal standards. In response, the FDIC and the other regulators issued implementing regulations and policy statements pertaining to many of the topics discussed in our report. 

The Office of the Comptroller of the Currency (OCC), the Board of Governors of 

the Federal Reserve System (FRB), and the FDIC oversee the Nation’s insured depository institutions to ensure they operate in a safe and sound manner. The OCC 

supervises national banks, the FRB supervises State-chartered banks that are members of the Federal Reserve System and bank holding companies, and the FDIC supervises State-chartered banks that are not members of the Federal Reserve System 

(State nonmember banks). The FDIC has additional responsibilities for insuring deposits, effectively resolving failed institutions, and maximizing the recovery of receivership assets. 

In examining insured depository institutions, the regulators assess the condition 

of institutions through off-site monitoring and on-site examinations, and have longstanding policies for reviewing an institution’s lending and loan review functions, 

assessing capital adequacy, and recommending improvements, if needed. When regulators determine that an institution’s condition is less than satisfactory, they may 

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tions, to address identified deficiencies. Each regulator has somewhat different approaches to enforcement actions. 

Should an institution’s condition decline to a point that it becomes Critically 

Undercapitalized, the chartering regulator (a State banking authority or the OCC) 

is generally required by law to promptly close institutions that cannot be recapitalized. The FDIC is required by law to resolve failing institutions in the least costly 

manner. 

Study Results—Observations, Findings, and Conclusions 

The financial crisis had devastating impacts on the banking industry, businesses, 

communities, and consumers. At the time of our review, over 400 institutions had 

failed and some of the country’s largest institutions had required Government intervention to remain solvent. Commercial real estate (CRE) collateral values had fallen 

by more than 42 percent. Construction starts remained partially complete and continued to detract from the quality of neighborhoods and home values. Trillions of 

dollars of household wealth had vanished, and almost 18 million loans had faced 

foreclosure since 2007. Unemployment peaked at 10 percent in October 2009 and 

remained stubbornly high at the time of our study. 

Events leading to the financial crisis and subsequent efforts to resolve it involved 

the dynamic interrelationship of laws passed by the Congress, regulatory rules, and 

agency-specific policies and practices with the real estate and financial markets in 

ways that are continuing to play out. In that regard, our study indicated the following: 

• The markets drove behaviors that were not always prudent. Banks expanded 

lending to keep pace with rapid growth in construction and real estate development, rising mortgage demands, and increased competition. Many of the banks 

that failed did so because management relaxed underwriting standards and did 

not implement adequate oversight and controls. For their part, many borrowers 

who engaged in commercial or residential lending arrangements did not always 

have the capacity to repay loans and pursued many construction projects without properly considering the risks involved. Ultimately, these loans created significant losses for the institutions involved and often left the FDIC with the 

challenge of managing and disposing of troubled assets. 

• In response to unprecedented circumstances, the regulators generally fulfilled 

their supervisory and resolution responsibilities as defined by statutes, regulations, accounting standards, and interagency guidance in place at the time. In 

addition, the regulators reacted to a rapidly changing economic and financial 

landscape by establishing and revising supervisory policies and procedures to 

address key risks facing the industry. While not a focus of this study, our report 

does acknowledge, however, material loss review findings that showed the FRB, 

OCC, and FDIC could have provided earlier and greater supervisory attention 

to troubled institutions that ultimately failed. For its part, among other initiatives associated with resolutions, the FDIC reinstituted the use of shared loss 

agreements (SLA) with acquiring institutions and took steps to promote private 

capital investments in failing institutions. 

In our report, we provided a detailed presentation of our findings and conclusions 

for each of the topics under the law’s eight matters. These matters include (1) SLAs, 

(2) significance of losses at institutions that failed, (3) examiner implementation of 

appraisal guidelines, (4) examiner assessment of capital adequacy and private capital investment in failing institutions, (5) examiner implementation of loan workout 

guidance, (6) application and impact of formal enforcement orders, (7) impact of 

FDIC policies on investments in institutions, and (8) the FDIC’s handling of private 

equity company investments in institutions. In addressing these matters, we also 

made the following observations: 

• The FDIC’s resolution methods—including the SLAs that we studied—were 

market driven. Often, failing banks with little or no franchise value and poor 

asset quality did not attract sufficient interest from viable bidders to enable the 

FDIC to sell the banks without a loss-share guarantee. The FDIC used SLAs 

to keep failed bank assets in the banking sector, support failed bank asset values, and preserve the solvency of the Deposit Insurance Fund (DIF). The FDIC 

has established controls over its SLA monitoring program, which help protect 

the FDIC’s interests, promote loan modifications, and require equal treatment 

of SLA and legacy loans. We did find, however, that the FDIC should place additional emphasis on monitoring commercial loan extension decisions to ensure 

that acquiring institutions do not inappropriately reject loan modification requests as SLAs approach termination. In addition, we concluded that the FDIC 

23 

needed to formulate a better strategy for mitigating the impact of impending 

portfolio sales and SLA terminations on the DIF so that the FDIC will be prepared to address the potentially significant volume of asset sale requests. 

• The majority of community banks failed as a result of aggressive growth, asset 

concentrations, poor underwriting, and deficient credit administration coupled 

with declining real estate values. These factors led to write-downs and chargeoffs on delinquent and nonperforming real estate loans as opposed to examinerrequired write-downs or fair value accounting losses. 

• The regulators have longstanding policies for classifying problem assets, monitoring appraisal programs, assessing capital adequacy, evaluating CRE loan 

workouts, and administering enforcement actions, when warranted. The regulators also have processes and controls, training programs, and job aids to help 

ensure examiner compliance and consistency. We found that examiners generally followed relevant policies and implemented them appropriately. For example, examiners usually did not classify as loss loans that the institution 

claimed were paying as agreed without justification, nor did they question or 

reduce the appraised values of assets securing such loans. However, examiners 

did not always document the procedures and steps that they performed to assess institutions’ appraisal and workout programs. We also noted that the regulators had different approaches to enforcement actions, particularly related to 

nonproblem banks. 

• The FDIC has investment-related policies in place to protect the DIF and to ensure the character and fitness of potential investors. These policies are largely 

based in statute. By their nature, such policies are going to have an impact on 

investments in institutions. The FDIC approved most change-in-control and 

merger applications, although approval rates were lower for States such as California, Florida, and Nevada that were heavily impacted by the financial crisis. 

The FDIC has policies and procedures for certain aspects of the review of private capital investors, and the FDIC generally followed those policies. Purchases of failed institutions by private capital investors accounted for 10 percent 

of total failed bank assets acquired. Finally, we identified instances where the 

FDIC did not accept proposed open bank investments and instead closed an institution. However, in each case, we found that the FDIC identified concerns 

with the proposed investment related to safety and soundness issues, proposed 

management, or proposed business plans, or determined that the proposed 

transaction would not present the least loss option to the DIF. 

Recommendations 

While the regulators generally implemented their policies appropriately, our study 

identified certain areas for improvement and issues warranting management attention. In the interest of strengthening the effectiveness of certain supervisory activities and helping ensure the success of the FDIC’s ongoing resolution efforts, we 

made seven recommendations. Five were addressed specifically to the FDIC and two 

were directed to the three regulators. These recommendations, which the regulators 

concurred with and proposed actions that adequately addressed the recommendations’ intent, involved the following areas: 

• SLA Program. We made recommendations related to developing additional controls for monitoring acquiring institutions’ commercial loan modification efforts 

and developing a more formal strategy for mitigating the impact of impending 

portfolio sales and SLA terminations on the DIF. 

• Appraisals and Workouts. We made several recommendations related to clarifying how examiners should review institutions’ appraisal programs and 

strengthening examiner documentation requirements to more clearly define examination methodologies and procedures performed to assess institutions’ appraisal and workout programs. These recommendations should help to assure 

agency management that examiners are consistently applying relevant guidance. 

• Enforcement Orders. We recommended that the regulators study differences between the types of enforcement actions that are used by the regulators and the 

timing of such actions to determine whether there are certain approaches that 

have proven to be more effective in mitigating risk and correcting deficiencies 

that should be implemented by all three regulators. 

Study Approach 

Signed into law on January 3, 2012, Public Law 112-88 required my office to conduct this study and submit a report to the Congress not later than 1 year after the 

date of enactment. The legislation required my office to conduct work at the FDIC, 

24 

OCC, and FRB, and as required, our scope included open and failed State member, 

State nonmember, and national banks. Our scope did not include institutions formerly regulated by the Office of Thrift Supervision. Our review time frames generally covered a 4-year period (i.e., 2008 through 2011). 

My office performed work at three FDIC regions, three OCC regions, eight reserve 

bank districts, and selected State banking agencies. In conducting our work, we 

• Interviewed agency officials and bank examiners, representatives at open 

banks, investment bankers, and compliance contractors; 

• Reviewed relevant policies and guidance; 

• Reviewed examination reports, working papers, material loss review reports, 

and documentation supporting loan workouts and enforcements orders; 

• Analyzed institution financial data and agency enforcement action statistics; 

and 

• Surveyed borrowers of failed institutions. 

We conducted our work from January 2012 through October 2012, in accordance 

with the Council of the Inspectors General on Integrity and Efficiency’s Quality 

Standards for Inspection and Evaluation. KPMG LLP assisted us with several areas 

of review. We also coordinated with the U.S. Government Accountability Office as 

that office conducted its work pursuant to Public Law 112-88. 

Other OIG Work 

As the Committee continues the discussion of the financial crisis and possible ‘‘lessons learned,’’ I wanted to highlight some of the other work my office has completed. 

Over the last 5 years, my office was heavily involved in the efforts to explain what 

happened during the financial crisis. The following is a brief snapshot of this work. 

During the financial crisis, my audit and evaluation staff was dedicated to conducting reviews of the FDIC-supervised banks that failed, and providing feedback 

to the FDIC to assist the Corporation in improving its bank supervision program. 

As required by section 38(k) of the FDI Act, and amended by the Dodd-Frank Wall 

Street Reform and Consumer Protection Act (Dodd-Frank Act), my office, along with 

our fellow financial regulatory OIGs, was required, at some level, to review the 484 

institutions that failed during the crisis. To date, we have issued 107 reports that 

take a comprehensive look at why the failed bank caused a material loss to the DIF 

and provide an assessment of the FDIC’s supervision of that bank. Since the DoddFrank Act amended the FDI Act, my office has also performed 166 failed bank reviews, where the failure was below a certain loss threshold and no unusual circumstances existed to warrant a more in-depth review of the loss. 

In a separate report, Follow-Up Audit of FDIC Supervision Program Enhancements (Report No. MLR-11-010), issued in December 2010, we examined the supervisory actions the FDIC had taken in response to an internal memorandum we 

issued in May 2009, which outlined major causes, trends, and common characteristics of the eight bank failures we had reviewed to date, and identified new trends 

and issues that emerged from our reviews of subsequent failures. Our January 2013 

study further supported the existence of these trends and issues, which included 

concentrated assets in the CRE and acquisition, development, and construction 

(ADC) loan portfolios, inadequate risk management practices for loan underwriting 

and credit administration, and reliance on volatile funding sources to support 

growth. 

In October 2012, my office issued a report, Acquisition, Development, and Construction Loan Concentration Study (Report No. EVAL-13-001), detailing our evaluation of FDIC-supervised institutions with significant ADC loan concentrations that 

did not fail during the economic downturn. We studied the characteristics and supervisory approaches for these institutions and identified the factors that helped 

them mitigate the risks associated with ADC concentrations during periods of economic stress. Our findings were not surprising, in that they confirmed what regulators have been saying are the ingredients for a strong bank—a well-informed 

Board, strong management, controlled growth, sound credit administration and underwriting, and adequate capital. We also observed that surviving banks were responsive to supervisory actions and guidance and maintained or secured capital 

needed to absorb losses in response to regulatory demands. 

My office also teamed up with the other bank regulatory OIGs and evaluated 

prompt regulatory action, as described in sections 38 and 39 of the FDI Act. The 

OIGs from the FDIC, FRB, and Department of the Treasury issued a comprehensive 

joint report in September 2011, Evaluation of Prompt Regulatory Action Implementation (Report No. EVAL-11-006), which discussed the use and impact of prompt corrective action (PCA) and the safety and soundness standards during the crisis. We 

25 

found that PCA occurred too late to rehabilitate most troubled institutions and 

while critically undercapitalize institutions were closed promptly, failure losses were 

still significant. We recommended the regulators consider several options for 

strengthening the prompt regulatory action provisions. 

The reports noted above are available on our Web site, www.fdicig.gov. 

This concludes my prepared statement. Thank you for the opportunity to discuss 

the work of the FDIC OIG. I will be pleased to answer any questions that you may 

have. 

26 

PREPARED STATEMENT OF LAWRANCE L. EVANS, JR. 

DIRECTOR, FINANCIAL MARKETS AND COMMUNITY INVESTMENT, GOVERNMENT

ACCOUNTABILITY OFFICE

JUNE 13, 2013 

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RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO 

FROM RICHARD A. BROWN 

Q.1. Academic researchers estimate that when Dodd-Frank is fully 

implemented, there will be more than 13,000 new regulatory restrictions in the Code of Federal Regulations. Over 10,000 pages of 

regulations have already been proposed, requiring more than 24 

million compliance hours each year. As FDIC’s Chief Economist, 

how are you trying to track the total compliance costs for community banks? Please share specific details. 

A.1. Quantifying Costs—The costs of regulatory compliance and 

their effect on profitability and competitiveness are frequent topics 

of discussion among community bankers. While our ability to quantify the costs of regulatory compliance is somewhat limited, the 

FDIC has undertaken a number of initiatives designed to make 

those costs as small as possible. 

This topic was repeatedly addressed in the six Roundtable discussions hosted by the FDIC in 2012 as part of the Community 

Banking Initiative, and also has been a frequent topic of discussion 

in meetings of the FDIC’s Community Bank Advisory Committee. 

Notwithstanding the high degree in interest in this topic by all 

concerned parties, regulatory data reported through the quarterly 

Call Reports provide only a limited picture of bank overhead expenses. While all FDIC-insured institutions report total noninterest 

expenses each quarter, these expenses are not broken down into 

regulatory and nonregulatory components. Expressed as a percent 

of total assets, noninterest expenses for community banks have 

been flat for three consecutive years (2010–12) at 3.0 percent. 

In view of the data limitations, FDIC researchers conducted 

interviews with nine community bankers as part of our 2012 Community Banking Study to try to better understand what drives the 

cost of regulatory compliance and, where possible, obtain actual financial data to better understand how regulation and supervision 

affects bank performance. 

Most participants stated that no single regulation or practice had 

a significant effect on their institution. Instead, most cited the cumulative strain imposed by a number of regulatory requirements 

over time. Several indicated that they have increased staff over the 

past 10 years to support regulatory compliance. Yet none indicated 

that they actively track compliance costs, citing the difficulties of 

breaking out these costs separately. 

These responses from community bankers speak to the careful 

balance regulators must achieve when trying to measure regulatory 

costs. While community bankers themselves are certainly in the 

best position to understand their cost structure, requiring that they 

report more detailed data about the nature of those costs would 

itself impose a new regulatory burden. 

Supervisory Approach—As the primary Federal regulator for the 

majority of smaller, community institutions (those with less than 

$1 billion in total assets), the FDIC is keenly aware of the challenges facing community banks and we already tailor our supervisory approach to consider the size, complexity, and risk profile of 

the institutions we oversee. 

In addition, the FDIC has implemented a number of initiatives 

to mitigate the compliance costs associated with new regulations, 

47 

based on feedback we received from community banks during our 

Examination and Rulemaking Review undertaken in 2012. This effort was informed by a national conference to examine the unique 

role of community banks in our Nation’s economy and the challenges and opportunities they face and a series of roundtable discussions conducted in each of the FDIC’s six supervisory regions 

that focused on the financial and operational challenges and opportunities facing community banks, and the regulatory interaction 

process. 

First, as a result of comments we received, we developed a Webbased tool (e-Prep) that generates a preexamination document and 

information request list tailored to a specific institution’s operations and business lines. 

Second, we instituted a new Regulatory Calendar that alerts 

stakeholders to critical information as well as comment and compliance deadlines relating to changes in Federal banking laws and 

regulations. 

Third, to enhance the ability of community banks to comply with 

regulatory requirements without the need for outside consultants, 

the FDIC recently made available new online resources. A new Director’s Resource Center provides links to more than a dozen new 

instructional videos, including a new Virtual Director’s College, designed to provide valuable information and advice to bank managers and directors. (In an effort to help reduce banks’ compliance 

training costs, we have been conducting director and banker colleges in each region for some time now.) In addition to these efforts, the FDIC includes in all Financial Institution Letters a 

Statement of Applicability that clarifies whether the specific rules, 

regulations, and guidance will apply to community banks. 

The FDIC continues to conduct outreach sessions, training workshops, and symposia to provide technical training and opportunities 

for discussion on subjects of interest to community bankers. 

Q.2. Do you agree with Federal Reserve Chairman Bernanke’s 

statement at a recent hearing that the burden of Dodd-Frank regulations falls disproportionately on small and community banks? If 

so, what can be done to reduce that burden? 

A.2. As demonstrated in the crisis of 2008, the economic costs of 

financial instability are enormous. Prudential regulation and supervision of depository institutions have been instituted under the 

Federal Deposit Insurance Act and other statutory mandates to 

promote financial stability and to reduce the frequency and severity of such crises. 

The costs of complying with these regulatory requirements on the 

part of FDIC-insured institutions are not insignificant. Moreover, 

these costs include some that vary a great deal with the size and 

complexity of the institution, and some that are relatively fixed. 

With regard to the latter category of fixed regulatory costs, it is 

true to say that they fall disproportionately on smaller institutions, 

which employ fewer people and have fewer financial resources that 

can be devoted to complying with regulatory requirements. 

At the same time, there are many examples of regulatory costs 

and requirements that have been designed to vary with the size 

and complexity of the institution, and therefore, do not necessarily 

48 

impose a higher cost on smaller institutions. Among these are the 

premiums charged by the FDIC for deposit insurance, which are 

based on both the size and the risk of each institution. It is worth 

noting that an important requirement of the Dodd-Frank Act was 

to broaden the assessment base for deposit insurance premiums 

from domestic deposits to total liabilities minus net worth. This 

shift, implemented by the FDIC in 2010, served to reduce the annual premiums paid by small banks (with assets under $1 billion) 

by about 30 percent. In addition, accommodations were made for 

smaller institutions when the Dodd-Frank mortgage rules were implemented. Special exemptions reduced the regulatory requirements and lowered compliance costs for smaller institutions. These 

exemptions were included in several key regulations, including 

those related to servicing, the ability-to-repay, and qualified mortgage regulations. 

Nonetheless, the FDIC continues to pursue initiatives that will 

help to further reduce the costs of regulatory compliance on community banks, as described in the response to Question 1. These 

efforts recognize the potential for regulatory compliance costs to 

fall disproportionately on smaller institutions and include specific 

steps designed to help smaller institutions to minimizethose costs. 

Q.3. In light of FDIC’s thorough report on community banks and 

their failures, is there a single element that we should monitor in 

the event of future crises? 

A.3. The FDIC Community Banking Study and the Material Loss 

Reviews conducted by the FDIC Office of Inspector General (OIG) 

both identified a collection of business strategies that proved to be 

especially problematic in the recent crisis and are now subject to 

close supervisory attention by the FDIC. 

The Community Banking Study showed that institutions pursuing high-growth strategies—frequently through commercial real 

estate or construction and development lending—encountered severe problems during real estate downturns and generally underperformed over the long run. In contrast, community banks that 

grew prudently and that maintained diversified portfolios or otherwise stuck to their core lending competencies during the study period exhibited relatively strong and stable performance over time. 

According to Material Loss Reviews conducted by the OIG in the 

aftermath of bank failures, losses at community banks during the 

crisis were most often caused by management strategies of aggressive growth and concentrations in commercial real estate loans, including notably, concentrations in acquisition, development and 

construction loans, coupled with inadequate risk management practices in an environment of falling real estate values that led to impairment losses on delinquent and nonperforming loans. Another 

common characteristic of failed banks was reliance on volatile brokered deposits as a funding source. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO 

FROM JON T. RYMER 

Q.1. Public Law 112-88 requires that the FDIC OIG conduct a 

study on the impact of the failure of insured depository institutions 

during the recent financial crisis. One of the findings in your study 

49 

is that the FRB, OCC, and FDIC could have provided earlier and 

greater supervisory attention to troubled institutions that ultimately failed. In your view, what have the regulators done to address such deficiencies? What else should they do? 

A.1. While not a focus of the review called for in Public Law 112- 

88, we noted in our report that material loss reviews (MLR) performed by our office and the Inspectors General (IG) of the Board 

of Governors of the Federal Reserve System (FRB) and Department 

of the Treasury showed that the FRB, Office of the Comptroller of 

the Currency (OCC), and Federal Deposit Insurance Corporation 

(FDIC) could have provided earlier and greater supervisory attention to troubled institutions that failed. As noted in our report, the 

regulators generally fulfilled their supervisory responsibilities as 

defined by statutes, regulations, accounting standards, and interagency guidance in place at the time. Our report also pointed out 

that the regulators reacted to a rapidly changing economic and financial landscape by establishing and revising supervisory policies 

and procedures to address key risks facing the industry. 

The three reports summarized below describe the efforts the 

FDIC has made to strengthen its supervision program in light of 

the issues we identified in the nearly 100 MLR reports our office 

issued and other related work our office performed since the crisis 

began in 2008. Although one of the reports also comments on the 

efforts the FRB and OCC have made to strengthen their supervision programs, we are not the IG for the OCC or FRB and, accordingly, have not assessed the efforts or progress they may have 

made to strengthen their respective supervision programs. 

Follow-up Audit of FDIC Supervision Program Enhancements 

(Report Number MLR-11-010, December 2010). In this audit, we 

discussed the efforts that the FDIC had taken to strengthen its supervision program in response to the financial crisis. We noted that 

the FDIC had implemented a comprehensive review and analysis 

of its approach to supervision and had implemented or planned actions that substantially addressed our reported MLR trends and 

issues. In particular, we reported that the FDIC had: 

• emphasized a forward-looking supervisory approach, consisting 

of a comprehensive training program and various financial institution and examiner guidance, including guidance related to 

de novo banks; 

• implemented other cross-cutting initiatives, such as establishing relevant Corporate Performance Goals in 2009 and 

2010 related to some MLR issues; 

• implemented a post-MLR assessment process to identify lessons learned from the bank failures and conclusions included 

in our MLR final reports and solicited input from its examination staff regarding suggested changes to policies and procedures. This process also resulted in the identification of potential best practices related to the FDIC’s examinations; 

• enhanced offsite monitoring activities; 

• enhanced coordination between its risk management and compliance examination functions; 

• improved interagency coordination for charter conversions; and 

50 

• worked with the other Federal regulatory agencies to implement a new agreement associated with the FDIC’s backup examination authority. 

Evaluation of Prompt Regulatory Action Implementation (Report 

Number EVAL-11-006, September 2011). In this evaluation, conducted jointly with the FRB and Department of the Treasury Offices of Inspector General (OIG), we reported that the regulators 

had begun to incorporate a number of lessons learned from the financial crisis into their regulatory processes, including those resulting from their respective IGs’ MLR reports. We reported that 

the regulators had recognized the need to re-emphasize a supervisory approach that encompassed consideration of an institution’s 

risk profile in all facets of the examination process. As it relates 

to the FDIC, we noted that the purpose of its supervisory enhancement initiative was to build upon the strengths of the supervision 

program, emphasize balanced and timely response to weak management practices and identified risks, and emphasize a more 

proactive approach to examination analysis and ratings based upon 

the lessons learned from recent failures. Importantly, we reported 

that although the new emphasis was a step in the right direction, 

sustaining long-term improvement depended on not forgetting the 

lessons learned once the economy and banking industry improve. 

Acquisition, Development, and Construction Loan Concentration 

Study (Report Number EVAL-13-001, October 2012). In this evaluation, we looked more specifically at a particular area of concern 

contributing to the crisis—the excessive concentration of acquisition, development, and construction lending on the balance sheets 

of many financial institutions. In our report, we noted that the 

FDIC, in response to MLR findings and other issues, had issued 

specific examiner and financial institution guidance and taken actions, including: 

• Recognizing factors that are indicative of elevated risk associated with management, which included high-risk appetite and 

degree of responsiveness to examiner recommendations; 

• Issuing additional guidance regarding the inappropriate use of 

interest reserves; 

• Emphasizing to examiners the risks that the use of noncore 

funding can present to a financial institution; 

• Issuing guidance regarding consideration of brokered deposits 

in the deposit insurance risk assessment process, use of such 

funding sources for institutions that are in a weakened condition, processing requests for brokered deposit waivers, and interest rate restrictions for banks that are less than Well Capitalized; and 

• Issuing guidance to emphasize the importance of monitoring 

institutions subject to enforcement actions, including the need 

to clarify expectations for quarterly progress reports, meet with 

an institution’s Board at the beginning of a corrective program, 

and conduct on-site supervisory activities between examinations. 

With regard to the question as to what else can be done, we believe, as we note in each of the reports described above, that susVerDate Nov 24 2008 10:17 Oct 22, 2013 Jkt 048080 PO 00000 Frm 00054 Fmt 6602 Sfmt 6602 L:\HEARINGS 2013\06-13 LESSONS LEARNED FROM THE FINANCIAL CRISIS REGARDIN
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taining long-term improvement will depend on the regulators remaining vigilant in their supervisory activities and not forgetting 

the lessons learned once the economy and banking industry begin 

to improve. In particular, early regulatory intervention (i.e., before 

an institution experiences financial and capital decline) is key to 

maintaining healthy banks. When examiners identify practices, 

conditions, or violations of law that could result in losses to a financial institution, they must aggressively address them and ensure that management takes prompt and effective corrective action. 

We acknowledge that these lessons may become more difficult to 

apply, or sustain, as the banks return to profitability. We also believe that the regulators should pursue interagency efforts to jointly address some of the more systemic MLR trends, such as capital 

definitions, capital levels, and liquidity. 

Q.2. Your study also found that examiners did not always document the procedures and steps that they performed to assess institutions’ appraisal and workout programs, and that the regulators 

had different approaches to enforcement actions, particularly related to nonproblem banks. How much progress have the regulators 

made to address such deficiencies? What else should the regulators 

do? 

A.2. Provided below is how each of the three agencies responded 

to the findings detailed in our study related to documentation concerns. 

• The OCC responded that while the agency believed its supervisory examination strategy and core assessment processes satisfied this recommendation, the OCC had plans to improve its 

guidance by including a section specific to appraisals in the 

commercial real estate and mortgage handbooks that are currently being revised. 

• The FRB responded that it is continually looking for ways to 

improve its examination processes, including ways to improve 

documentation procedures. 

• The FDIC agreed to coordinate with the FRB and OCC to review the interagency Appraisal and Evaluation Guidelines and 

determine the most appropriate way to strengthen examination documentation requirements. 

As we do not oversee the OCC or FRB, we have not made an assessment of the internal progress that these regulators may have 

made to respond to our recommendations. As for the FDIC, we 

have been provided information through our audit follow-up process regarding the Corporation’s efforts. Specifically, FDIC officials 

indicated that the FDIC, OCC, and FRB staff consulted in January 

and February 2013, and these officials continue to discuss with the 

OCC and FRB whether documentation requirements need to be 

strengthened going forward. At a February 2013 Federal Financial 

Institutions Examination Council (FFIEC) Task Force on Supervision meeting, the FDIC also discussed its plans to strengthen 

documentation, which include reiterating the FDIC’s existing working paper documentation guidance to examiners and monitoring examiner compliance as part of the FDIC’s internal control function. 

Finally, in February 2013, the FDIC clarified how examiners 

52 

1 Ninety-two percent (172) of the banks that failed in 1987 had assets under $100 million. 

At that time, banks were considered community banks if they had assets under $250 million. 

should approach and document their review of appraisal and workout programs during a policy conference call with regional FDIC 

representatives. The FDIC OIG will continue to monitor progress 

of these efforts until such time the FDIC takes sufficient action to 

close the recommendation. 

Regarding the question as to what else regulators should do, our 

office believes that the FDIC should continue to identify efficient 

ways to document procedures that were performed during an examination. 

The second part of the question related to the different approaches that regulators employ regarding enforcement actions and 

the progress that has been made to address such deficiencies. We 

do not view the regulators having different approaches to enforcement actions to be a deficiency on any regulator’s part. In our report, we pointed out the differences and recommended that the regulators study them to determine whether there are common approaches that should be implemented by all three agencies. All 

three regulators concurred on this recommendation. At the 

abovementioned February 19, 2013, FFIEC meeting, representatives of the FDIC, FRB, and OCC agreed to research this recommendation as part of a joint Task Force on Supervision project. 

As previously noted, as we do not oversee the OCC or FRB, we 

have not made an assessment of any internal initiatives these regulators may be pursuing. As noted in the comments on our study’s 

report, the FDIC agreed to conduct an internal study in 2013 on 

its approach for using informal and formal enforcement actions to 

determine whether an alternative approach to mitigate risk and 

correct deficiencies may be more effective. We understand that the 

FDIC has begun an internal review of the scope and effectiveness 

of enforcement actions and will complete the study in 2013. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO 

FROM LAWRENCE L. EVANS, JR. 

Q.1. As Director for Financial Markets at the GAO, you have to 

analyze historical data. How does the most recent financial crisis 

compare to past crises with regard to community banks? 

A.1. While we did not review the failure of community banks in 

past crises as part of our recent bank failures study, prior GAO 

work has addressed failures that occurred during the banking crisis of the 1980s and early 1990s. Between 1990 and 1994, more 

than 1,600 banks insured by FDIC were closed or received FDIC 

financial assistance. In our May 1989 report, ‘‘Bank Failures: Independent Audits Needed To Strengthen Internal Control and Bank 

Management’’ (GAO/AFMD-89-25), we reviewed the 184 bank failures that occurred during 1987. The vast majority of these failed 

banks were small institutions. 1 Common to the failures we studied 

in both crises were internal weaknesses in bank management and 

board oversight that led to weak underwriting, aggressive growth 

strategies fueled by riskier funding sources, and high loan concentrations. 

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Q.2. Did you recognize any of the underlying causes of past crises 

in this crisis that caused community banks to fail? If so, please describe such shared causes. 

A.2. As indicated above, we found several similarities in the underlying causes of the bank failures we studied in the banking crisis 

of the 1980s and early 1990s and the most recent crisis, in particular internal weaknesses in bank management and board oversight that led to weak underwriting, aggressive growth strategies 

fueled by riskier funding sources, and high loan concentrations. 

The objectives of the 1989 review were in part to summarize data 

on internal weaknesses that Federal banking examiners cited in 

examinations of these banks prior to their failure. Of the internal 

control weaknesses Federal banking regulators identified, those 

that contributed most significantly to the 184 bank failures were 

lack of general lending policies (79 percent), inadequate supervision 

by the bank’s board of directors (49 percent), weak loan administration (42 percent), and poor loan documentation and inadequate 

credit analysis (41 percent). Other internal weaknesses regulators 

cited related to an overreliance on volatile funding sources such as 

brokered deposits (32 percent), unwarranted loan concentrations 

(24 percent), excessive out-of-area lending (16 percent), excessively 

growth-oriented policies (26 percent), and a failure to establish adequate loan loss allowances (29 percent). We found that Federal regulators cited neither a single weakness nor a specific combination 

of weaknesses as the sole contributing factor to a bank’s failure. 

Rather, each bank demonstrated a unique combination of weaknesses. 

As we noted in our recent report, inadequate management of 

risks associated with high concentrations of CRE loans, and in particular, ADC loans were a primary cause of failure in small banks. 

Other internal control weaknesses we reported included weak underwriting and credit administration practices. In addition, these 

failed banks had often pursued aggressive growth strategies using 

nontraditional, riskier funding sources—particularly brokered deposits. Similar to the past crisis, failed banks often did not maintain an adequate loan loss allowance and some had engaged in outof-territory lending through loan participations. 

Q.3. If you had to single out one dominant cause for banks’ failure 

in this past crisis, what would that be? 

A.3. As our econometric analysis showed, banks with high concentrations of ADC loans and a greater use of brokered deposits 

were more likely to fail between 2008 and 2011. However, the 

build-up of such high concentrations of risky loans via a reliance 

on nontraditional funding sources is ultimately a reflection of aggressive growth strategies and poor risk management at these 

banks.