Vol. 8 No. 2 - Article I - Published: June 1995 - Full Article 

A Two-Window System for Banking Reform 

by Frederick S. Carns 

Bank specialness has eroded . . . If you went down the bank-asset balance sheet today, you would 

probably say that . . . only about $1.5 -- $2 trillion is special anymore (in the sense that deposit insurance 

protection is justified for the underlying activities). Why is the safety net still so big (protecting nearly $5 

trillion of assets in insured depositories), and shouldn't we think about shrinking it? Robert E. Litan 1 

Despite strong earnings, improving asset quality, healthy growth and low failure rates in the banking 

industry of late, banking reform remains a popular topic among lawmakers, bankers, scholars and 

industry observers. This seems appropriate, given the record number of depository institution failures 

during the 1980s, record losses for the deposit insurance funds and the changing nature of banking due 

to innovation and increased competition. Traditional bank intermediation, the distinguishing feature of 

which is the conversion of liquid deposits into illiquid loans, or 'liquidity transformation,' is shrinking as a 

share of total economic activity (Figure 1 illustrates two components of this shrinkage). As banks seek 

new ways to remain profitable without repeating the results of the 1980s, it is useful to consider whether 

the structural design of the banking industry and the accompanying safety net are appropriate for the new 

environment. Such considerations underlie the continuing interest in banking reform, and this interest has 

generated a variety of reform proposals. 

The common goals driving most reform proposals are to remove unnecessary restrictions on banking 

organizations that restrain competition for financial services and to eliminate undue risk to the deposit 

insurance funds (the Bank Insurance Fund (BIF), and the Savings Association Insurance Fund (SAIF)). 

The proposed reforms vary considerably, due in part to different diagnoses of the structural problems in 

the industry, different conceptions of banking's role in the economy, and different priorities regarding the 

policy objectives of federal deposit insurance. 

This article discusses one version of a 'two-window' approach to banking reform. 2 The general approach 

is based upon principles set forth in the FDIC's 1987 study of reform issues, Mandate for Change, and it 

proceeds from the premise that the industry faces potential long-run problems due to restrictions on the 

product lines and ownership of banking organizations. 3 The proposed solution is 'two-window' banking, 

whereby customers could choose between a window offering insured deposits and a window offering 

various uninsured investments issued by nonbank affiliates. This approach is intended to allow banking 

organizations to engage in a wide array of 'nonbank' activities without benefit of insured-deposit funding, 

while strictly circumscribing the deposit insurance safety net to cover only traditional banking activities. 
 

 

 

 

Structural Framework 

Basic Elements 

There are three primary features of the specific two-window structure discussed in this article: (1) Bank 

risk-taking is confined to traditional intermediation by restricting the activities that may be funded with 

insured deposits: illiquid loans and high-quality securities held for liquidity purposes are to be the primary 

assets of insured entities; (2) activities that are prohibited for insured banks are permitted for uninsured 

affiliates (perhaps subsidiaries) within the same banking organization, but the insured bank is insulated 

from nonbank risks through separate capitalization and a set of reinforcing 'firewalls' to maintain legal and 

financial separation; and (3) all ownership and product-line restrictions now applied to banking 

organizations are lifted so that new capital can be attracted from other industries and banking 

organizations can compete more directly with nonbank and foreign firms. 

The 'two-window' approach occupies a unique middle ground between the major types of banking-reform 

proposals. So-called 'narrow-bank' proposals, which are discussed below, typically require that banks 

invest insured deposits entirely in liquid financial assets so that risk to the deposit insurance funds is 

minimal. This reflects a presumption that traditional bank lending can occur safely and sufficiently outside 

of the financial safety net. 4 The two-window proposal does not share this presumption. But unlike the 

group of modest reform proposals at the other end of the spectrum, there is a presumption underlying the 

two-window approach that banking reform must proceed beyond a mere 'turning of the dials' on existing 

policy instruments; for example, adjusting capital standards, accounting standards, or levels of depositor 

protection. In response to the shrinking role of traditional bank intermediation in today's economy, the 

two-window proposal offers a redesigned safety net that will shrink in a corresponding fashion. 

Stated otherwise, the size and shape of the safety net would be adjusted as necessary under the twowindow system to ensure that deposit insurance protects only the 'traditional' type of bank intermediation. 

5 Perhaps more important than reducing risk for the deposit insurance funds, this measure is intended to 

rationalize the scope of safety-net coverage so that any risk exposure of the deposit insurance funds 

serves a legitimate economic purpose. 
 

 

 

 

 

 

 

 

 

 

In response to the shrinkage of traditional intermediation, the two-window proposal also permits banking 

organizations to conduct nonbank activities of their choice within a structure that is designed to insulate 

insured institutions from nonbank risks. This provision likewise occupies a middle ground, between the 

status quo that features 'consolidated supervision' of the bank holding company and limited entry by 

holding-company affiliates into nonbank financial activities, and a system of 'universal banking' in which a 

wide variety of nonbank activities might be conducted within the legal banking entity itself, funded with 

insured deposits. 6 

The two-window proposal confronts policymakers with some fundamental issues that often are neglected 

in discussions of banking reform. The remainder of this article examines one version of a two-window 

system and discusses the fundamental issues that arise in connection with these features. 7 

Comparisons With the 

'Narrow' Bank 

The concept of two windows derives from the same philosophy that underlies the so-called 'core-bank' or 

'narrow-bank' proposals for banking reform (these will hereafter be referred to as 'narrow-bank' 

proposals). 8 A common purpose is to reduce the risk exposure of the deposit insurance funds (hence, 

the taxpayer) to the minimum level that is consistent with adequate safety-net protection for deposits. The 

common approach is to restrict the permissible uses of insured deposits and to remove what are argued 

to be unnecessary restrictions on the activities of banking organizations. The major differences between 

the two-window system and various versions of the narrow-bank proposal relate to the proper means of 

achieving a largely common set of goals. The two-window approach departs from most narrow-bank 

proposals in the criteria used for determining acceptable uses of insured deposits, the restrictions 

imposed on nonbank-affiliate activities, and the structural design of the banking organization as a whole. 

These three major differences will be considered briefly in turn. 

Activities Funded With Insured Deposits. Narrow-bank proposals tend to use risk measures alone for 

determining what are acceptable uses of insured funds 9. Only the safest activities are permitted in the 

insured entity, and thus the proposed 'bank' typically resembles a money-market mutual fund: its deposits 

are transactions accounts that are serviced through investments in Treasury securies and high-grade 

commercial paper. In the two-window approach, the decision whether an activity should be funded with 

insured deposits involves more than risk measurement. Also important is whether there exists a legitimate 

economic rationale for extending the safety net to the activity in question. 

For example, the traditional banking business of liquidity transformation arguably fulfills a unique and 

important economic purpose (the arguments are considered under Risk to the Deposit Insurance Funds, 

below). Accepting this premise for the moment, and recognizing that such intermediation is intrinsically 

susceptible to destabilizing bank runs that may impose significant social costs, there is a legitimate 

economic rationale for extending deposit insurance to this function. 10 It is much more difficult to provide 

a defensible rationale for extending the safety net to products or services that are traded in established 

markets with no inherent susceptibility to costly market failures (for example, foreign-exchange or 

government securities markets). 11 

According to this logic, insured banks should be limited to activities that are consistent with the traditional 

business of banking: issuing deposits and other relatively liquid claims, clearing payments, and investing 

in short- and intermediate-term illiquid loans such as commercial loans and, perhaps, some consumer 

loans, as well as some high-quality investments for liquidity. 12 In the two-window system, all other 

activities would be conducted in separately capitalized subsidiaries or affiliates that are not funded with 

insured deposits. If there are important synergies between traditional banking functions and certain 

nontraditional activities, exceptions would be permitted. 

Of course, there would be no avoiding some arbitrary judgments and operational difficulties in 

implementing this type of two-window system. How illiquid must a loan be to qualify for funding with 
 

 

 

 

 

 

 

 

 

insured deposits, and how should this be measured? Precisely how much investment for liquidity 

purposes should be permitted? There are no easy answers to these and a host of similarly practical 

questions. 13 In recognizing that the two-window system would inject some additional arbitrariness and 

complexity into banking regulation, however, it should be recognized that some would be removed as 

well. For example, there would be no artificial percentage limits on holding-company investments, and 

such investments would not be restricted to those activities 'closely related to banking.' Other examples 

will be discussed in what follows but, in the final analysis, the two-window alternative poses a trade-off of 

the existing set of arbitrary decisions for a different set. >BR> 

Moreover, there are alternative versions of the two-window system that would pose fewer practical 

difficulties. There is nothing inherent in the basic concept of 'two windows' that requires a strict adherence 

to a liquidity-transformation test for determining insurable activities; thus, at least three different 'twowindow' approaches to reform can be identified: 

•	 Passive Approach or Status Quo. It might be determined to continue to permit all activities that 

currently are conducted by insured banks. New activities could be placed outside the insured 

bank and funded through an uninsured window if they are not closely related to the creditgranting process. The safety net still would shrink if traditional intermediation continues to shrink, 

and it could not grow arbitrarily. 

•	 Intermediate Approach. Deposit-taking, lending and the holding of some marketable securities 

would be permitted for the insured bank, without making judgments about the degree of liquidity 

transformation that is accomplished. All other activities would be conducted in separately 

capitalized affiliates and funded through an uninsured window. 

•	 Activist Approach Based Upon Liquidity Transformation. This option, emphasized throughout 

this article, requires a willingness to make judgments about the proper types of loans and 

deposits for insured banks, i.e., about the degree of liquidity transformation that would justify 

deposit insurance protection, and a willingness to relocate current activities as needed to 

uninsured affiliates. Clearly, it poses more practical problems than the other options. 

The third option is the primary focus of this paper because, in the author's judgment, it reflects the 

strongest economic rationale for safety-net protection of bank activities. However, operational and other 

factors also are important and, as will become evident, many advantages of the basic two-window 

structure are equally obtainable under the other two options. 

Restrictions on Nonbank-Affiliate Activities. In most narrow-bank proposals, affiliates of the bank are 

restricted in their lines of business to some set of financial activities. 14 The operating principle embodied 

in the two-window approach is that insured banks should be free to affiliate with both financial and 

nonfinancial enterprises provided that: The bank is well-capitalized upon completion of any affiliation 

transaction; nonbank affiliates are separately capitalized; and supervisors are satisfied that the resulting 

entity will not operate in a manner that is abusive to the bank. Supervisors should have authority to 

preclude affiliation if there are concerns about the quality or character of management in either the bank 

or the prospective affiliate. Moreover, after an affiliation occurs, there should exist clear supervisory 

authority to audit both sides of any transaction between the bank and its affiliate and to require reporting 

as necessary from both parties to the transaction. 15 

The general rule for bank supervision in a two-window system is that all advances of bank funds should 

be governed by an 'arm's-length' requirement. The two-window framework includes firewalls and 

regulatory safeguards to ensure legal and financial separation. 16. For the two-window structure to 

function safely and properly, financial flows from the bank to its affiliates must be strictly limited. 

The Structure of the Banking Organization. So long as firewalls exist, capital flows are properly 

restricted, and proper supervisory measures are taken to ensure arm's-length dealings among insured 

banks and their nonbank affiliates, any corporate structure is permissible under two-window banking. 

Narrow-bank proposals typically impose a specific structure (usually resembling a holding company) 
 

 

 

 

 

 

 

 

 

 

 

 

along with a set of regulations and supervisory measures that apply to the banking organization as a 

whole. 17 The two-window structure is designed specifically to avoid this type of oversight and control: 

Consolidated supervision has the potential to impede cost efficiency and artificially reduce the value of 

the banking franchise, thus inhibiting the industry's ability to attract new capital. In order to enter banking 

under current law, nonbank firms typically must subject their entire organizations to federal supervision. 

As noted, the two-window system would remove this deterrent, replacing it with functional supervision of 

separate corporate units and a system of firewalls (discussed under Supervisory Issues, below). 

Risk to the Deposit Insurance Funds Under 'Two Windows' 

Again, the two-window system envisioned in this article would restrict the banking entity to traditional 

activities, except where important synergies with nontraditional activities have been demonstrated. The 

major risks posed to the deposit insurance funds thus would be the traditional types of banking risks, 

primarily related to credit quality, as well as the possibility that problems at the nonbank affiliates may 

adversely affect the insured entity. The effectiveness of firewalls will be discussed in a later section. At 

this point it is sufficient to note that the risk-reducing effects of a two-window approach are unclear. 

However, risk reduction is not the sole aim of the two-window approach. Narrow-bank structures would 

achieve greater risk reduction for the insurance funds than would the two-window structure. The logic 

underlying the two-window approach suggests that this extra risk exposure is worthwhile because, as 

mentioned earlier, the traditional intermediation function of banks is considered to be essential for efficient 

credit allocation in the economy. More specifically, evidence suggests that an important component of the 

economy's production depends primarily upon banks for financing. 18 Such production is undertaken by 

firms that, for various reasons, tend to incur prohibitively high costs in attempting to convey information 

about their investment projects to potential investors. These firms are likely to find that they cannot 

successfully borrow by issuing their own securities, even when the projects to be financed are viable and 

productive. 

Similarly, not all such firms with viable projects may be able to borrow from finance companies or other 

substitute lenders. While these lenders offer commercial loans just as banks do, they do not offer liquid 

claims to investors. This may limit their fundraising ability, so that it is unclear whether nonbank lenders 

could finance all of the viable projects that depend upon such lending in our economy. 

At first glance, this last point appears counterintuitive. Why could not nonbank lenders attract sufficient 

funds from savers simply by offering higher rates of return on their claims? Perhaps they could, but there 

may be limits to the willingness of savers to sacrifice liquidity for return. Benston and Kaufman (1988) cite 

evidence from the money-market mutual fund experience indicating that those funds originally 

guaranteeing a return, instead of a share's nominal value, eventually were forced via competition to 

switch to nominal-value guarantees. The conclusion, as described by Phillips (1994), is that the 'public 

wishes to have a guaranteed nominal value, even at the expense of return.' If so, it is equally plausible 

that, at some point, individuals will opt for liquidity, even at the expense of return. Intermediation thus may 

be reduced if lenders are unable to issue liquid claims. 19 

More fundamentally, there are no significant historical examples of strong economies in which illiquid 

lending has been financed primarily by private institutions issuing illiquid debt. Because such institutions 

have the distinct advantage over banks of reduced susceptibility to runs, it seems reasonable to believe 

that fundraising limits may explain their relative obscurity across time and across different economies. 

While today's information revolution undoubtedly has expanded the fundraising possibilities for such 

institutions, the foregoing discussion suggests that it is unclear whether they alone could finance all of an 

economy's viable projects requiring illiquid loans; 20 some liquidity transformation by banks may be 

necessary. As a result, the threat of bank runs may impose large social costs because it impairs this 

special banking function and precludes the funding of potentially productive projects. 
 

 

 

 

 

 

 

 

Under this view of credit markets, there is a presumptive market failure to allocate credit appropriately in 

the absence of deposit insurance -- or some equivalent protection -- for traditional bank intermediation. 21 

To remove safety-net protections from the traditional banking function could easily create more social 

costs than benefits if this view is correct. 

Such a view is controversial, and a thorough treatment is beyond the scope of this article. 22 Most 

narrow-bank proponents do not share the presumption that the market failure cited above is sufficiently 

important to justify deposit insurance protection for traditional banking functions. Absent this presumption, 

it is highly unlikely that the two-window structure could be viewed as optimal, since narrow banks would 

expose the taxpayer to far less risk. 

Regardless of which view is correct, this two-window approach serves as a reminder that there is likely to 

be no 'free lunch' with deposit insurance reform. Too often when changes in deposit insurance coverage 

are proposed, there appears to be an implicit assumption that the risk exposure of the insurance funds 

can be reduced costlessly. The two-window proposal reminds policymakers that real economic costs are 

likely to be associated with reforms that reduce the potential for bank intermediation. The relevant issue, 

of course, is whether these costs are likely to be smaller or larger than the benefits of the proposed 

reforms. Given the difficulty of estimating the benefit/cost ratio with any accuracy, opinions on this issue 

reflect a high degree of subjective judgment. 

Profitability and Diversification of Risks 

Expanded powers per se may change the risk exposure of the deposit insurance funds: They will create 

the opportunity for greater profits as well as greater losses within banking organizations. Expanded 

powers could reduce risks for banking organizations if appropriate diversification rules are followed, but 

no reliable prediction is possible for the banking industry as a whole. New investment opportunities will 

not be exploited identically at different institutions and similar investment choices may influence risk and 

return differently at different institutions, depending upon the characteristics of existing portfolios, the size 

of new investments relative to the existing portfolios, and managerial efficiency in capturing any 

economies of scope offered by new powers. 23 

Although the net effect of new powers via two-window banking is impossible to predict with any precision, 

it also may be largely irrelevant. The more relevant fact is that well-managed banking organizations 

currently face artificial obstacles to diversifying appropriately and maximizing returns for their 

shareholders; these institutions are likely to become safer and more competitive with expanded powers, 

potentially benefiting consumers as well as shareholders and taxpayers. 24 Poorly managed institutions, 

on the other hand, likely will suffer the consequences of a new set of poor choices if expanded powers 

become available, and many of these firms may fail. 

The deposit insurance funds may benefit under a two-window system to the extent that nonbank risks 

would be removed from the insured entity and to the extent that scope economies, synergies or 

innovations resulting from new powers would salvage some banking franchises that now are endangered. 

Capital also would be free to move to nonbank uses within the organization when banking returns are 

low, thus stabilizing earnings. More-stable earnings may allow organizations to provide better support for 

their banking units during difficult times, should the owners wish to do so. 25 Meanwhile, any new risks 

posed by expanded powers would be borne outside the safety net, if the firewalls and regulatory 

safeguards embedded in the two-window structure are effective. 26 If effective, this structure dispenses 

with any need for concern about the effects of new powers. Effectiveness is considered in the following 

section. 

Supervisory Issues Under Two Windows 

The supervisory issues that arise under the two-window structure may be grouped into two categories. 

The first category consists of familiar concerns that apply to any proposed expansion of banking powers. 
 

 

 

 

 

 

 

 

 

 

 

Foremost among these concerns are the possibility of anticompetitive effects, including undue 

concentrations of power, and the potential problems associated with conflicts of interest, including 

abusive 'tie-in' sales and improper uses of inside information. Such concerns have been debated 

extensively and, thus, are relegated here to an Appendix that provides a brief summary. The second 

category of issues deals with the effectiveness of firewalls in maintaining the safety and soundness of 

insured banks. Because the two-window proposal relies so heavily upon firewalls to protect the insured 

bank without impairing the ability of the larger organization to capture economies of scope and other 

synergies, this category is particularly important for evaluating the relative merits of two-window banking. 

The remainder of this section focuses on firewalls. 

Firewalls for Safety and Soundness. For purposes of deciding the merits of a two-window structure, 

determining whether insured financial institutions can be effectively insulated from risks posed by their 

nonbank affiliates is more critical than selecting a particular set of permissible activities for those 

nonbanks. If corporate separation can be achieved within a banking organization and safety-net 

protections can be confined to the insured bank as required under the two-window framework, then the 

selection of activities to be conducted by nonbank affiliates is of second-order importance. 

Economic theory and formal empirical evidence are ambiguous regarding the prospects for effective 

separation. 27 Similarly, the abundant anecdotal evidence on both sides of the question offers no firm 

conclusions. 28 The following discussion contrasts opposing perspectives on the feasibility of corporate 

separation under a two-window system. 

Affiliations may carry two types of risks for an insured bank and, ultimately, the insurance funds: (1) the 

bank may endanger its own financial health by directly or indirectly assisting a troubled affiliate, and (2) 

public confidence may be shaken by problems plaguing a nonbank affiliate, with negative repercussions 

for the bank (such as higher funding costs, bank runs, etc.). For convenience, these risks may be termed 

'financial' and 'market' risks, respectively. 29 

As noted earlier, financial separation implies separate funding, no commingling of assets, and an arm'slength requirement for all advances of bank funds to affiliates. It follows that loans or services obtained by 

an affiliate from an insured bank should be on terms comparable to those available for nonaffiliates. 

Financial separation also requires that a bank does not unduly transfer assets to, or purchase bad assets 

from, an ailing affiliate. 'Firewalls' refer to the behavioral rules and restrictions that promote the fulfillment 

of these requirements for financial separation among affiliates. 

Banks currently are subject to lending limits, statutory restrictions on transfers of funds, dividend 

restrictions, and restrictions on amounts and terms for insider loans. 30 Nonetheless, abuse of an insured 

financial institution by individual owners to benefit outside activities has resulted in a number of bank 

failures. While this may occur under the strongest of firewall systems, it is relevant to note that state laws 

governing corporate separation are uneven. The two-window system would potentially close state law 

loopholes that facilitate such abuse by requiring a minimal set of uniform firewalls for all insured 

institutions affiliated in any manner with nonbank firms. Despite this, it is reasonable to expect that the 

incidence of such abuse will rise if there are expanded opportunities for affiliation. 

There is no doubt that strong incentives exist to manage the various components of an organization as an 

integrated whole. For example, funding costs can be lowered for any given affiliate if creditors believe that 

the strength of the entire organization stands behind the affiliate's obligations. To the extent that 

stockholders' returns can be elevated or risks can be better controlled by managing the various affiliates 

as an integrated entity, there will be strong incentives for management to do so. However, experience 

confirms that regulators also can create strong incentives that affect the bottom line for shareholders. The 

firewalls separating holding-company affiliates (Sections 23A and 23B of the Bank Holding Company Act) 

have insulated many banks effectively against repercussions from the demise of nonbank affiliates, and 

such firewalls always can be strengthened if necessary with stiffer penalties for noncompliance. 
 

 

 

 

 

 

 

 

 

A fair assessment of the anecdotal evidence would suggest that existing firewalls work well in the usual 

course of business but occasionally fail when there are serious problems in one or more parts of the 

organization. As Flannery (1986, p. 223) has noted: 'The policy question is therefore whether the 

possibility of . . . relatively extreme behavior should have an important weight in making regulatory 

decisions.' 

A complicating factor is that the anecdotal evidence comes from a regulatory regime that differs from the 

one envisioned under a two-window system. Firewalls have, to date, operated within the context of 

consolidated supervision for bank holding companies by the Federal Reserve Board (see note 6). 

Because the two-window framework does away with consolidated supervision, it is unclear whether 

firewalls would be equally effective in that environment. 

A counterpoint is that consolidated supervision has served as a signal to the market that regulators 

expect affiliates to be managed as integrated entities. This could account for those past instances in 

which insured banks have been punished by the market for problems arising in their nonbank affiliates. 

Thus, it is unclear whether the market reaction would be similar in an environment where regulators 

demand corporate separation and show a willingness to strengthen firewalls as necessary to enforce it. 

As this discussion indicates, complete financial separation is impossible without 'market' separation. 

Economic theory and empirical evidence suggest that some amount of market risk is probably 

unavoidable for banking units within financial holding companies, even if firewalls work well. 31 For 

example, to the extent that customers seek a complete set of financial products and services from an 

organization, a nonbank affiliate's performance in delivering one element of the set will also affect the 

demand for the bank's products and services. 32 Similarly, because empirical evidence indicates that the 

market uses new information regarding one firm's performance to infer changes in the stock values of 

unrelated firms in the same industry, it is reasonable to expect that the performance of affiliates in 

businesses closely related to banking will influence also the market's valuation of a bank. 33 

Even if affiliates conduct activities that are unrelated to banking, the market is unlikely to ignore signs of 

poor management anywhere in the organization. If the parent selects management of questionable 

quality for a nonbank affiliate, the quality of bank management may also come under suspicion. This will 

be expressed through higher funding costs for the bank, with or without the presence of effective firewalls. 

Moreover, entities within any conglomerates are likely to be chosen such that their risk-return 

characteristics are complementary. 34 While firewalls may prevent direct interrelationships among 

affiliates, they cannot prevent the indirect connections established through the judicious use of financial 

theory and statistical evidence in exploiting covariance or other properties of asset returns. The market is 

likely to recognize these indirect connections and understand their implications for the bank's 

performance. Correspondingly, a bank's portfolio choices are likely to be influenced by the risk-return 

characteristics of its affiliates, even in the presence of firewalls. 

In short, it seems clear that some exposure to market risk will be unavoidable for banks under a twowindow system. Such exposure already exists for holding-company banks, but the two-window framework 

places no restrictions on the types of affiliates that banks may choose. As a result, the mix of affiliates 

within a two-window organization could have diverse and complex consequences for a bank's exposure 

to market risk. More generally, the net effect on the banking industry's safety and soundness is 

impossible to predict with confidence. 

Given this ambiguity, some argue that a reliance upon firewalls to protect the insured bank would be too 

risky. 35 They note that perfect insulation is not possible, and that attempts to strengthen firewalls may 

merely negate any economic advantages resulting from expanded powers. It is not certain that firewalls 

can be simultaneously strong enough to maintain an acceptable level of risk for the deposit insurance 

funds and flexible enough to allow banking firms to exploit new opportunities or economies of scope 

associated with expanded powers. It is argued that these uncertainties signal a continuing need for 

consolidated supervision of banking firms in order to catch any problems that may slip through cracks in 

the firewalls. Quite apart from the substantive merits of consolidated supervision, such skeptics note that 
 

 

 

 

 

 

 

 

 

 

this concept is firmly embraced in the revised Basle Concordat; hence, an important international 

agreement could be threatened by any reforms that suggest a weakened U.S. commitment to 

consolidated supervision. 36 

The case for two-window banking does not rest upon a denial of these complications and uncertainties. It 

rests upon a belief that there are crucial flaws in the structural design of the banking industry, including 

the financial safety net, with potential consequences that justify the risks associated with two-window 

reforms. More concretely, it appears that the safety net is now and, in the absence of reforms, 

increasingly will be extended to activities for which it is not essential. This creates artificial incentives in 

the marketplace and raises questions concerning the future ability of the deposit insurance system to 

support the safety net. The list of nontraditional activities conducted by insured banks (foreign-exchange 

operations, bond underwriting, off-balance-sheet activities) continues to grow virtually without regard to 

the design and purpose of federal deposit insurance. No legitimate economic rationale exists for 

extending safety-net protections in this manner. This argument, and the corollary concern over undue risk 

to the insurance funds, motivate the redesign of the safety net to protect only traditional intermediation in 

the two-window system. 

An additional 'two-window' argument for structural reform is that restrictions on bank ownership and 

affiliations currently restrain competition in the financial marketplace. Consolidated supervision appears 

as an integral part of this problem. It potentially deters entry into banking by nonbank firms and narrowly 

restricts activities that may be conducted in nonbank units of a holding company; thus, it reduces the 

flexibility of banking organizations to adapt to a rapidly changing environment and otherwise meet the 

diverse needs of borrowers and savers. 

Conclusions 

The two-window proposal, like the recent versions of the narrow-bank proposal, was motivated by the 

experience of the 1980s. Enactment of the Federal Deposit Insurance Corporation Improvement Act of 

1991 (FDICIA) has changed the landscape significantly. 

The FDIC's loss exposure has been reduced by the least-cost failure-resolution requirement of FDICIA 

and, perhaps, by the incentives created through prompt corrective action for undercapitalized institutions 

(PCA). As well, the Budget Act of 1993 amended FDICIA by providing that domestic-office depositors of 

federally insured U.S. financial institutions would occupy a preferred position in the failure-resolution 

process with respect to foreign-office depositors and general creditors. Taken together, these provisions 

may reduce significantly the maximum potential failure-resolution costs of the FDIC. 

Moreover, FDICIA may have greatly reduced the potential magnitude of the deposit insurance subsidy by 

addressing the 'too-big-to-fail' problem. This aspect of FDICIA has been little noticed and apparently 

underappreciated. The least-cost resolution requirement generally prohibits the FDIC from extending 

protection to any failed-bank creditors other than insured depositors, unless such action reduces FDIC 

costs. An explicit process is created for systemic-risk exceptions, requiring agreement among the FDIC, 

Federal Reserve, and the Secretary of the Treasury in consultation with the President, and FDICIA 

provides for a special assessment on the industry to pay for any losses exceeding the least-cost amount. 

Thus, it can be argued that the process for determining whether large banks get special treatment is 

similar to, but more systematic than, the process that might be used for other large firms. 37 It would now 

be difficult to argue that the deposit insurance system per se is responsible for any perception in the 

marketplace that some banks are 'too big to fail.' 

On balance, then, FDICIA appears to weaken substantially the case for those reforms aimed primarily at 

reducing risk to the deposit insurance fund and eliminating the 'too-big-to-fail' doctrine. 

Despite this, and despite the strong performance of the banking industry recently, it can be argued that 

structural reform is necessary because of an overextension of the safety net and unnecessary restrictions 
 

 

 

 

 

 

 

 

 

 

 

 

on bank ownership and affiliations. On these bases, the two-window proposal merits serious 

consideration. 

In particular, a two-window system avoids potential problems posed by reforms that rely upon 'narrow 

banks' and/or consolidated supervision of banking organizations. Narrow-bank proposals ignore social 

costs that may be associated with removing safety-net protections for traditional bank intermediation and 

do not address concerns that consolidated supervision deters entry into banking and restricts the 

flexibility of banking organizations to meet the needs of customers. 

There are legitimate concerns regarding the effectiveness of firewalls in a two-window system. Given 

expanded opportunities for bank affiliation with nonbanks, it is reasonable to expect new temptations that 

could lead to abuse of insured banks. The effectiveness of firewalls in preventing such abuse has not 

been tested in an environment of functional supervision. On the other hand, to the extent that FDICIA 

successfully limits the costs associated with bank failures, reliance on firewalls may pose less risk to the 

deposit insurance funds and the taxpayers. Moreover, it should be considered that such a risk may be 

worth taking in order to rationalize the financial safety net, bring it under control, and reduce barriers to 

entry in the financial-services industry. 

APPENDIX 

Competition, Concentration of Power, and 

Conflicts of Interest With Expanded Powers 

Decreased Competition and Conflicts of Interest. A longstanding fear associated with expanded 

product powers and nationwide branching is that a comparatively small number of large organizations 

may ultimately dominate the financial marketplace. This raises the specter of localized monopolies, 

destabilization of the financial system in the event of a single bank failure, and disproportionate control 

over the nation's financial resources on the part of a few large institutions. 

Such concerns are real but difficult to assess. While banking organizations may be larger and fewer 

under a two-window system, they also may be better diversified. Thus, while any given bank failure under 

this system may be more costly and destabilizing, there may be fewer failures. Similarly, a decline in the 

number of banks need not mean that fewer banks will be competing in any given market. Technological 

advances in information processing and communications are constantly reducing the costs associated 

with entry into new markets. This suggests that if inadequate competition creates excess profits in a given 

market, new entrants are likely to be attracted until above-normal profits are competed away. To the 

extent that expanded powers would increase either actual or potential competition, this would provide a 

safeguard against the costly excesses typically associated with concentrations of power. 38 

For these reasons, it appears unlikely that concentrations of power would produce any serious economic 

problems. Under a two-window system, however, other legitimate concerns may arise in connection with 

this issue, including potential effects of financial concentration on the political process. Before committing 

to any structure that allows for large-scale consolidation in financial services, lawmakers may wish to 

consider whether remedies would be available to offset any untoward implications of concentration. 39 

Another longstanding fear associated with expanded powers is that conflicts of interest will multiply 

unmanageably as product lines grow, leading to widespread abuses. The primary concern for bank 

supervisors is that insured institutions may be jeopardized by attempts to combat financial problems 

elsewhere in the organization. For example, banks may be called upon to make unsound loans, capital 

injections or asset purchases for the benefit of a nonbank affiliate. This concern is addressed with 

firewalls and other regulatory safeguards in the two-window system, as discussed in the text. The 

remainder of this Appendix examines two conflicts that may harm consumers: 'tie-in' sales and improper 

uses of inside information. 
 

 

 

 

 

 

 

 

 

 

 

 

 

Tie-ins occur when a business entity attempts to condition the sale of a particular product or service upon 

the purchase of another of the entity's products or services. Typically, problems with tie-ins can be traced 

to inadequate information or weak competition. For example, extensions of credit to bank customers may 

be conditioned upon the customers obtaining additional services from a bank, its parent company, or one 

of its affiliates. In such cases, customers may enter into undesirable tie-in arrangements if uninformed of 

the consequences of their actions or if unaware of their alternatives. If no viable alternatives exist, 

customers may feel compelled to purchase products or services they do not want. The fear is that 

expanded powers will create more opportunities and stronger incentives for tie-in sales, so that problems 

of this type will become more widespread. 

Implicit in the two-window approach is the view that tie-in problems resulting from inadequate information 

are best controlled by requiring full disclosure of costs, alternatives, and other pertinent facts. Likewise, 

tie-in arrangements arising from inadequate competition are best addressed through policies that will 

strengthen competition in the financial marketplace. Under the two-window system, there would be no 

geographic or product-line restrictions to protect firms that saddle their customers with undesirable tie-in 

arrangements. The potential competition created by these new ground rules would act as a deterrent to 

tie-in abuses. 

A related concern is that violations of a bank's fiduciary responsibilities might increase along with the 

number of products and services offered by affiliates. As banking organizations obtain new powers, 

bankers are likely to gain access to new types of confidential information. Skeptics argue that such 

information is likely to be misused, because there is a conflict of interest whenever one entity acts as both 

a promoter of services or products and a disinterested financial advisor. 

Such arguments historically have centered on bank involvement in securities underwriting and, in part, 

served as the basis for passage of the Glass-Steagall Act. Recent evidence indicates, however, that, far 

from harming investors, issues underwritten by bank affiliates prior to 1933 were, on average, of higher 

quality and better performing than those underwritten by independent investment banks (Krozner and 

Rajan, 1994). 

More generally, potential conflicts of this type within banking typically have been neutralized successfully 

in the past. Because banks generally have succeeded in creating an effective 'Chinese Wall' between 

their commercial lending and trust departments, for example, it would seem that similar steps could be 

taken if banking organizations are permitted to engage in activities that grant them access to other types 

of confidential information. Should the level of abuse prove unacceptable under the two-window system, 

however, lawmakers could enact additional safeguards and stiffer penalties. Given the changing 

dynamics of competition in the market for financial services, product-line restrictions should probably be 

viewed as a last resort. 

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Benston, George J. The Separation of Commercial and Investment Banking: The Glass-Steagall Act 

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__________ and George G. Kaufman. Risk and Solvency Regulation of Depository Institutions: Past 

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__________ and Mark Gertler. Agency Costs, Net Worth and Business Fluctuations. American Economic 

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__________. Banking and Macroeconomic Equilibrium. In New Approaches to Monetary Economics, 

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Borrowing Firm's Equity Return. University of Florida Working Paper, June 1993. 

Blair, Christine E. Bank Powers and the Separation of Banking from Commerce. FDIC Banking Review 

(Spring/Summer 1994): 28-38. 

Bryan, Lowell L. Bankrupt: Restoring Health and Profitability to Our Banking System. New York, NY: 

Harper Business, 1991. 

Carns, Frederick S. Should the $100,000 Deposit Insurance Limit Be Changed? FDIC Banking Review 

(Spring/Summer 1989): 11-19. 

Carns, Frederick S., Arthur J. Murton and Lynn A. Nejezchleb. No Free Lunch in Deposit Insurance 

Reform. In The Financial Safety Net for Consumer Savings: Policy Options for the 1990s. Proceedings of 

a public-policy forum at Pace University, November 1989, pp. 51-59. 

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Corrigan, Gerald E. Financial Market Structure: A Longer View. Federal Reserve Bank of New York 

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__________. Reforming Federal Deposit Insurance, Modernizing the Regulation of Financial Services, 

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Committee on Banking, Housing and Urban Affairs, U.S. Senate, May 3, 1990. 

Cornyn, A., G. Hanweck, S. Rhoades and J. Rose. An Analysis of Corporate Separateness in BHC 

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Diamond, Douglas W. and Philip H. Dybvig. Banking Theory, Deposit Insurance, and Bank Regulation. 

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__________. Bank Runs, Deposit Insurance, and Liquidity. Journal of Political Economy (June 1983): 

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__________. Deposit Insurance for the Nineties: Meeting the Challenge. (Unpublished Draft.) 

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__________. Mandate for Change: Restructuring the Banking Industry. Washington, DC: Federal Deposit 

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__________. Report to the Congress on the Findings and Recommendations Concerning the TwoWindow Deposit System Proposal. Washington, DC: Federal Deposit Insurance Corporation, September 

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Flannery, Mark J. Contagious Bank Runs, Financial Structure and Corporate Separateness Within a Bank 

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Goodhart, C.A.E Money, Information, and Uncertainty. Cambridge, MA: MIT Press, 1989, especially 

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Gorton, Gary and George Pennacchi. Nonbanks and the Future of Banking. In Federal Reserve Bank of 

Chicago Proceedings: A Conference on Bank Structure and Competition. Chicago: n.p., 1992. 

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Federal Reserve Bank of Chicago Economic Perspectives (May/June 1994): 2-21. 

Krozner, Randall S. and Raghurm G. Rajan. Is the Glass-Steagall Act Justified? A Study of the U.S. 

Experience with Universal Banking Before 1933. American Economic Review (September 1994): 810-32. 

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Capital Market Response to Bank Loan Agreements. Journal of Financial Economics, 25 (1989): 99-122. 

McConnell, C.E. and W.S. Marcias. Bank Loans to REITs: How Serious the Problem? Keefe, Bruyette, 

and Woods, Inc., May 1975. 

Meyer, Paul. Will Expanded Banking Powers Raise Prices and Reduce Efficiency? mimeographed, 

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Murton, Arthur J. Bank Intermediation, Bank Runs, and Deposit Insurance. FDIC Banking Review 

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Pierce, James L. The Future of Banking. New Haven, CT: Yale University Press, 1991. @REFER = 

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Investigations, Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, May 

1, 1990. 

Seidman, L. William. Proposals to Establish a `Core' or `Narrow' Bank, testimony before the Committee 

on Banking, Finance and Urban Affairs, U.S. House of Representatives, June 18, 1991. 

Shockley, Richard and Anjan V. Thakor. Information Content of Commitments to Lend in the Future: 

Theory and Evidence on the Gains from Relationship Banking, Indiana University Working Paper, 

January 1993. 

Swary, Itzhak. Continental Illinois Crisis: An Empirical Analysis of Regulatory Behavior. (Unpublished 

Manuscript.) Hebrew University of Jerusalem, January 1985. 

Tobin, James. The Case for Preserving Regulatory Distinctions. In Restructuring the Financial System, 

Federal Reserve Bank of Kansas City (1987), pp. 167-83. 

U.S. Department of the Treasury. Modernizing the Financial System: Recommendations for Safer, More 

Competitive Banks, a Report to Congress. Washington, DC: U.S. Department of the Treasury, February 

1991. 

U.S. General Accounting Office. Bank Powers: Insulating Banks from the Potential Risks of Expanded 

Activities. Washington, DC: U.S. General Accounting Office, April 1987. 

White, Eugene N. Before the Glass-Steagall Act: An Analysis of the Investment Banking Activities of 

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Vol. 8 No. 2 - Article III - Published: June 1995 - Full Article 

Recent Developments Affecting Depository Institutions 

by Benjamin B. Christopher 

REGULATORY AGENCY ACTIONS 

Inter-Agency Actions 

The federal bank and thrift regulatory agencies are engaging in joint or coordinated efforts in a number of 

regulatory areas that are mentioned specifically in this issue of the Review , among which are: 

Community Reinvestment Act compliance evaluation; risk-based capital requirements; capitalrequirements accounting; appraisal guidelines; and examinations of bank-affiliate sellers of mutual funds. 

For full information on the inter-agency actions included in this issue, reference is necessary to the pages 

devoted to each of the agencies and the Federal Financial Institutions Examination Council. 

Federal Deposit Insurance Corporation 

Assessments 

The FDIC proposed changes in its risk-related insurance premium system, including a significant 

reduction in rates paid by well-capitalized and well-managed banks. No change is proposed at this time in 

the insurance rates paid by savings associations. Under the proposal, premiums paid by about 90 percent 

of BIF-insured institutions would fall to four cents per $100 of domestic deposits, from their current rate of 

23 cents per $100. The 31-cent rate currently paid by the lowest-rated BIF-institutions would continue. 

Present law requires the BIF to have an average assessment rate of 23 cents per $100 of deposits until 

the Fund amounts to $1.25 per $100 of insured deposits. As of the third quarter of 1994, the Fund 

balance of $19.4 billion represented $1.03 per $100 of insured deposits. The FDIC projects that the 1.25 

ratio will be reached between May 1 and July 31, 1995. Premiums can be reduced 'because of the efforts 

of the banking industry to make their individual institutions stronger' and to make their insurance fund 

stronger, said Chairman Ricki Helfer. The proposed new assessment rate would not be implemented until 

it can be verified that the BIF has been recapitalized. 

The FDIC also is considering a process for adjusting BIF rates quickly in response to changing 

conditions. As proposed, the entire assessment rate schedule could be raised or lowered twice a year, 

within a range of five cents per $100 without first seeking public comment. 

The FDIC proposed retaining the existing assessment rate schedule for the Savings Association 

Insurance Fund (SAIF). Under the existing SAIF assessment rate schedule, which averages 24 cents per 

$100, the Fund is projected to be capitalized in the year 2002. As of the third quarter of 1994, the SAIF 

had an estimated balance of under $2.0 billion, this representing a ratio of 26 cents per $100 of insured 

deposits. The SAIF also will assume from the Resolution Trust Corporation the responsibility for resolving 

failed thrifts, starting July 1, 1995. Comments were requested additionally on the proposal to keep SAIF 

assessment rates unchanged, and on the potential impact of a substantial premium differential between 

BIF-insured and SAIF-insured institutions. PR-6-95, FDIC, 1/31/95. 

The FDIC is seeking comments on whether the deposit insurance assessment base should be redefined 

and, if so, how. Broadly stated, the assessment base is defined as an institution's total domestic deposits 

as of the end of a quarter. The definition of the assessment base has remained substantially the same 

since 1935. Until recently, the FDIC did not have statutory authority to change the definition. However, the 

FDIC Improvement Act of 1991 (FDICIA) gave the agency the ability to determine the assessment base, 

starting January 1, 1994. Among the key questions on which the agency is seeking guidance is whether it 

should begin charging insurance premiums for deposits that U.S. banks have in their foreign offices and 

for certain nondeposit liabilities and 'off-balance-sheet' items. Comments also are sought on whether 
 

 

 

 

 

 

 

 

 

 

 

assessments should be based on an average level of deposits held by the institution rather than quarterend figures. The latter question is intended in part to address situations where institutions temporarily shift 

funds out of the assessment base at the end of a quarter solely to reduce their insurance payments. If the 

FDIC Board finds revisions to be warranted, it will propose specific amendments and invite public 

comment. PR-64-94, FDIC, 9/27/94; FR, 10/5, p. 50710. 

The FDIC is taking steps to modernize the way deposit insurance premiums are collected to make the 

process more efficient and less burdensome. Institutions currently mail a check to the FDIC twice a year 

after determining how much they owe for deposit insurance, based on their assigned risk-related 

assessment rate and their deposit base. Under a new rule scheduled to take effect April 1, 1995: 

(a) The FDIC will compute the assessment owed, thereby improving the accuracy and relieving 

each institution of the burden of performing the calculation; 

(b) The agency will arrange for each institution's payment electronically through the Automated 

Clearing House (ACH) Network; 

(c) Each semiannual insurance assessment will be paid in quarterly installments, based on an 

invoice prepared by the FDIC showing the insurance calculation and information on any 

adjustments from previous quarters. 

The revisions delete from the assessment regulation the existing references to experience factors, which 

are not available for use after 1994. 

The new rule also changes the way insurance premiums are collected from insured institutions that 

acquire deposits through mergers or other transactions in the latter half of a semiannual assessment 

period. When such a transaction occurs, the surviving institution's payments will be adjusted to account 

for the increased insurance risk the deposits may pose. PR-83-94, FDIC, 12/20/94; FR, 12/29, p. 67153. 

Required New Disclosures of 'Pass Through' Coverage 

The FDIC adopted new rules requiring insured institutions to provide timely disclosures to depositors in 

certain retirement accounts and employee benefit plans about whether their funds qualify for ' pass 

through' insurance coverage. In general, ' pass through' insurance means that the share of each 

participant in the account, rather than the total account balance, is insured up to $100,000. A 1991 law 

and FDIC regulations that went into effect in 1992 provide for pass through deposit insurance for 

employee benefit plan accounts if the insured institution satisfies certain capital standards. 

At issue are deposits in accounts such as 401(k) retirement accounts, Keogh plan accounts, and 

corporate pension plan and profit-sharing plan accounts. Among the new required disclosures are the 

institution's 'prompt corrective action' (PCA) category, and whether the deposits are believed to be eligible 

for ' pass through' insurance (must be disclosed in writing when an affected account is opened, and upon 

request of the account manager); and notification if new, rolled-over or renewed deposits will not be 

eligible for 'pass through' insurance (must be disclosed in writing within ten days of when an existing 

account is believed to be no longer eligible for 'pass through' insurance coverage). 

The new rules become effective July 1, 1995; however, holders of employee benefit plan deposits made 

between December 19, 1992 and July 1, 1995, will receive specified disclosures if at the time of deposit 

the account was not eligible for pass through insurance coverage. PR-7-95, FDIC, 1/31/95; FR, 2/9, p. 

770. 

Brochure on Insurance Coverage 

In an effort to reduce continuing customer confusion, the FDIC is now offering a free brochure, 'Insured or 

Not Insured - A Guide to What Is and Is Not Protected by FDIC Insurance.' The brochure explains the 

term mutual funds, advises purchasers to obtain definitive information, states clearly that 'mutual funds' 

are not deposits and therefore are not insured by the FDIC or any federal agency, and explains the 

difference between FDIC coverage of deposits and insurance from other sources that may be available 
 

 

 

 

 

 

 

 

 

on certain other bank products. The brochure also includes a discussion of the insurance aspects of 

Treasury securities, safe deposit boxes and robberies. Institutions that sell nondeposit products either 

directly or through a third party are strongly urged to provide this brochure to anyone who inquires about, 

or purchases, such products. FIL-53-94, FDIC, 7/20/94. 

BIF Rises to $19.4 Billion in Third Quarter; Agency Staff Reduced 

The Bank Insurance Fund (BIF) increased to $19.4 billion as of September 30, 1994, up 48 percent from 

the 1993 year-end level of $13.1 billion. The Fund balance amounted to 1.03 percent of insured deposits 

on September 30. As a result of the improving financial health of the banking industry, the estimated 

liability for the cost of anticipated bank failures declined to $1.46 billion, from $3.00 billion at the end of 

1993. BIF revenue for the nine-month period totaled $5.00 billion, of which $4.22 billion was assessments 

earned. Expenses and losses were a negative $1.23 billion, this amount representing mainly provision for 

insurance losses of minus $1.66 billion. 

The FDIC reported that its current staff of 12,116 is 421 less than the initial projected 1995 year-end staff 

level, and 1,200 below the year-end authorized level. Staff levels decreased by 820 during the third 

quarter, and 2,103 (14.8 percent) for the year-to-date. Most of these reductions were related to office 

closings in Houston, Denver, Orlando, Encino, and San Antonio. Financial Management Report, 3rd 

Quarter 1994, FDIC. 

Thirteen Banks Failed Last Year 

In 1994, there were 13 failures of BIF-insured banks, which had assets of just under $1.6 billion, down 

from 41 failed banks, with assets of $3.5 billion, the year before. The number of closures in 1994 was the 

lowest since the year 1981. 

The FDIC's 'problem' list at the end of the third quarter consisted of 293 commercial banks, with assets of 

$36 billion, and 84 savings institutions, with $59 billion in assets. From year-end 1993, the total number of 

'problem' institutions declined by 195, and their assets were down by $239 billion. FDIC Quarterly 

Banking Profile, Third Quarter 1994; FDIC Office of Corporate Communications. 

Supervisory Guidance on Mortgage Derivative Products 

The FDIC has updated and distributed to FDIC-supervised banks its supervisory guidance to examiners 

on mortgage derivative products. The new guidance incorporates the provisions of the Federal Financial 

Institutions Examination Council's (FFIEC) interim revision to its Supervisory Policy Statement on 

Securities Activities, which addressed the application of Statement No. 115 of the Financial Accounting 

Standards Board (FASB) to mortgage derivative products. 

The FDIC's guidance states that a mortgage derivative product that was non-high-risk at purchase and 

designated as held-to-maturity later becomes high-risk, the security will not be subject to redesignation as 

available-for-sale or trading if the institution can continue to demonstrate a positive intent and ability to 

hold the security to maturity. However, examiners will continue to consider any unrealized net 

depreciation in held-to-maturity, high-risk mortgage derivative products in the evaluation of an institution's 

capital adequacy. Mortgage derivative products that expose an institution to risk of loss of principal or 

book value may be classified in accordance with the provisions in attached exhibits. The entire amount of 

unrealized losses (not just any amounts scheduled as loss) on available-for-sale debt securities that are 

adversely classified must be deducted from Tier 1 capital before calculating regulatory capital ratios. No 

such adjustment to regulatory capital calculations is necessary for adversely classified trading securities, 

as unrealized gains and losses on trading securities are included in an institution's earnings. FIL-82-94, 

FDIC, 12/13/94. 

Supervisory Guidance For Structured Notes 

The FDIC issued a supervisory guidance to the agency's examiners and to FDIC-supervised banks on the 

characteristics, risks and examination treatment of structured notes. Since 1990, U.S. Governmentsponsored enterprises, private corporations, and multilateral development banks have issued structured 
 

 

 

 

 

 

 

 

 

 

notes, with the Federal Home Loan Banks the most predominant issuers. Banks have increased their 

investment in structured notes. These securities typically contain embedded options such as caps, calls, 

and floors and have cash flows that are linked to indices such as interest rates, foreign-exchange rates, 

commodities prices, prepayment rates, and other financial variables. The cash-flow uncertainty of 

structured notes, caused by movements in interest rates, foreign-exchange rates, and other indices, may 

expose banks to greater market risk, liquidity risk, operating risk, or interconnection risk than traditional 

medium-term notes. As a result, bank investments in structured notes warrant increased supervisory 

attention to ensure that bank management understands the nature of the risks in the securities and has 

the ability to measure, monitor, and manage these risks. Specific examination guidance regarding the 

characteristics and risks in structured notes is provided. FIL-61-94, FDIC, 8/31/94. 

Management of Interest-Rate Risk 

The FDIC issued a guidance to its examiners and to FDIC-supervised banks on the assessment and 

management of interest-rate risk in financial institutions. The guidance considers such factors as the size 

of the institution, capital adequacy, earnings and the complexity of the institution's business. The 

management of interest-rate risk may range from the formation of formal management committees and 

the use of complex measurement systems to informal management oversight and the use of simple 

measurement tools in smaller, more basic, bank operations. 

Interest-rate-risk management can be defined as the management of the potential impact of interest-rate 

movements on an institution's net interest income and market value. Applicable to all banks in various 

degrees, interest-rate risk management in larger institutions can be segmented into several parts which 

are discussed in the guidance: (a) the establishment of an interest-rate-risk management committee that 

is approved by and reports to the board of directors or assumption of such responsibility by the full board; 

(b) written policies and procedures, including risk limits; (c) a written interest-rate-risk management 

strategy or strategies; (d) an appropriate measurement and monitoring system(s) to quantify interest-raterisk exposure; (e) the evaluation of interest-rate-risk exposure. FIL-60-94, FDIC, 8/26/94. 

Rapid-Growth Rule Rescinded 

Effective November 7, 1994, the FDIC rescinded a section of its regulations on notification of rapid 

growth. Currently, all insured banks, except insured bankers' banks, are required to give the FDIC prior 

notice of planned rapid growth as a result of any 'special funding plan or arrangement.' For purposes of 

this requirement, such a funding plan is any effort to increase the assets of a bank through the solicitation 

and acceptance of fully insured deposits obtained from or through the mediation of brokers or affiliates 

(which would include insured brokered deposits); the solicitation of fully insured deposits outside a bank's 

normal trade area; or secured borrowings, including repurchase agreements. The recission will lessen the 

regulatory burden on banks which are currently also required to comply with the FDIC's brokered deposit 

regulation and the prompt corrective action rule, both of which were designed in part to address the same 

risks resulting from rapid growth. FR, 10/6/94, p. 50826. 

Task Force on Risks From Capital Market Instruments 

FDIC Chairman Ricki Helfer announced the creation of a special task force to analyze and make 

recommendations regarding the potential risks posed to the federal deposit insurance funds by capital 

market instruments, including derivatives. The recommended actions will include those necessary to 

enhance the agency's ability to respond appropriately to the possibility that failed banks could be involved 

in these capital market activities and to situations in which these activities could pose a systemic risk that 

threatens the deposit insurance funds or the financial system. The FDIC noted the unprecedented growth 

in capital market instruments and the advances in technology that enable practitioners, including insured 

depository institutions, to condition their income streams on increasingly complex financial relationships. 

To the extent that these complexities including the global nature of the inter-linkages between market 

participants are not well-understood or are mismanaged, capital market instruments can result in losses 

that may take management and regulators by surprise. The agency said there is no reason to believe that 

the capital market activities of any insured financial institution pose a significant risk at this time to the 

deposit insurance funds. PR-72-94, FDIC, 11/7/94. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

Early-Warning System on Loan Underwriting Standards 

The FDIC plans to establish a system designed to identify any relaxation in the underwriting standards for 

bank lending before problems occur. The new program will commence with pilot projects in all eight of the 

agency's supervisory regions, and will involve periodic surveys of bank examiners to identify changes in 

underwriting standards as they occur. Chairman Ricki Helfer said 'this effort will allow the FDIC to analyze 

systematically the findings of our field personnel who observe lending practices on a day-to-day basis, 

and then to work with banking institutions to correct any problems before they are serious.' 

FDIC personnel at selected, regularly-scheduled bank examinations during the first quarter of 1995 will be 

asked to report on the prevalence of specific lending and investment practices that have led to difficulties 

in the past, such as commercial real-estate loans based on unrealistic cash-flow projections, and to 

identify new practices that could have implications for the safety and soundness of the banking system. 

PR-79-94, FDIC, 12/13/94. 

Revised Proposal on CRA Compliance Evaluation 

The FDIC, the Office of the Comptroller of the Currency (OCC), the Federal Reserbe Board (FRB) and 

the Office of Thrift Supervision (OTS) modified a proposal that the agencies published in December 1993, 

(see this Review , Spring/Summer 1994, p. 40) to change the way institutions are evaluated under the 

Community Reinvestment Act (CRA). The revised proposal retains the structure and principles of the 

December plan; for example, both would replace the 12 factors now used to evaluate an institution's CRA 

performance with a more objective, performance-based system. However, the revised plan would make 

the performance tests more flexible, simplify data reporting requirements and increase the importance of 

community development lending, such as loans for affordable housing and economic development in lowand moderate-income areas. The revised proposal gives greater recognition to the importance of all types 

of lending to low- and moderate-income individuals and neighborhoods, treats community development 

lending as a principal component of lending performance, and clarifies that an institution's loans outside 

its service area to low- and moderate-income individuals and to small businesses and small farms could 

be considered as part of its CRA performance. 

As in the December proposal, large financial institutions (generally those with $250 million or more in 

assets) would be evaluated for their CRA performance under three 'tests' -- a lending test, an investment 

test and a service test. However, under the revised proposal, the tests would be less rigid and would 

allow the examiner more flexibility to take into account the characteristics and needs of a community and 

the capacity and limits of an institution. Large institutions also would be required to file new data about 

their lending and investments, but less than what was proposed in December. A new reporting 

requirement is data on an institution's loans to small businesses and small farms that would include 

information on the race and gender of the borrowers. Small banks and thrifts would be evaluated under a 

streamlined method that would not subject them to additional reports of loan data. The revised proposal 

would not require, as initially proposed, a small institution to have at least a 60 percent loan-to-deposit 

ratio in its community in order to be given a 'satisfactory' CRA rating. The agencies instead propose to 

consider each institution's financial condition and the credit needs of the community in evaluating lending 

performance under CRA. PR-135-93, FDIC, 12/9/93; FIL-67-94, 10/12/94; FR, 10/7, p. 51232. 

Self-Testing Guide on Fair Lending 

The FDIC issued a 56-page booklet on self-testing for fair lending practices. The guide is designed to 

help lenders compare the treatment of loan applicants and identify differences that may be discriminatory, 

and offers suggestions on how to correct discriminatory practices and improve lending performance. 

Among the topics included are: 

(a) How to plan and manage a pre-application testing program. The focus here is the point where 

an applicant inquires about a loan, gathers information and receives counseling or an invitation to 

apply. Financial institutions are encouraged to take whatever steps are necessary, including 

some form of pre-application testing, to inspect the treatment of potential applicants, as a means 

of helping to prevent illegal discrimination, improving customer service and attaining lending 

goals. 
 

 

 

 

 

 

 

 

 

 

 

(b) Treatment of applicants after submission of an application through a comparative analysis of 

loan files. Examples are provided of how loan product features, underwriting standards, or 

instances of lender assistance to borrowers can be compared to identify unequal treatment that 

may constitute discrimination. The use of comparative file analysis is discussed with reference to 

applications where disparate treatment may occur regarding applicants who are neither clearly 

qualified nor clearly unqualified for a loan. 

(c) How to identify and correct specific forms of discrimination, that may occur as overt or subtle 

discrimination, disparate treatment, disparate impact, an individual instance of discrimination or a 

pattern or practice of discrimination. 

(d) Criteria used by the regulatory agencies in taking enforcement actions and seeking remedial 

measures. 

(e) The importance of providing training on multicultural awareness, and on race, gender, and 

handicap sensitivity, to all levels of an institution's staff. Side By Side: A Guide to Fair Lending, 

FDIC, August 1994. 

Audit Reports 

Under an FDIC proposal that could affect approximately 70 institutions, annual audit reports on a 

separate, bank-only basis would be eliminated for institutions with over $9 billion in assets, if they are 

rated '1' or '2' on the CAMEL system and are subsidiaries of multibank holding companies. Instead, these 

institutions could be included in the holding company's annual report. 

Another proposal relating to procedures for determining compliance with certain laws and regulations, 

that would affect about 1,000 banks, includes new formatting and modifications of certain procedures so 

that they are more efficient and less burdensome. PR-9-95, FDIC, 2/2/95. 

FDIC Will Test Consumer Disclosures in Bank Sales of Mutual Funds 

The FDIC announced that it has hired a market research firm to study whether institutions are doing a 

good job explaining to consumers the distinctions between FDIC-insured deposits and uninsured 

products being offered by banks and thrifts, such as mutual funds. The agency's action is in response to 

concerns from lawmakers, bank customers and other regulators that confusion still exists despite various 

educational efforts by the industry and regulators about insured and uninsured bank products. To 

implement the study, trained representatives of the research firm, in person and by telephone, will pose 

as consumers asking typical questions about mutual funds, annuities and other nondeposit investment 

products, in the process of surveying a random, nationwide sample of several thousand locations of 

FDIC-insured banks and thrifts that sell these products. While the study is not intended to be used as an 

enforcement tool, if significant problems are found at an FDIC-supervised institution, the agency will seek 

appropriate corrective measures, and will refer problems found at other institutions to their primary 

regulator for follow-up. Results of the study are expected to be publicly available by mid-1995. PR-80-94, 

FDIC, 12/13/94. 

Mutual-to-Stock Conversions The FDIC issued a final rule, to become effective January 1, 1995, that 

addresses the conversion by mutual savings banks to stock form of ownership. The rule, applicable to the 

approximately 600 state-chartered mutual savings banks supervised by the FDIC, combines elements of 

an interim rule adopted in February 1994 and a rule proposed in June. A proposed policy statement 

issued in February, and a separate request for comment issued in May on certain fundamentals of the 

conversion process have been withdrawn. 

Among the requirements, which, under the final rule, a bank that proposes to convert must meet are: 

provide 60 days' advance notice to the FDIC of plans to convert, and if the FDIC finds any features to be 

unfair or unsafe it can object to and prevent the transaction; submit a full, independent appraisal report on 

the institution's value; and obtain a favorable vote on the conversion by depositors. Proxies are not 

permitted that are obtained from depositors in advance when they open an account. Eligible depositors 

must be given a priority over other buyers, including employee stock ownership plans, in purchasing stock 

when it is first offered, and bank management is permitted, but not required, to give preference to eligible 

local depositors. A bank generally is not permitted to buy back its stock within the first year after 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

conversion. After one year, stock repurchases are subject to case-by-case review by the FDIC. The bank 

must submit a business plan detailing the use of capital to be acquired in the conversion and expected 

earnings. 

The final regulation does not prohibit conversions through a merger with an existing institution or an 

acquisition by a holding company; however, because of the abuses that have been associated with such 

conversions, the FDIC will scrutinize closely these proposed transactions. PR-77-94, FDIC, 11/22/94; FR, 

11/30, p. 61233. 

Capital Rule For Unrealized Gains and Losses on Securities 

The FDIC adopted a final rule, effective January 27, 1995, that clarifies the regulatory capital treatment 

for unrealized gains and losses on securities that are 'available for sale.' Statement No. 115 of the 

Financial Accounting Standards Board requires institutions to recognize as a separate component of 

stockholders' equity any holding gains and losses on securities that are deemed available-for-sale. In 

general, this refers to securities that a bank does not have a positive intent and ability to hold to maturity 

but also does not intend to actively trade. Banks already are required by the banking regulators to follow 

FASB 115 for the quarterly Reports of Condition and Income (Call Report), under instructions issued in 

1993 by the FFIEC. At issue, however, has been the application of FASB 115 to regulatory capital 

standards. 

The FDIC and the other banking regulators previously proposed to require that net unrealized gains or 

losses on all available-for-sale securities (debt as well as equity securities) be included in determining 

Tier 1 capital (see this Review , Winter 1995, p. 35). The FDIC has joined with the FRB and OCC in 

rejecting that earlier proposal. Instead, the FDIC is adopting only technical changes to conform the 

wording in its leverage and risk-based capital rules with the terminology used in FASB 115. A similar rule 

is expected to be issued by the OTS for the institutions it regulates. FDIC Chairman Ricki Helfer said: We 

believe bank regulatory capital levels would be unnecessarily volatile, without appreciable benefits to the 

safety and soundness of the banking system, if institutions were required to include all unrealized 

securities losses in their regulatory capital calculations. 

The new rule closely tracks an interim guidance jointly issued by the three bank regulatory agencies in 

December 1993, and the capital treatment recommended by an inter-agency task force of the FFIEC in 

November 1994. Under the final rule, net unrealized holding losses on available-for-sale equity securities 

(but not debt securities) with readily determinable fair values will be deducted from the elements that 

determine Tier 1 capital. All other unrealized holding gains or losses on available-for-sale securities will 

be excluded from the definition of Tier 1 capital. However, the extent of any unrealized appreciation or 

depreciation on securities will continue to be a factor that FDIC examiners consider in their overall 

assessment of an institution's capital adequacy. The amortized cost rather than the fair value of availablefor-sale debt securities generally will continue to be used when calculating leverage and risk-based 

capital ratios. Banks also should continue to use the amortized cost of available-for-sale debt securities 

when reporting average total assets and risk-based capital data in the Call Report. PR-85-94, FDIC, 

12/20/94; FR, 11/25, p. 60552; 12/28, p. 66662. 

Proposed New Appeals Process 

The FDIC proposed guidelines for a new process that institutions could use to appeal supervisory 

decisions involving examination ratings, adverse classifications of significant assets, and the adequacy of 

loan-loss reserves. An 'independent' appeals process for 'material supervisory determinations' is required 

by Section 309 of the Riegle Community Development and Regulatory Improvement Act of 1994 for the 

FDIC as well as the other federal regulators of banks, thrifts and credit unions. The law defines an 

independent appeals process as one where the review is by an agency official who does not directly or 

indirectly report to the person who made the supervisory determination being questioned. 

The new program would replace a less formal appeals process adopted by the FDIC in February 1992. 

Under the proposed guidelines, an institution first would be encouraged to attempt to resolve the disputed 

matter with the regional office of the agency's division that made the supervisory determination. However, 
 

 

 

 

 

 

 

 

 

 

 

 

 

the institution could file an appeal with the Washington-based director of the appropriate division within 60 

days after receiving written notification of the initial FDIC decision. That division director either would 

grant the change requested by the institution or promptly refer the matter to a special committee 

consisting of the FDIC's Vice Chairman, General Counsel, an internal ombudsman and supervisory 

division directors. This committee would decide the appeal and notify the institution of its decision. From 

the time the FDIC receives an appeal, it would reach a final decision and notify the institution within 60 

days. 

Certain types of determinations would not be subject to this appeals process, including decisions to 

appoint a conservator or receiver for a failing institution; 'prompt corrective action' taken when an 

institution's capital falls below specified levels; formal enforcement actions; and risk classifications for 

deposit insurance premiums (review of these determinations is covered by other FDIC procedures). The 

proposed guidelines also contain safeguards against possible retaliation by FDIC examiners. PR-84-94, 

FDIC, 12/20/94; FR, 12/28, p. 66965. 

The OCC has issued a similar request for comments. FR, 12/22/94, p. 66067. 

Applications For Merger Transactions 

The FDIC amended its requirements to provide that in emergency cases necessitating prompt action, an 

applicant for a transaction under the Bank Merger Act will be required to publish only twice during the 

statutory ten-day period, with the second publication on the tenth day or the newspaper's publication date 

closest to ten days after the first publication, instead of daily for ten days as presently required. In nonemergency cases, publication will be required only three times at approximately two-week intervals. The 

regulation brings the FDIC's notice requirements into greater conformance with those of the other federal 

banking agencies, gives applicants more flexibility, and lessens regulatory burden. 12/28/94, p. 66653. 

Remote Service Facilities 

The FDIC is revising its requirements, effective immediately, for the establishment and relocation of 

remote service facilities (RSFs) in order to lessen the regulatory burden on state nonmember banks and 

state-licensed branches of foreign banks. Prior to the revisions, banks desiring to establish an initial RSF 

were required to comply with all the application and publication requirements applicable to the 

establishment of a 'brick and mortar' branch office. Successive RSFs could be established or relocated 

without a formal application under somewhat less involved requirements. The amended regulation 

provides that a state nonmember bank or an insured state-licensed branch of a foreign bank whose 

recent CRA rating is Satisfactory or better may establish and operate or relocate an RSF by filing a letter 

with the appropriate FDIC regional director. The letter must state the location of the RSF and information 

indicating compliance with the National Historic Preservation Act. Unless the institution is notified 

otherwise by the FDIC within seven days of receipt of the letter, the institution may establish or relocate 

the RSF. The public notice requirements are being dispensed with in this case. 8/23/94, p. 43281; FIL-59-

94, FDIC, 8/24. 

Loans to Executive Officers 

The FDIC amended its regulations to except loans which are fully secured by certain types of collateral 

from the general limit on 'other purpose' loans to executive officers of insured nonmember banks. The 

FDIC's rules place limits on loans that a bank can make to its executive officers for purposes other than 

an education or a home, such as commercial loans, farm loans and other types of consumer loans. When 

secured by any of the specified types of collateral, which in part include a perfected security interest in a 

segregated deposit account in the lending bank, a loan may be made in any amount and will not be 

subject to the limit for other purpose loans set forth elsewhere in the regulation. The amendment parallels 

recent changes by the FRB to that agency's regulations on insider loans. FR, 8/16/94, p. 41990; 12/28, p. 

66666; FIL-5-95, FDIC, 1/5/95. 

Foreign Banks 

The FDIC is amending its regulations, effective January 1, 1995, concerning applications procedures and 

plans for divestiture or cessation of activities by state-licensed insured branches of foreign banks. FDICIA 
 

 

 

 

 

 

 

 

 

provides that after December 19, 1992, such a branch may not engage in any activity that is not 

permissible for a federal branch of a foreign bank without the approval of the FRB and the FDIC. In the 

event that an application to begin or to continue to engage in an activity is denied by the FRB or FDIC, or 

the foreign bank elects not to continue the activity, a plan of divestiture or cessation must be submitted 

and the transaction completed within one year, or sooner if the FDIC so directs. 11/28/94, p. 60703. 

Courts Again Decide For Gross Negligence Standard 

The U.S. Court of Appeals for the Sixth Circuit, in the case of FDIC v. Bates , ruled that the Financial 

Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) requires regulators to meet a 

gross negligence standard in suits against officers and regulators. It was the third federal appeals court 

decision upholding the gross negligence standard, which generally makes it more difficult for regulators to 

prove negligence than would a simple negligence standard.AB, 12/29/94, p. 2. 

Agency Uses Self-Appointment Authority 

The FDIC appointed itself receiver of the $3.2 million-deposit The Meriden Trust and Safe Deposit 

Company, Meriden, Connecticut, and on July 7, 1994, took possession of and closed the bank. This was 

the first exercise of the agency's self-appointment authority which it received in 1991. The announcement 

said the bank would reopen the following day as a 'bridge bank,' New Meriden Trust and Safe Deposit 

Company, National Association. Meriden Trust's closing was the direct result of the 1991 failure of an 

affiliated institution, Central Bank of Meriden. The FDIC used its 'cross guaranty' authority to assess 

Central Bank's affiliated insured depository institution for potential losses to the deposit insurance fund, 

resulting in Meriden Trust's insolvency. PR-41-94, FDIC, 7/7/94. 

Real-Estate Recovery Less Widespread Than Earlier 

While reports of improvement in real-estate conditions continued overall to substantially exceed reports of 

decline, the margin of difference diminished in the FDIC's quarterly survey for the third consecutive time. 

The national composite index of survey results fell to 62 in January from 67 in October and 72 in July 

1994. Values of the index above 50 indicate more respondents believed conditions were improving than 

declining, compared to the previous quarter, while values below 50 indicate the opposite. The surveys, 

which began in April 1991, are based on interviews across the country with senior examiners and asset 

managers of federal bank and thrift regulatory agencies. The 407 participants in the latest survey were 

polled in late January. 

In residential markets, the index declined to 58 in January from 64 in October. Over half of the January 

respondents reported local housing conditions unchanged, while 32 percent saw continuing improvement 

down from 41 percent in October and 17 percent reported a decline. The recovery continued to be 

somewhat more widespread in commercial real-estate markets, as 38 percent of the respondents in 

January reported gains in that sector, while only 4 percent saw worsening conditions. These results were, 

however, somewhat less favorable than in October, when the percentages were 44 and less than one, 

respectively. 

As another indicator of the recovery in real estate, where the results were better than in the previous 

surveys, 28 percent of the respondents assessing local housing markets, and slightly over one-half for 

commercial real estate, reported an excess supply in the markets. 

Regionally, respondents in January reported small differences in the overall indexes, as the index for the 

West mirrored the national average. The evaluations for the South and Northeast were slightly more 

positive than for the nation as a whole, but were below the average in the Midwest, where the 22 percent 

of responses indicating improvement in local housing markets was down from 40 percent in the October 

survey. More than three-fourths of reports in California indicated commercial property sales were below 

average for that area. Survey of Real Estate Trends, FDIC, January 1995. 
 

 

 

 

 

 

 

 

 

 

Agency Will Sell Mortgage-Backed Securities 

The FDIC will issue approximately $761.4 million of securities backed by commercial mortgage loans. 

The issue is the FDIC's first entry into the mortgage-backed securities market. The certificates will 

evidence beneficial ownership interests in real-estate loans that were originated by failed depository 

institutions nationwide that were insured by the Bank Insurance Fund (BIF). The issue consists of $264.0 

million of floating-rate Class I certificates and $497.4 million of fixed-rate Class II certificates. The 

certificates include a limited FDIC guaranty provided solely by the BIF against credit losses and other 

shortfalls due to credit defaults. The guaranty will be limited to a maximum of 32.5 percent of the principal 

amount of the collateral outstanding; any additional losses will be borne by the holders of the certificates. 

Except under the limited guaranty, the certificates are not guaranteed by the FDIC or any other 

government agency. The offering of the securities will be made only by means of a prospectus. PR-51-94, 

FDIC, 8/9/94. 

Standards of Ethical Conduct For FDIC Employees 

The FDIC, with the concurrence of the Office of Government Ethics (OGE), proposes to issue regulations 

for the employees of the Corporation that would supplement the Standards of Ethical Conduct for 

Employees of the Executive Branch issued by the OGE. The proposed rule would establish prohibitions 

on borrowing and extensions of credit; prohibitions on the ownership of certain financial interests; 

prohibitions on the purchase of property controlled by the Corporation or the Resolution Trust 

Corporation; limitations on official dealings with former employers and clients; disqualification 

requirements relating to employment of family members outside the Corporation; and limitations on 

outside employment activities. FR, 7/12/94, p. 35480. 

Treasury Reduces BSA Information Requirements 

The Treasury Department issued a final rule, effective immediately, rescinding a requirement adopted 

pursuant to the Bank Secrecy Act for financial institutions to maintain a chronological log, and reducing 

substantially the amount of information required to be recorded. The BSA prohibits financial institutions 

from issuing or selling bank checks or drafts, cashier's checks, money orders or traveler's checks for 

$3,000 or more in currency unless the financial institution verifies and records the identity of the 

purchaser. Treasury also withdrew a proposal that would have required banks with deposits over $100 

million, and certain nonbank financial institutions, regardless of asset size, to maintain specific systems to 

aggregate currency transactions, and would have required financial institutions that file more than 1,000 

Currency Transaction Reports per year to file by magnetic media. FR, 10/17/94, pp. 52250, 52275. 

Resolution Trust Corporation
 

Audit Report by the General Accounting Office (GAO)
 

A GAO report of its audit of the RTC's statements of financial position as of December 31, 1993 and 

1992, found that: (a) the Corporation's financial statements were reliable in all material respects; (b) 

internal controls as of December 31, 1993, were effective in safeguarding assets against unauthorized 

acquisition, use, or disposition; (c) there was no material noncompliance with laws and regulations that 

were tested; and (d) the Corporation adequately addressed the material weakness and reportable 

conditions that were identified in the GAO's 1992 audit. The report noted that although the Corporation 

used the best available information to estimate securitization credit losses and future losses arising from 

representations and warranties, significant uncertainties exist. The limited claims experience raises the 

risk that the amount of future losses may significantly increase or decrease. These future losses will be 

affected by the behavior of the economy, interest rates, and real-estate markets as well as the 

performance of the collateral underlying the transactions. The Chairman of the Thrift Depositor Protection 

Oversight Board announced a management reform agenda in March 1993, which included requirements 

that the Corporation strengthen its internal controls in several areas. Among the steps the Corporation 

has taken to enhance its internal controls is the oversight of contractors that perform services for 

receiverships. However, audits of some contractors are continuing to identify contractor performance 

problems, such as poor asset management and disposition practices and questionable billings, which 

could result in increased expenses or reduced recoveries on assets. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

The report contains estimates of unused loss funds after completion of the RTC's resolution activities. 

Based on total loss funding made available of $105 billion, and estimated loss funding needs of $92 

billion, the estimated unused loss funds would total $13 billion. However, if actual asset recoveries are 

less than estimated or future resolution costs are greater than anticipated, the RTC will need to use 

additional loss funds. Loss funds not used by the Corporation are available for losses incurred by the 

Savings Association Insurance Fund (SAIF), subject to the conditions set forth in the RTC Completion 

Act. Funds in excess of the amounts needed by both the RTC and SAIF will be returned to the general 

fund of the Treasury. Under the RTC Completion Act, the Corporation will terminate on or before 

December 31, 1995. All remaining assets and liabilities will be transferred to the FSLIC Resolution Fund, 

which is managed by the FDIC. Annual Management Report, RTC, submitted to Congress on June 30, 

1994, containing Opinion Letter from the U.S. General Accounting Office. 

Operations Update 

The resolution, in December 1994, of one institution under the Accelerated Resolution Program brought 

the total number of resolutions to 774 since the inception of the RTC in 1989. As of December 31, the 

RTC had one institution to be resolved. 

As of November 30, 1994, the assets under RTC management had decreased to $31 billion, consisting of 

$4 billion in cash and securities, $5 billion in performing 1-4 family mortgages, $5 billion in other 

performing loans, $7 billion in delinquent loans, $2 billion in real estate, $5 billion in investments in 

subsidiaries, and $3 billion in other assets. The conservatorship program held $3 billion in gross assets 

on November 30. Assets in receiverships remaining from the institutions closed by the RTC amounted to 

$28 billion. Because many of the relatively marketable assets have been sold before an institution enters 

a receivership, most of the assets retained by the RTC in receivership consisted of lower-quality, lessmarketable assets. Thus, real estate and delinquent loans represented 32 percent of receivership assets. 

From inception through November, the RTC collected $156 billion from securities, $103 billion from 1-4 

family mortgages, $54 billion from other mortgages, $30 billion from non-mortgage loans, $16 billion from 

real estate, and $21 billion from other assets. The recoveries, which have amounted to 88 percent of 

book value reductions, included 98 percent from securities, 96 percent from 1-4 family mortgages, 77 

percent from other mortgages, 90 percent from non-mortgage loans, 55 percent from real estate, and 65 

percent from other assets. Through the end of November the RTC also had collected $19.3 billion in 

receivership income. The thrifts closed through November held $240 billion in assets at the time of 

closure. Estimated resolution costs for these closures totaled $88.2 billion. RTC Review , January 1995. 

Marketing Real Property on an Individual Basis 

In September 1994, the RTC adopted an interim rule, implementing the marketing provisions contained in 

the FHLBank Act and the RTC Completion Act, to provide policies and procedures for the marketing of 

real-estate-owned (REO) assets on an individual basis, and for the disposition of REO assets with a book 

value of more than $400,000 and nonperforming real-estate loans with a book value of more than $1 

million. The agency subsequently adopted the interim rule without change as a final rule to be effective 

December 23, 1994. FR, 9/19/94, p. 47790; 11/23, p. 60304. 

Affordable Housing Disposition Program 

The RTC is amending its regulations to implement provisions of the Resolution Trust Corporation 

Refinancing, Restructuring and Improvement Act of 1991 and other statutes enacted in 1992 and 1993 

that changed the manner in which the RTC is to identify, market and sell certain affordable housing 

properties. The regulations as amended will enhance the availability and affordability of residential real 

property for very-low-income, lower-income and moderate-income families and individuals. An interim 

final rule became effective October 19, 1994, and this rule was adopted in October without change as a 

final rule to be effective January 12, 1995. FR, 10/19/94, p. 52669; 12/13, p. 64111. 

Affordable Housing Unification Plan 

The RTC reported that in the four-month period beginning in June 1994, RTC-FDIC joint sales of singlefamily and multifamily affordable housing properties totalled over $6.8 million. In April 1994, the FDIC 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Board approved the unification plan of the affordable housing programs of the two agencies, which would 

implement the merger approved in March by the newly-formed Affordable Housing Advisory Board, in 

accordance with the RTC Completion Act of 1993. The FDIC will assume full control of both affordable 

housing programs by October 1, 1995. 

Among the key elements of the unification plan are: (a) FDIC will use RTC seller financing to underwrite 

its single-family and condominium sales through the transition period 1994-1995; (b) the agencies will 

consolidate their clearing house notices of available single-family and condominium properties; (c) the 

agencies will hold joint sales events, including at least two auctions in 1994 and two in 1995; (d) the 

agencies will use the same purchaser eligibility certification forms, and will develop a standard system of 

purchaser incentives for single-family sales, such as direct discounts and buyer counseling. The Silver 

Lining, RTC, Spring 1994, Summer 1994. 

Minority Thrift Sales 

As of June 14, 1994, the RTC had sold 14 savings-and-loan associations to minority bidders during the 

year. The RTC Completion Act, enacted in December 1993, requires the RTC to provide minorities a 

distinct preference to purchase failed savings-and-loan institutions. By April 1994, the agency had 

finalized new assistance terms for minority acquirers purchasing thrifts or branches that serve minority 

neighborhoods. Under these assistance provisions, minority acquirers can obtain financing for up to twothirds of the required regulatory capital and any premium, provided that the total amount financed does 

not exceed the tangible book value of the institution. Minority acquirers can obtain performing assets to 

offset deposit liabilities, giving them an option to acquire assets of up to 100 percent of net deposits. The 

RTC will make owned branch facilities located in minority neighborhoods available on a rent-free basis to 

minority acquirers for up to five years. 

The RTC permits the highest minority bidder to match the highest non-minority bidder's offer if, after a 

competitive bid process, the minority bidder's offer is within ten percent of the highest non-minority bid. If 

the minority bidder matches the high bid, it will be considered the winning bid. In order to acquire 

branches in minority neighborhoods, minority investors do not have to make an initial bid. They can 

acquire these branches from a majority acquirer that purchased the minority branches from the RTC. In 

effect, minority acquirers can work in consortium with majority bidders and still receive the full benefits of 

the minority assistance. The RTC Investor, 8/94, p. 4. 

RTC's Power to Subpoena Information 

A federal appeals court in early 1994 limited the RTC's power to issue subpoenas for personal financial 

information to persons that the RTC may reasonably suspect may be liable for an institution's failure (see 

this Review , Winter 1995, p. 38). In December the U.S. Court of Appeals for the District of Columbia, in a 

case stemming from the 1990 failure of San Jacinto Savings and Loan Association, ruled that the agency, 

having sued a person, cannot use an administrative subpoena solely to determine that individual's net 

worth. AB, 12/29/94, p. 2. 

Gross Negligence Standard Upheld in Bank Officials' Liability 

The U.S. Court of Appeals for the Fifth Circuit ruled that bank officers and directors cannot be held 

personally liable under federal common law for anything less than gross negligence (RTC v. Miramon, 

6/21/94). The Court said that the federal common law, which the RTC claimed would allow bank officers 

to be held liable for simple negligence, was preempted by FIRREA. The Act specifically provides that 

directors and officers of federally insured institutions may be held personally liable for damages in cases 

of 'gross negligence,' but that this provision does not impair any right of the RTC 'under other applicable 

law.' Stressing the limited role of the federal common law, the Court found that Congress spoke directly to 

the issue and thus preempted the federal common law. 

The Court made no ruling on whether FIRREA preempts state common law that allows actions against 

bank directors and officials based on simple negligence. Several courts have held that such suits are not 

preempted. BBR, 7/18/94, p. 94. 
 

 

 

 

 

 

 

 

 

 

 

 

Federal Reserve Board 

Capital Guidelines 

The FRB is amending, effective December 31, 1994, its capital guidelines for state member banks and 

bank holding companies to generally direct institutions to not include in regulatory capital the 'net 

unrealized holding gains (losses) on securities available for sale.' Net unrealized losses on equity 

securities with readily determinable fair market values will continue to be deducted from Tier 1 capital. 

The rule has the general effect of valuing available-for-sale securities at amortized cost, rather than at fair 

value (generally at market value), for purposes of calculating the risk-based and leverage capital ratios. 

The OCC and the OTS have adopted a similar rule for the institutions under their regulatory authority. FR, 

11/25/94, p. 60552; 12/8, p. 63241; Press Release, FRB, 12/5. 

The FRB adopted amendments, to be effective April 1, 1995, to its capital adequacy guidelines for state 

member banks and bank holding companies to establish a limitation on the amount of certain deferred tax 

assets that may be included in Tier 1 capital for risk-based and leverage capital purposes. The rule was 

developed in response to FASB Statement No. 109. 

Under the final rule, deferred tax assets that can only be realized if an institution earns taxable income in 

the future are limited for regulatory capital purposes to the amount the institution expects to realize within 

one year of the quarter-end report date -- based on its projection of taxable income -- or ten percent of 

Tier 1 capital, whichever is less. Deferred tax assets that can be realized from taxes paid in prior 

carryback years would generally not be limited. Press Release, FRB, 12/19/94. 

The FDIC has adopted these amendments with respect to banks subject to its supervisory authority. PR8-95, FDIC, 1/31/95. 

The FRB is amending its risk-based capital guidelines to recognize the risk-reducing benefits of qualifying 

bilateral netting contracts, implementing a recent revision to the Basle Accord. The effect of the final rule, 

to be effective December 31, 1994, is that state member banks and bank holding companies may net 

positive and negative mark-to-market values of interest-rate and exchange-rate contracts in determining 

the current exposure portion of the credit-equivalent amount of such contracts to be included in riskweighted assets. The OCC, FDIC, and OTS have issued parallel rules. FR, 12/7/94, p. 62987; Press 

Release, FRB, 12/2; AB, 12/30, p. 2; FIL-6-95, FDIC, 1/6/95; NEWS, OTS, 12/28/94. 

As part of its payment system risk-reduction program, the FRB, effective December 21, 1994, is 

integrating its policies on privately operated large-dollar multilateral netting systems into a single policy 

statement. Multilateral netting systems, including clearinghouse arrangements, have the potential to 

improve the efficiency of interbank settlements by reducing the costs of credit, liquidity and operations. 

However, these systems concentrate settlement and operational risks at a single point in the financial 

system. The FRB's statement incorporates the minimum standards for the design and operations of such 

systems contained in a report of the central banks of the Group of Ten countries published in November 

1990 by the Bank for International Settlements. These standards are designed to provide a set of 

minimum standards that permit the advantages of multilateral netting to be gained, while controlling 

systemic risks. FR, 12/29/94, p. 67534; Press Release, FRB, 12/21. 

The FRB modified its Policy Statement on Payment System Risk, doubling from 20 to 40 percent of riskbased capital the multiple associated with the de minimis net debit cap. Previously, an institution could 

request this cap which permitted daylight overdrafts up to 20 percent of risk-based capital. The FRB's 

action increases that limit to 40 percent. It is estimated that the change will eliminate 85 to 90 percent of 

cap overruns by institutions that currently have 'exempt from filing' or 'de minimis' caps. 

The FRB also approved administrative counseling flexibility for institutions that continue to exceed their 

net debit caps due to the posting of non-Fedwire transactions. Under this flexibility, the Reserve Banks 

will work with affected institutions on means of avoiding daylight overdrafts, but will not subject these 
 

 

 

 

 

 

 

 

 

 

 

institutions to routine counseling for daylight overdrafts. Effective: 10/13/94. FR, 11/2/94, p. 54915; BBR, 

11/7. p. 660. 

Bank Settlement on Derivatives' Risk Disclosure 

Bankers Trust New York Corp. signed a 'written agreement' under which the banking firm is required by 

the Federal Reserve to take measures for ensuring that its customers are able to understand the risks 

and price fluctuations involved with leveraged derivatives. Several Bankers Trust customers, including 

Gibson Greetings Inc. and Proctor and Gamble Co., have suffered heavy losses on derivatives contracts. 

Among the requirements under the agreement, Bankers Trust will disclose the risks of the derivatives 

prior to their purchase. For some derivatives after purchase, the bank will report their value to the 

customer each day. Previously, the bank provided this information only after the customer requested it. 

The agreement also calls for the bank to take actions to improve internal training, supervision and 

controls for leveraged derivatives activities. Several employees have been suspended by the bank for 

violations of internal rules regarding the selling of leveraged derivatives. The New York Times, 12/6/94, p. 

A1; WSJ, 12/6, p. A3. 

International Banking Operations 

The FRB proposed amending its Regulation K to provide criteria for use in evaluating the operations of 

any foreign bank in the United States that is not subject to comprehensive supervision or regulation by its 

home-country supervisor. The Foreign Bank Supervision Enhancement Act requires the FRB to develop 

these criteria in consultation with the Treasury Department. When the FRB has determined that a foreign 

bank is not subject to comprehensive, consolidated, home-country supervision, the criteria will be used to 

decide whether the bank should be permitted to continue its U.S. operations with or without supervisory 

restraints, or whether these operations should be terminated. Press Release, FRB, 12/9/94; FR, 12/13, p. 

64171. 

Activities of State-Licensed Branches and Agencies of Foreign Banks 

The FRB amended its Regulation K to set forth the application procedures for state-licensed branches 

and agencies of foreign banks seeking the Board's permission to engage in or continue to engage in an 

activity that is not permissible for a federal branch of a foreign bank and the requirements of divestiture 

and cessation plans. Section 202(a) of FDICIA provides that after December 19, 1992, a state-licensed 

branch or agency of a foreign bank may not engage in any activity that is not permissible for a federal 

branch of a foreign bank unless the FRB has determined that the activity is consistent with sound banking 

practice, and in the case of an insured branch, the FDIC has determined that the activity would pose no 

significant risk to the affected deposit insurance fund. The regulation is effective on January 1, 1995, 

except for one part effective December 5, 1994. FR, 11/3/94, p. 55026. 

Tying Restrictions Are Revised 

The FRB is adopting a final rule, effective January 23, 1995, amending its Regulation Y to permit a bank 

holding company or its nonbank subsidiary to offer a discount on its product or service on condition that a 

customer obtain any other product or service from that company or from any of its nonbank affiliates. The 

final rule would generally remove FRB-imposed restrictions on tying when no bank is involved in the 

arrangement and the products are separately available for purchase by the customer. The purposes of 

the amendment are to relieve bank holding companies of a competitive disadvantage, promote efficiency 

in the delivery of services, and provide benefits for consumers. FR, 12/20/94, p. 65473. 

Banking Firm's Investment Powers Are Widened 

The FRB approved a request for subsidiary banks of Norwest Corp. to inform customers about the 

products offered by Norwest Investment Services, a Section 20 subsidiary, through joint seminars, direct 

mail, letters on bank stationery, and statement stuffers. Among the offerings of Norwest Investment are 

stocks, bonds and mutual funds. About 30 banking firms operate Section 20 subsidiaries, through which 

since 1987 they have been granted limited powers by the FRB to underwrite and deal in securities. The 

FRB also gave approval for Norwest Investment to underwrite and deal in certain unrated municipal 

revenue bonds. This action should assist in broadening the market for the bonds of small municipalities. 

AB, 12/6/94, p. 5; BBR, 12/12, p. 862. 
 

 

 

 

 

 

 

 

 

 

 

Applications Under Regulation Y 

The FRB issued interim rules, with request for comments, implementing changes to the FRB's application 

procedures established by the Riegle Community Development and Regulatory Improvement Act of 1994 

(RCDRIA). The RCDRIA makes certain revisions to the procedures that bank holding companies must 

follow to gain approval of bank and nonbank acquisition proposals under the Bank Holding Company Act. 

The RCDRIA establishes a prior notice procedure to replace the current application process for all 

proposals by bank holding companies to engage in nonbanking activities. It establishes a streamlined 

notice procedure for the formation of a new bank holding company as part of a reorganization by the 

existing shareholders of a bank. Also, it eliminates the need for prior FRB approval of certain 'Oakar' 

transactions whereby a bank acquires a thrift or thrift's assets. Because these amendments became 

effective upon enactment of the RCDRIA, the FRB has adopted interim rules implementing these 

changes. Press Release, FRB, 10/27/94; FR, 11/2/94, pp. 54801, 54805. 

Appeals of Supervisory Decisions 

The FRB requested comment on an internal appeals process for institutions wishing to appeal an adverse 

material supervisory determination. Section 309 of the RCDRIA requires the FRB (as well as other federal 

banking regulators) to establish an independent, intra-agency appellate process, which will be available to 

review material supervisory determinations made at insured depository institutions, such as an adverse 

examination report. The FRB is proposing guidelines for appeals that are consistent with current practice 

at the Reserve Banks and the specific requirements of Section 309. Press Release, FRB, 12/22/94; FR, 

12/29, p. 67297. 

Home Mortgage Disclosure 

The FRB amended its Regulation C and the instructions and reporting forms that financial institutions 

must use in complying with the annual reporting requirements. The amendments respond to the statutory 

provisions regarding earlier availability of the Home Mortgage Disclosure Act (HMDA) disclosure 

statements to the public; provide clarifications; and are intended to help improve the quality of the HMDA 

data. The amendments require reporting in machine-readable format, except for institutions reporting 25 

or fewer line entries, require institutions to update their loan application registers quarterly during the year 

as data are being collected; and make a number of other changes. 

The rule is effective January 1, 1995, with required compliance for certain data beginning in calendar year 

1995 and in 1996. FR, 12/9/94, p. 63698; Letter to Financial Institutions, FFIEC, 12/9. 

The federal bank and thrift regulatory agencies have proposed changes to their regulations implementing 

the Community Reinvestment Act (CRA) under which the banks and savings associations that report data 

about their home mortgage lending pursuant to HMDA, and which have assets of $250 million or more, or 

are subsidiaries of a holding company with total banking and thrift assets of $250 million or more, would 

collect and report geographic information on loans and loan applications relating to property located 

outside the 'metropolitan statistical areas' (MSAs) in which these lenders have an office. Currently, 

geographic information is required only within MSAs where these lenders have an office. The new data 

would facilitate complete CRA assessments for institutions that do not qualify as small banks or thrifts. 

FR, 10/7/94, p. 51323. 

Truth in Lending 

The FRB proposed amendments to its Regulation Z to implement changes made to the Truth in Lending 

Act by the Riegle Community Development and Regulatory Improvement Act of 1994 that imposes new 

disclosure requirements and substantive limitations on mortgages bearing high rates or fees. More 

protections would be provided to consumers entering into high-rate, high- fee mortgages. The law also 

imposes new disclosure requirements for comparing the cost of reverse mortgages, which provide for 

periodic payments, based principally on a home's value, to primarily elderly homeowners. FR, 12/2/94, p. 

61832; Press Release, FRB, 11/29. 

The FRB proposed revisions to its official staff commentary to Regulation Z. The proposals relate to 

several issues of general interest, such as the treatment of various fees and taxes associated with real-
 

 

 

 

 

 

 

 

 

 

 

 

 

 

estate-secured loans, and a creditor's responsibilities when investigating a claim of unauthorized use of a 

credit card. FR, 12/14/94, p. 64351. 

The FRB solicited comments on whether consumers would benefit from having greater flexibility in 

waiving the right of recision in transactions with new creditors to refinance or consolidate home-secured 

loans (where no additional debt is incurred). Under present law, consumers may waive the right of 

recision in refinancings or consolidations with new creditors only when a bona fide personal emergency 

exists. FR, 12/21/94, p. 65771; Press Release, FRB, 12/20. 

Truth in Savings 

The FRB is reconsidering its action on January 4, 1995, in amending its Regulation DD requiring that the 

annual percentage yield (APY) reflect the frequency of interest payments. The original regulation is being 

left in place pending final action on the issue, except as indicated below. The FRB is seeking comment on 

the amendment, as well as the interest rate of return formula that was previously proposed but withdrawn 

last year. It adopted as an interim rule a narrowly drawn amendment to the Regulation to permit 

institutions to disclose an APY equal to the contract interest rate for time accounts with maturities greater 

than one year that do not compound but require interest distributions at least annually. Press Release, 

FRB, 1/18/95; FR, 1/26, pp. 5128, 5142. 

The FRB amended its Regulation DD and the official staff commentary to implement changes made to 

the Truth in Savings Act by the Riegle Community Development and Regulatory Improvement Act of 

1994. RCDRIA narrows the scope of accounts covered by TISA to accounts held by individuals for a 

personal, family or household purpose. Accounts held by unincorporated nonbusiness associations of 

individuals are no longer subject to TISA requirements. Effective date: September 23, 1994. FR, 

10/19/94, p. 52657. 

Equal Credit Opportunity 

The FRB proposed revisions to the official staff commentary to its Regulation B. The proposed revisions 

provide guidance on several issues including disparate treatment, special-purpose credit programs, credit 

scoring systems, and marital status discrimination. FR, 12/29/94, p. 67235; Press Release, FRB, 12/21. 

Public Welfare Investments 

The FRB adopted revisions, effective January 9, 1995, under which bank holding companies that have 

received approval to engage in activities that promote community welfare may make similar investments 

permissible for state member banks. These investments would primarily benefit low- and moderateincome persons or small businesses, and address demonstrated community needs by providing housing, 

services, and jobs to low- and moderate-income communities. Investments that comply with specified 

requirements, and do not exceed five percent of the total consolidated capital stock and surplus of the 

bank holding company when aggregated with similar investments made by depository institutions 

controlled by the holding company, may be made without additional FRB or Federal Reserve Bank 

approval. FR, 12/9/94, p 63712; Press Release, FRB, 12/7. 

Investment Advisor Activities 

The FRB is seeking comment on a proposal that would allow a bank holding company and its bank and 

nonbank subsidiaries to purchase in their sole discretion in a fiduciary capacity, securities of an 

investment company advised by the holding company if this purchase is specifically authorized by the 

terms of the instrument creating the fiduciary relationship, by court order, or by the law of the jurisdiction 

under which the trust is administered. The OCC and FDIC recently have granted this authority to the 

banks they regulate. Many states have amended their laws to allow banks to engage in these types of 

transactions. FR, 12/30/94, p. 67654; Press Release, FRB, 12/27. 

Recordkeeping For FundsTransfers 

The Department of the Treasury and the FRB adopted a final rule, effective January 1, 1996, that requires 

each domestic financial institution involved in a wire transfer to collect and retain certain information for 
 

 

 

 

 

five years. The amount and type of information depend upon the type of financial institution, its role in the 

particular wire transfer, the amount of the wire transfer, and the relationship of the parties to the 

transaction with the financial institution. The rule exempts wire transfers below $3,000. 

Under the Bank Secrecy Act of 1970, as amended in 1992, the FRB and the Treasury are authorized to 

impose recordkeeping requirements for domestic wire transfers by insured depository institutions 

whenever the agencies determine that such records have a high degree of usefulness in criminal, tax, or 

regulatory investigations or proceedings. In addition, the 1992 amendment requires the Treasury and the 

Board to issue final regulations with regard to international transactions. FR, 1/3/95, pp. 220, 231; Press 

Release, FRB, 12/22/94. See also related statement by OCC. FR, 1/3/95, p. 234. 

Disclosure Requirement Eliminated 

The FRB adopted an interim rule, effective December 1, 1994 and with a request for comments, 

eliminating from its Regulation E the requirement that an electronic terminal receipt disclose a number or 

code that 'uniquely' identifies the consumer, the consumer's account, or the access device. This 

requirement currently poses a significant security risk for consumers and financial institutions. The 

Electronic Fund Transfer Act (EFTA) requires that when a consumer initiates an EFT at an electronic 

terminal, the financial institution must make a written receipt available to the consumer that identifies the 

consumer's account with the financial institution from or to which funds are transferred. To ensure 

adequate identification, the FRB's regulation has required since 1979 that the receipt show a number or 

code that is 'unique.' Under the amendment, the receipt will still provide sufficient information, such as the 

date, amount, and type of the transfer, and the location of the terminal, to allow the consumer to identify 

transfers. Each transaction on the periodic statement could be matched with the transaction receipt. FR, 

12/2/94, p. 61787. 

Imputed Income on Clearing Balances 

The FRB proposed to modify the methodology for imputing clearing balance income to more closely 

parallel the practices of a private-sector provider. Specifically, comment is requested on changing the rate 

used to impute clearing balance income from the 90-day Treasury bill coupon- equivalent yield to a 

longer-term Treasury rate based on the earning asset maturity structure of the largest bank holding 

companies. 

The Monetary Control Act of 1980 requires the Federal Reserve Banks to establish fees for their services 

similar to those of private-sector service providers. In establishing fees, the FRB considers the objectives 

of fostering competition, improving the efficiency of the payments mechanism, and providing financial 

services nationwide. The Federal Reserve imputes costs in the private-sector adjustment factor (PSAF) 

that are intended to mirror private-sector sales taxes, income taxes, cost of funds, and FDIC 

assessments. Capital structure, equity and debt rates, and an income-tax rate are derived from a model 

of the largest (in asset size) 50 bank holding companies. The intended effect of the proposal is to promote 

competitive equity with private-sector practices by matching the maturity structure for investment of 

clearing balances to the structure revealed in bank holding company data on investments. Press Release, 

FRB, 8/16/94; FR, 8/19, p. 42832. 

Report Publication Requirement Eliminated 

The FRB amended its Regulation H to remove the requirement that state member banks publish their 

Reports of Condition. The amendment, effective November 10, 1994, implements Section 308 of the 

Riegle Community Development and Regulatory Improvement Act of 1994. Banks' Call Reports, including 

their Reports of Condition, will continue to be publicly available through the National Technical 

Information Service of the U.S. Department of Commerce. Additionally, state member banks will continue 

to be required to advise shareholders, customers, and the general public of the availability of year-end 

Call Reports and other financial information. FR, 11/10/94, p. 55987. 

Applications Approved For Firms to Operate in Mexico 

The FRB approved applications for a number of U.S. banking companies to establish operations in 

Mexico, the first such approvals since a provision of the North American Free Trade Agreement (NAFTA) 
 

 

 

 

 

 

 

 

 

 

 

became effective allowing U.S. and Canadian investors to acquire Mexican bank subsidiaries and 

establish financial holding companies. The firms receiving approval included Citibank Overseas 

Investment Corp., Morgan Guaranty International Finance Corp., Chemical International Finance Ltd., 

Republic National Bank of New York, Chase Manhattan Overseas Banking Corp., NationsBank Overseas 

Corp., and BankAmerica International Finance Corp. 

Among the requirements set by Mexico, foreign banks must have a business plan showing how their 

operations would benefit the nation's economy. Foreign banks cannot comprise more than eight percent 

of the total Mexican banking system in the first year, increasing to 15 percent in 1999, and no one 

institution can comprise more than 1.5 percent until the year 2000. BBR, 8/1/94, p. 173; Press Release, 

FRB, 7/27/94. 

Office of the Comptroller of the Currency 

Policies and Procedures For Corporate Activities 

The OCC is proposing to revise its rules governing corporate applications and notices, in order to 

modernize and clarify the rules, reduce regulatory burden, and eliminate unnecessary rules. The proposal 

would extensively revise and reorganize the agency's rules for national bank corporate activities. 

Among its provisions, the proposal provides for a new expedited review procedure for many types of 

applications submitted by healthy, well-managed banks which should entail low levels of risk. A national 

bank that is well-capitalized, has a rating of 1 or 2 under the CAMEL rating system, has a Community 

Reinvestment Act rating of 'outstanding' or 'satisfactory,' and is not subject to a cease and desist order or 

other enforcement actions, would be defined as an 'eligible bank'. Eligible banks submitting filings for 

branches, corporate reorganizations, operating subsidiaries to engage in certain activities, and other 

specified filings would qualify to use the expedited approval process. FR, 11/29/94, p. 61034. 

Concentrations of Credit and Nontraditional Activities 

The OCC, FRB, FDIC and OTS issued a final rule to implement Section 305 of FDICIA requiring the 

agencies to revise their risk-based capital standards for insured depository institutions to ensure that 

those standards take adequate account of concentration of credit risk and risks of nontraditional activities. 

The final rule, to be effective January 17, 1995, explicitly identifies such risks, as well as an institution's 

ability to manage them, as important factors in assessing an institution's overall capital adequacy. 

Concentrations of credit typically refer to situations when a lender has a relatively large portion of loans 

involving one borrower, industry, location, collateral or loan type. Nontraditional activities are considered 

those that have not customarily been part of the banking business but that start to be conducted as a 

result of developments in, for example, technology or financial markets. No mathematical formulas or 

explicit capital requirements for these two risks were adopted. Rather, a case-by-case approach will be 

used in assessing an institution's risks and overall capital adequacy. As an institution begins or 

significantly expands its participation in a nontraditional activity, the primary federal regulator will analyze 

the risks and request the appropriate capital and supervisory treatment. FR, 12/15/94, p. 64561; FIL-85-

94, FDIC, 12/19. 

Management of Derivatives 

The OCC released a 93-page booklet of examination procedures that expand on the guidelines on 

derivatives activities of banks which the agency issued in October 1993. The procedures specify the 

responsibilities of a bank's board and senior management in managing derivatives activities, 

distinguishing between different types of derivatives users. There are procedures for evaluating each of 

several types of risk, including market, credit, liquidity, operations and legal risks. The procedures will 

'give examiners detailed guidance for assessing whether banks have the necessary expertise, controls 

and procedures to manage the risks inherent in these complex instruments and use them in a safe and 

sound manner,' an OCC official said. Risk Management of Financial Derivatives, OCC, October 1994; 

BBR, 10/31/94, p. 620; AB, 10/24, p. 1. 
 

 

 

 

 

 

 

 

 

Disclosures in Mutual Fund Sales 

The OCC announced in May 1994, that in response to an interest expressed by a number of national 

banks in having the agency review disclosure materials they use in sales of mutual fund and annuity 

products, the agency would offer the opportunity for a one-time review of these disclosure materials. The 

OCC reported in September that it had completed a review of the materials. More than 700 national 

banks voluntarily submitted over 8500 different documents. 

Each national bank that participated in the review will receive a personalized letter that will include a 

document-by-document analysis of the materials it submitted. All national banks were sent a summary of 

the types of problems identified in the review and the type of action the OCC believes will correct the 

problems. Some of the specific areas where problems and corrections were discussed are: 

conspicuousness of disclosure displays; nondeposit products and bank obligations; investment risk; 

disclosure of bank and affiliate relationships; and annuities disclosures. Letter to National Banks, OCC, 

5/4/94; Disclosure Materials Used in Selling Mutual Funds and Annuities, OCC, 9/12/94. 

The FDIC distributed copies of the OCC's study to FDIC-supervised banks. The agency endorses the 

recommendations in the study, and encourages each bank that sells mutual funds or annuities to the 

public to review the report and correct any problems they find in their own disclosures. FIL-64-94, FDIC, 

9/27/94. 

Examinations of Noncomplex Community Banks 

The OCC adopted a policy and examination procedures for noncomplex community banks applicable only 

to the safety-and-soundness examinations of these banks. The new procedures are intended to improve 

efficiency and consistency in examinations, and reduce regulatory burden. 

Noncomplex community banks are banks that have composite ratings of 1 or 2 under the Uniform Interagency Bank Rating System, and operate under stable conditions demonstrated by stable bank 

management and ownership, no significant change in operations since the last examination, and a local 

economy that poses no material threat to operations. The definition also includes having management 

that is effective and responsive in addressing risks and conditions facing the institution, consistent and 

strong financial performance, and few or limited nontraditional products. Use of the new procedures is 

mandatory, beginning October 1, 1994. Bulletin 94-40, OCC, 6/20/94. 

State Regulation of Insurance Sales Upheld 

A panel of the U.S. Court of Appeals for the 11th Circuit, affirming a trial court's decision, ruled that the 

McCarran-Ferguson Act overrides other federal laws and gives states the right to regulate bank insurance 

sales. Barnett Banks Inc. argued in this Florida case that the National Bank Act supersedes state 

insurance law. The state allows independent state-chartered banks to sell insurance, but as a result of the 

decision it can deny insurance licenses to national banks. AB, 2/2/95, p. 1. 

Supreme Court Says Banks Can Sell Annuities 

The U.S. Supreme Court in a unanimous opinion in the case of NationsBank Corp. v. Variable Annuity 

Life Insurance Co . (Valic), upheld a decision of the OCC in the case that began in 1990 that selling 

annuities is 'incidental' to banking and a permissible activity under the National Bank Act. The Court's 

ruling is said to mark the first time it has explicitly stated that the OCC has the authority to grant powers 

not expressly included in the National Bank Act. An OCC spokesperson said the decision establishes a 

framework for the OCC to extend additional powers to banks. She said that in order that the grant of a 

new power is 'reasonable' as required by the Court, it would be necessary for the agency to show that the 

new power resembles an existing one. AB,<-3> 1/19/95, p. 1. 

Court Rules Banks Can Tie CD Rate to Stock Index 

A U.S. district court judge upheld a 1988 decision by the OCC allowing Chase Manhattan Bank to offer a 

CD tied to the performance of the Standard and Poor's 500 composite index. In his ruling the judge cited 

the case of NationsBank v. Valic, (see above), in which the Supreme Court concluded that the OCC has 
 

 

 

 

 

 

 

 

 

 

 

 

broad authority to decide what powers can be exercised by national banks. The Chase case is said to be 

the last of a series of challenges to bank securities powers that were carried over from the late 1980s. 

AB, 1/27/95, p. 2. 

Court Rules Bank Cannot Export Fees 

In a case involving late fees on credit cards, the Superior Court of Pennsylvania ruled against their 

interstate export by a Bank One unit. In 1978, the U.S. Supreme Court ruled that a national bank could 

export interest rates outside its home state. The Pennsylvania court said that late fees, and charges for 

exceeding credit limits and for insufficient funds, which are not levied on a percentage basis, cannot be 

defined as interest. The decision runs contrary to the rulings of a number of other courts, including seven 

different appellate courts. AB, 12/20/94, p. 14. 

Court Limits Banks' Sale of Insurance 

A federal magistrate judge in Indiana, in the case of NBD Bank v. Bennett, ruled that the National Bank 

Act does not empower banks to sell insurance outside the small towns where they operate. She said that 

Congress, in allowing national banks to sell insurance from offices in towns with fewer than 5,000 

residents, wanted to provide an incentive for banks to maintain their small-town branches. 

The U.S. Court of Appeals for the District of Columbia ruled in 1993 that banks may sell insurance 

anywhere from a branch in a small town. AB, 12/30/94, p. 1. 

CRA Enforcement Authority 

The Justice Department, responding to a request from the OCC, issued a legal opinion on use of 

regulatory general enforcement authority against institutions rated in substantial noncompliance with the 

CRA. Justice said the Act empowers the regulators to deny applications from these institutions for 

changes in corporate structure. Because of the sanctions explicitly provided, the regulators cannot utilize 

their general enforcement authority. Bank News, 1/95, p. 43. 

Appraisal Guidelines 

The OCC, FDIC, FRB, and OTS jointly issued appraisal and evaluation guidelines, superseding 

guidelines issued in 1992. Title XI of FIRREA requires the agencies to adopt regulations on the 

preparation and use of appraisals by federally regulated financial institutions. Such real-estate appraisals 

are to be in writing and performed in accordance with uniform standards. Although the agencies' appraisal 

regulations exempt certain categories of real-estate-related financial transactions from the appraisal 

requirements, most real-estate transactions over $250,000 are considered federally related transactions 

and thus require appraisals. An agency may impose more-stringent appraisal requirements than the 

appraisal regulations require. 

Among the specific topics addressed in the guidelines are elements of an effective real-estate appraisal 

and evaluation program, selection of individuals who may perform appraisals and evaluations, minimum 

appraisal standards, and program compliance. Inter-agency Appraisal and Evaluation Guidelines, OCC, 

FDIC, FRB, and OTS, 10/27/94; Joint Release, PR-73-94, FDIC, 11/7/94. 

NASD and Regulatory Agencies Agree on Coordinating Examinations 

The National Association of Securities Dealers (NASD) and the OCC, FRB, FDIC and OTS agreed in 

principle to coordinate their examinations of registered broker dealers selling mutual funds and other 

nondeposit investment products on the premises of depository institutions. The agreement is intended to 

ensure that their common interest in the supervision of broker dealers affiliated with depository institutions 

is addressed with a minimum of duplication of activity, and to promote regulatory consistency and reduce 

unnecessary burdens. 

Among other things, the NASD and banking agencies will share examination schedules for depository 

institutions that have affiliated broker dealers, and they may request that an observer be present at each 

other's examination. The NASD will provide the banking agencies with access to findings and workpapers 
 

 

 

 

 

 

 

 

 

 

 

from its most recent examination of affiliated broker dealers. There is a reciprocal agreement for referrals 

of apparent violations of apparent securities laws, and banking laws and regulations, among the NASD 

and the banking agencies. Joint Release, OCC, FDIC, FRB, OTS, NASD, 1/3/95. 

It was announced earlier that planning is under way to subject bank-employed brokers who sell mutual 

funds and other securities to the same licensing requirements as govern other such brokers. The NASD 

would administer entrance exams to bank brokers but have no further disciplinary authority. Comptroller 

of the Currency Eugene Ludwig expressed hope that a testing program can be established within the next 

year. AB, 9/28/94, p. 2. 

Risk-Based Capital 

The OCC and the FRB proposed amending their risk-based capital guidelines to modify the definition of 

the OECD-based group of countries, in which claims on governments and banks generally receive lower 

risk-weights than corresponding claims on these entities in non-OECD-based countries. The revisions are 

based on an announcement by the Basle Committee of a planned modification to the Basle Accord, the 

effect of which would be to exclude from the so-defined group of countries any country that has 

rescheduled its external sovereign debt within the previous five years. FR, 10/14/94, p. 52100. 

The OCC issued a final rule to amend its risk-based capital guidelines to lower the risk-weight from 20 

percent to zero percent for securities lending, repurchase agreement transactions, and certain 

collateralized accounts and financial exposures. One purpose of the rule is to ensure that the risk-weight 

assigned to transactions collateralized with cash or government securities more accurately reflects the 

minimal operational risk and near absence of credit risk in those transactions. FR, 12/28/94, p. 66642. 

Equity Derivative Swaps Approved 

The OCC gave approval, in a letter to Citibank N.A., for national banks and their operating subsidiaries to 

engage in equity swaps and equity index swaps. The agency said the equity swaps are essentially 

activities that have been approved for national banks in other forms. It said equity derivative swaps are 

incidental to the express power of national banks to receive deposits, make loans, and to the business of 

banking. BBR, 9/19/94, p. 375. 

Approval For D.C. Bank to Branch Into MD 

The OCC gave approval for the $77 million-asset Capital Bank in the District of Columbia to move its 

headquarters to Maryland and retain its existing offices in D.C. Under the OCC's regulations, a national 

bank may move its head office up to 30 miles even if the move crosses a state line. This is the first such 

approval for branching into a state where the banking firm had no existing operations. AB, 10/21/94, p. 2. 

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, which was signed into law on 

September 29, 1994, authorizes a bank holding company, beginning one year after enactment, to acquire 

a bank located in any state. It authorizes an insured bank, beginning June 1, 1997, to merge across state 

lines unless the affected states have 'opted-out' of interstate branching by enacting laws that prohibit 

interstate branching. Also, it authorizes, among other things, an insured bank to establish a de novo outof-state branch if the host state expressly permits interstate branching through the establishment of de 

novo branches. 

Securities-Offering Disclosures 

The OCC adopted amendments, effective April 3, 1995, to replace rules detailing the contents of offering 

documents covering national bank securities, and to require that offering documents conform to the 

information requirements contained in the Securities and Exchange Commission (SEC) registration form. 

The amendments are intended to reduce unnecessary regulatory burdens on national banks and 

enhance their ability to raise capital, while maintaining the %4 quality of disclosures provided to investors. 

The final rule generally treats national bank securities comparably to those of other corporations. 

Because the OCC rules will now actually reference the SEC rules, rather than parallel or copy them, the 

OCC rules will automatically remain current. FR, 11/2/94, p. 54789. 
 

 

 

 

 

 

 

 

Contracting Outreach Program 

The OCC adopted a rule, effective October 11, 1994, that is intended to ensure that businesses owned 

and controlled by members of minority groups, women and individuals with disabilities are provided the 

opportunity to participate in the agency's contracting processes. It also designates the official responsible 

for implementing the Outreach Program and its oversight. FR, 9/8/94, p. 46325. 

Assessments and Fees to Be Reduced 

The OCC adopted an interim rule, and requested comments on changing the method for the calculation 

of fees for examinations of fiduciary activities, and certain other examinations and investigations, to give 

the agency more flexibility for reducing existing rates. 

The agency also has announced several reductions, among which are the supervision hourly rate, from 

$102 to $50, applications for ATMs, from $1,500 to $400, and applications for branch or head office 

changes, from $900 to $700, all to be effective January 1, 1995. FR, 11/18/94, p. 59640; BBR, 11/7, p. 

659; 11/18, p. 776; AB, 11/17, p. 2. 

Office of Thrift Supervision 

Mergers and Charter Conversions 

The OTS, effective September 29, 1994 and pursuant to Sections 501 and 502 of FDICIA, amended its 

regulations governing mergers and combinations involving federal savings associations to give 

associations more flexibility to change charters, either by charter conversion or by merging. For example, 

the rule allows federally chartered savings associations to convert directly to state or national banks, and 

establishes procedures non-thrifts must follow to convert to a federal savings association or savings bank. 

With the new rule, well-managed, well-capitalized savings associations that wish to change charters need 

only notify the OTS. Applications, subject to OTS approval or denial, are still required when the savings 

association has a CAMEL or Compliance rating of 3, 4, or 5; a less than satisfactory CRA rating; or fails 

its capital requirements. 

The final regulations authorize federal stock associations to combine with any FDIC-insured depository 

institution, and authorizes federal mutual associations to combine with any FDIC-insured institution, 

provided that a mutual association is the resulting institution. In addition, certain combinations are 

authorized that involve federal associations and depository institutions not insured by the FDIC. Other 

amendments concern the procedures regarding applications to engage in the above-described actions. 

NEWS, OTS, 8/30/94; FR, 8/30, p. 44615. 

Conversions From Mutual to Stock Form 

On May 3, 1994, the OTS issued an interim final rule and a proposed rule, each with a request for 

comments (see this Review , Winter 1995, p. 46), on conversions from mutual to stock form and mutual 

savings-and-loan holding companies. A final rule, issued on November 22 and effective January 1, 1995, 

revised the interim rule by making local depositor preference in stock purchases optional rather than a 

requirement. A companion rule proposed in May requires a converting institution to meet the 

'convenience and needs' of its community. The OTS will henceforth consider a conversion applicant's 

CRA performance and other related factors in evaluating such an application. Among other changes, the 

final rule deletes the 100-mile local area definition of the local community for purposes of local depositor 

preference. FR, 11/30/94, p. 61247; NEWS, OTS, 11/22/94. 

Investments in Structured Notes 

The OTS alerted savings associations to potential risks inherent in structured notes. These notes are debt 

securities with derivative-like characteristics that are issued by corporations and government-sponsored 

enterprises, including the Federal National Mortgage Association, the Federal Home Loan Mortgage 

Corporation, and the Federal Home Loan Banks. Structured notes take various forms and often contain 

complex rate-adjustment formulas and embedded options. They may be customized to meet the needs of 

a particular investor, or issued in a more generic form to meet the needs of a broader range of investors. 
 

 

 

 

 

 

 

 

 

 

 

 

The agency said that while structured notes can be useful investments, they may, because of their 

complexity, be inappropriate for unsophisticated investors. Steps are indicated that savings associations 

should take before buying structured notes. For example, thrifts should make sure structured notes are 

consistent with their investment policy, that they thoroughly understand the risk/return characteristics of 

the instruments, and that they evaluate the effect of the investment on the institution's net portfolio value 

and earnings under different interest-rate scenarios. NEWS, OTS, 8/16/94; Thrift Bulletin 65, 8/15. 

Manual Explains Interest-Rate- Risk Measurement 

The OTS released a 300-page manual describing the computer model it uses to measure interest-rate 

risk (IRR) at the savings associations it regulates. Under the agency's capital regulation, savings 

institutions are required to hold capital as a cushion against potential losses if they have IRR above a 

certain level. The manual explains how the model is used to assess institutions' IRR and to calculate their 

capital requirements based on that risk. There is a general, non-technical discussion of OTS' approach to 

measuring IRR, and a detailed technical description of how the interest-rate sensitivity of institutions' 

assets, liabilities and off-balance- sheet items are estimated. NEWS, OTS, 12/22/94. 

Interest-Rate-Risk Appeals Process 

In August 1993, the OTS issued its final rule concerning the interest-rate-risk component of the risk-based 

capital requirement. The agency now proposes a process by which certain savings associations may 

appeal their IRR component calculated by the OTS. Three methods are proposed by which savings 

associations could be authorized to deviate from the interest-rate-risk methodology now in use by OTS. 

An institution could appeal its IRR component using appeals procedures described in the notice. An 

abbreviated certification process is available for certain highly capitalized institutions under specified 

conditions. This certification process may result in authorization for the institution to calculate its own IRR 

component for regulatory purposes. Finally, an institution could petition the OTS to change the 

methodology used in OTS' Net Portfolio Value Model. 

Under the proposal, the agency would consider appeals related to the IRR component only from 

institutions whose capital level would fall to a lower prompt corrective action (PCA) category as a result of 

their IRR component. An institution would have to show that the IRR exposure calculated by the OTS 

would be made more accurate through the use of either more refined data or more appropriate 

assumptions than those used in the NPV model. Certain fundamental parameters and scenarios used in 

constructing the computer model could not be the basis of an appeal. An institution would have to file its 

appeal within six months after the end of the quarter on which the disputed interest-rate-risk component is 

based. An OTS appeals committee would issue a decision within 60 days. 

The FRB, OCC, and the FDIC have published proposed rules to incorporate interest-rate-risk components 

in the risk-based capital requirements of commercial banks and expect to finalize these rules during the 

next year. NEWS, OTS, 8/16/94. 

Inter-Affiliate Banking Expanded 

The OTS Chief Counsel issued an opinion that federal savings associations regulated by the agency no 

longer must file a branch application to enter into inter-affiliate banking arrangements. Thus, affiliated 

federal associations may offer basic banking services to each other's customers without the need to 

obtain regulatory approval, even when the services are provided across state lines. NEWS, OTS, 2/9/95. 

Annual Independent Audits 

The OTS amended its annual independent audit requirements for savings associations to be more 

consistent with those applicable to other federally insured depository institutions. Pursuant to Section 112 

of FDICIA, all insured depository institutions with total assets of $500 million or more are required to 

obtain an annual independent audit. The agency's rules are amended also to eliminate the mandatory 

annual independent audit requirement for small savings associations with composite CAMEL ratings of '1' 

or '2'. The OTS still can require an independent audit of any savings association with assets of less than 

$500 million, as needed for purposes of safety and soundness. Effective date:December 23, 1994 . FR, 

11/23/94, p. 60300. 
 

 

 

 

 

 

 

 

 

 

Capital Distributions 

The OTS proposed amending its capital distributions regulation to conform to the system of prompt 

corrective action (PCA) established by FDICIA and by implementing its own regulations and those of 

other federal banking agencies. Under the proposal, which incorporates the PCA definition of capital 

distributions, a savings association that is not held by a savings-and-loan holding company and that has a 

composite CAMEL rating of '1' or '2' need not notify the OTS before making a capital distribution. 

Associations that would be at least adequately capitalized after making a capital distribution would be 

required to provide notice to the OTS. 'Troubled' associations and undercapitalized associations may 

make capital distributions only by filing for and receiving OTS approval, which may be granted only under 

certain limited conditions. The proposed regulation defines 'troubled condition' as a function of a savings 

association's composite examination rating, its capital condition, or on the basis of supervisory directives 

or designation by the OTS. FR, 12/5/94, p. 62356. 

Funds-Cost Index May Be Eliminated 

The OTS announced that its monthly median cost of funds, which is one of several indexes used to 

change interest rates on adjustable-rate mortgages (ARMs), may be terminated or modified. The index, 

compiled since December 1982, reflects the median interest rate that thrift institutions pay on deposits 

and on borrowed money. Comments are requested on whether the monthly index should be retained in 

light of a recent survey indicating relatively few ARM loans with rates tied to the index are made, and 

because other indexes, such as Treasury bills, are currently available to take its place. NEWS, OTS, 

10/17/94. 

Agency's Authority Upheld on Receivership 

A federal appeals court ruled that the courts may not review a decision by the OTS to replace a 

conservator of a failed savings association with a receiver. The decision by the Tenth Circuit Court of 

Appeals came on an appeal by Franklin Savings Association, Ottawa, Kansas, and its holding company, 

Franklin Savings Corporation. The RTC was first appointed conservator for the association by the OTS in 

February 1990, and had its status changed to receiver in September 1992. The association was resolved 

by the RTC in June 1994. The court cited FIRREA as providing for judicial review of an 'appointment' of a 

conservator or receiver, but not for a 'replacement' of a conservator with a receiver. NEWS, OTS, 9/21/94. 

Court Orders New Rulemaking in Conversion Regulation 

A U.S. district judge found that the OTS failed to seek the required public comment on the local-depositor 

provision of an 'interim final rule' it issued in late April that, in mutual-to-stock conversions, gave priority 

stock purchase rights to depositors who live in a thrift's 'local community' or within 100 miles of a home or 

branch office (see this Review , Winter 1995, p. 46). The OTS' objective in adopting the rule was to 

restrict windfall profits for insiders, and speculators who deposit funds in distant thrifts in which they could 

purchase stock should the institution later convert. The judge nullified this part of the broader rule issued 

by the OTS, and ordered the agency to conduct new rulemaking, including seeking public comment. 

WSJ, 10/3/94, p. A4. 

Application Decision Deferred Based on CRA Performance 

The OTS deferred action on an application by Avondale Federal Savings Bank, Chicago, to convert from 

a mutual to stock association, based on 'needs to improve' CRA ratings the thrift has received. An OTS 

official said it was the agency's first deferral of a conversion application based on an institution's CRA 

compliance record. An Avondale spokesperson said the institution has taken steps to improve its CRA 

performance, including establishing special marketing plans for low-income neighborhoods, and 

improving its community relations. BBR, 8/22/94, p. 247. 

Agency Continues to Reduce Staff 

The OTS announced consolidations and realignments of certain functions and a year-end 1995 staffing 

target of 1,500. The projected cut in staff is a continuation of annual reductions that have shrunk the 

agency from 3,389 at year-end 1989 to 1,771 in September 1994. The 48-percent reduction in staff over 

the past five years has been achieved through a combination of attrition and formal reduction-in-force 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

actions. The OTS projects expenses for 1994 of $178.1 million, compared with $296.9 million for 1990. 

NEWS, OTS, 9/13/94. 

Federal Financial Institutions Examination Council 

Capital Treatment of Unrealized Gains/Losses 

A task force of the FFIEC recommended to the member agencies that the net unrealized holding gains 

(losses) on available-for-sale debt securities not be included in regulatory capital for purposes of 

computing the leverage and risk-based capital ratios. Accordingly, when calculating these ratios, the 

amortized cost rather than the fair value of available-for-sale debt securities generally would be used. 

With regard to equity securities that have readily determinable fair values, it is recommended that they 

continue to be valued at the lower of cost or fair value for regulatory capital purposes. Examiners should 

continue their longstanding practice of considering any unrealized appreciation and depreciation on debt 

and equity securities not recognized in capital ratios when evaluating the adequacy of an institution's 

capital. These recommendations would continue the interim policies adopted by the FRB, FDIC, and OCC 

when FASB Statement No. 115 became effective, but would represent a reversal of the interim OTS 

policy issued in August 1993 to follow the Statement in computing savings associations' regulatory 

capital. Press Release, FFIEC, 11/10/94; Accounting for Certain Investments in Debt and Equity 

Securities, Financial Accounting Standards Board, May 1993. 

The FFIEC issued a statement regarding the regulatory reporting treatment of allowances established 

under Statement No. 114, ' Accounting by Creditors' for Impairment of a Loan, FASB, and regulatory 

capital issues arising from Statement No. 109, 'Accounting for Income Taxes.' Press Release, FFIEC, 

11/18/94. 

Information on Reporting Changes 

The FFIEC issued a 17-page booklet, for distribution to all insured banks, detailing the deletions and 

additions in the preparation of Call Reports for March 31, 1995. Among the changes thus far are: 

expansion of disclosures about a bank's involvement with off-balance-sheet derivatives; providing data on 

investments in high-risk mortgage securities and structured notes and on sales of proprietary mutual 

funds and annuities; reducing the level of detail regarding certain restructured loans and leases; and 

deleting items for total risk-based capital and average loans to states and political subdivisions. BBR, 

11/28/94, p. 780. 

National Credit Union Administration 

Mergers or Conversions of Credit Unions 

The NCUA is issuing an interim final rule, effective immediately, to clearly establish the agency's 

jurisdiction over all conversions by insured credit unions (see this Review , Winter 1995, p. 49). The 

interim rule requires that all mergers or conversions, involving one or more federally insured credit unions, 

including those where the resulting institution is not a credit union, must be approved by the NCUA Board. 

The rule also specifies that all notices are subject to NCUA approval. Comments on a number of related 

issues are requested. FR, 9/23/94, p. 48790. 

Corporate Credit Unions 

The NCUA amended, effective January 1, 1996, its regulations governing corporate credit unions to 

reduce the close ties between many corporate credit unions and credit union trade associations. Among 

the requirements in the final rule is that at least a majority of a corporate credit union's directors, including 

the chair, be representatives of member credit unions. A majority of a corporate credit union's directors 

may not be individuals who also serve as officers, directors, or employees of the same trade association 

or affiliated trade associations. The rule requires that the chief executive officer of a corporate credit union 

answer solely to the board of directors and not also serve as an employee of a trade association. 

Corporate officials must distance themselves from any decision involving another organization to which 

they belong. Corporate membership may not be linked to membership in a trade group. 
 

 

 

 

 

 

 

 

 

 

 

 

As of early 1994 there were 44 corporate credit unions serving the nation's 13,000 natural person credit 

unions. The corporate credit union system provides liquidity, investment and payment services to credit 

unions. FR, 4/19/94, p. 18503,; 11/17, p. 59357; AB, 11/14, p. 1. 

The NCUA placed the $1.4 billion-asset Capital Corporate Federal Credit Union into conservatorship, 

after Capital suffered large losses and was unable to meet withdrawals. The Corporate, based in a 

Maryland suburb of Washington, D.C., had invested heavily in collateralized mortgage obligations, whose 

value fell sharply when interest rates rose. The agency reportedly has moved quickly to sell off the 

investment portfolio, causing concern in the industry that the Corporate, which has 483 credit union 

members, will be liquidated. Latest information indicates that the credit union's $74 million in capital will 

cover any loss. AB, 2/2/95, p. 1; 2/17, p. 1. 

CAMEL Rating System Is Revised 

The NCUA is restructuring its credit union rating system to give examiners more flexibility to consider both 

qualitative and quantitative factors when assigning supervisory ratings to federally insured credit unions. 

Changes in the new system focus in particular on evaluating the condition and performance of credit 

unions in absolute terms rather than against peer averages or predetermined benchmarks. Numerous 

revisions are made in the various financial ratios used for evaluation purposes. Other changes include 

expansion of management review to include business strategy/financial performance; internal controls; 

management conduct; and service to members. Letter to Credit Unions, No. 161, NCUA, 12/94; BBR, 

1/9/95, p. 78. 

Courts Uphold the NCUA on Credit Union Expansions 

The U.S. Court of Appeals for the Sixth Circuit, in Cincinnati, upheld a NCUA decision permitting Portland 

Federal Credit Union, Portland, Michigan, to expand its service area from Portland, which has a 

population of 4,000, to a surrounding area having a population of about 70,000. The decision comes from 

the highest court yet to rule on the 'common bond' issue, following losses by bankers of decisions in three 

states. They have sued the NCUA in six states, and state regulators in two, charging excessively liberal 

policies in allowing credit unions to expand their territories. Some of these cases involve the ability of 

credit unions to serve unrelated groups of people, not communities. Also, the appellate court in the 

Portland case said its decision is confined to the facts of that case. AB, 12/9/94, p. 1; BBR, 12/12, p. 882. 

The U.S. District Court for the District of Columbia agreed with the NCUA's interpretation of the common 

bond, saying it was 'a reasonable construction of an ambiguous statute.' The case began in 1990 when 

four North Carolina banks and the American Bankers Association sued the NCUA, claiming a violation of 

the Federal Credit Union Act, for permitting AT&T Family Federal Credit Union to enroll employees of 

groups unrelated to its original sponsor. AB, 9/16/94, p. 4. 

Truth in Savings 

The NCUA published its official staff commentary to Part 707 of its Regulations. As required by the Riegle 

Community Development and Regulatory Improvement Act of 1994, the accounts of unincorporated 

business associations are exempted from coverage of Part 707. Effective date: 1/1/95. FR, 11/21/94, p. 

59887. 

The NCUA early in 1994 extended the date for compliance with its Truth-in-Savings regulation, to March 

31, 1995 for credit unions of an asset size between $500,000 and $1 million as of December 31, 1993, 

that are not automated, and to June 30, 1995 for credit unions of less than $500,000 that are not 

automated. The compliance date for all other credit unions remained January 1, 1995. Subsequently, the 

agency extended compliance to January 1, 1996 for credit unions of an asset size of $2 million or less as 

of December 31, 1993, that are not automated. FR, 8/3/94, p. 39425. 

Supervisory Review Committee 

The NCUA proposed a review process pursuant to a requirement of the Riegle Community Development 

and Regulatory Improvement Act of 1994 that the federal banking agencies each establish an appeals 
 

 

 

 

 

 

 

 

 

 

process to review material supervisory determinations made with respect to insured institutions . FR, 

11/17/94, p. 59437. 

Loan Interest Rates 

The NCUA is continuing an 18 percent federal credit union loan rate ceiling for the period from September 

9, 1994 through March 8, 1996. Loans and line of credit balances existing prior to May 15, 1987 may 

continue to bear their contractual rate of interest, not to exceed 21 percent. The current rate ceiling was 

scheduled to revert to 15 percent on September 9, 1994, unless otherwise provided by the NCUA Board. 

The Board said a 15 percent ceiling would restrict certain categories of credit and adversely affect the 

financial condition of a number of federal credit unions. FR, 8/3/94, p. 39423. 

Federal Housing Finance Board 

FHLBank System Membership Now Over 5,000 

The Federal Home Loan Bank System has increased by 1,800 members since the enactment of FIRREA 

in August 1989, which made it possible for commercial banks and credit unions to voluntarily join the 

System. As of July 31, 1994, a total of 4,936 financial institutions were members of the System, including 

2,736 commercial banks, 2,112 thrifts, 70 credit unions and 18 insurance companies. Currently, System 

members hold $925 billion in residential mortgage loans, about one-third of all home mortgage debt 

outstanding in the United States. After approval, an institution becomes a member by purchasing District 

Bank stock. Members receive a competitive dividend return on their stock investment. Included among 

the statutory requirements for membership in the System are that an institution must make long-term 

mortgage loans, and it must have at least ten percent of its total assets in residential mortgage loans. 

Through the 12 member-owned, FHFB-regulated District FHLBanks, the System provides long-term loans 

on many types of mortgage collateral, and provides liquidity for housing finance by means of advances 

(loans) to member institutions. Advances are made at interest rates that are lower than those in the 

commercial market, particularly on longer-term funds. The System raises funds by selling consolidated 

obligations to retail and institutional investors. Because the System has a stand-alone Triple-A credit 

rating and is a government-sponsored enterprise, it can raise debt at rates only slightly higher than rates 

on Treasury securities. NEWS, FHFB, 9/93; 7/94; News Release, FHLBank System, 9/30/94. 

Under FIRREA, the FHLBanks were required to implement an Affordable Housing Program with 

subsidized loans to member institutions for financing housing projects in low-income communities. At mid1994, outstanding commitments under the program amounted to $272 million, for nearly 1,900 projects 

involving construction or rehabilitation of about 72,000 housing units for low-income families. Also, the 

program's resources have leveraged $3.8 billion in development funds to date, with a leveraging ratio of 

over 13 to 1. BBR, 8/29/94, p. 286. 

STATE LEGISLATION AND REGULATION 

Bank Loses Insurance Power in BHC Takeover 

Arkansas: The state's Supreme Court ruled that the Arkansas Bank and Trust Company, with total assets 

of about $400 million, lost its right to operate an insurance company, which had been grandfathered when 

the bank was acquired in 1990 by First Commercial Corp., a multibank holding company. The Court, in a 

split decision, held that First Commercial acts as a bank and thus a provision of the law preventing 

transfer of the right to another bank is applicable. Divestiture is required under the decision. AB, 11/17/92, 

p. 2. 

Acquisitions of Banks 

Illinois: A new law, effective June 29, 1994, eliminates the current prohibition, which has threatened 

Illinois' reciprocal banking status with other states, on purchases by bank holding companies of banks in 

the state that are less than ten years old. Illinois Banker, 9/94, p. 24. 

Lending Limits 

Illinois: New legislation, effective June 29, 1994, raises the lending limits for state banks consistent with 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

changes being made for national banks. While state banks have a higher lending limit (currently 20 

percent) than national banks (currently 15 percent), the state's lending limit is based on definitions of 

capital and surplus that do not include numerous capital-related accounts that have been added to the 

federal definition over time. Illinois Banker, 9/94, p. 24. 

Kansas: An amendment, effective July 1, 1994, increases the lending limit for active officers and 

employees of state-chartered banks from five percent to 15 percent of unimpaired capital stock and 

unimpaired surplus. 

The amount of any loan in excess of which the prior approval of a bank's board of directors is required is 

raised to $50,000 from $10,000. The Kansas Banker, 7/94, p. 31. 

Reverse Mortgage Loans 

Illinois: An omnibus banking law, effective January 1, 1995, authorizes banks to make reverse mortgage 

loans for any purpose to persons under age 62. Presently, these loans can be made to persons of this 

age only for home improvements and repairs or the payment of insurance premiums and residential realestate taxes. The loans are not similarly restricted for those 62 and over. Illinois Banker, 9/94, p.20. 

Credit Cards Accepted For Taxes 

Kansas: A new law, effective July 1, 1994, permits the state Director of Taxation and county treasurers to 

accept credit-card payment for any taxes or fees assessed by these offices. The type of cards accepted is 

subject to the discretion of the state and local officials. The Kansas Banker, 7/94, p. 31. 

Credit Union's Membership Base Expanded 

Maine: The Banking Superintendent approved the conversion of the $15 million-asset Saco Valley 

Federal Credit Union to a state charter, under which the institution's membership base will widen to 

include persons who live or work in ten communities. The official said the larger base would help Saco 

Valley survive cutbacks by its membership's employers, and that competitor banks should not be 

materially impacted. The agency denied six communities requested by Saco Valley, some of which are 40 

miles from its headquarters, for reasons of the lack of a common bond, and doubts concerning Saco's 

ability to serve the towns. AB, 9/9/94, p. 11. 

Depositor Reimbursement Law Ruled Unconstitutional 

Nebraska: The state Supreme Court ruled that a 1993 state law that appropriated $16.5 million to 

reimburse depositors of three failed industrial loan companies is unconstitutional. Deposits of the 

companies were insured by the Nebraska Depository Institution Guaranty Corp., which did not have the 

assets to meet its insurance commitments. The basis for the Court's decision was the fact, which the 

state did not contest, that the depositors' claims were not legal obligations of the state. BBR, 7/25/94, p. 

132. 

Bank Protection Against Foreign Government Actions 

New York: New legislation, effective immediately, protects state-chartered banks and trust companies and 

national banks in the state from repayment claims of depositors in their foreign subsidiaries, if payment is 

made impossible by war, civil strife or an act of a foreign government, unless the deposit contract 

specifically provides that the home office would pay off these deposits. Legislation enacted initially by the 

state in 1937 has protected banks in such circumstances, but the courts have ruled in two recent cases 

that this protection does not cover the claims of depositors in their foreign branches. BBR, 8/1/94, p. 158. 

Basic Checking Services 

New York: The state Banking Board approved a proposal for low-cost checking accounts at statechartered banking institutions, as required under the state's Omnibus Consumer Protection and Banking 

Deregulation Act of 1994. Basic checking accounts would require an initial deposit of no more than $25, 

and with no minimum required balance. Banks could impose a $3 maximum monthly maintenance 

charge, and would provide at no additional cost a minimum of eight withdrawal transactions per month, 
 

 

 

 

 

 

 

 

 

 

 

including institution-operated automated teller machine transactions. Extra fees could be charged to 

customers for withdrawals or deposits at ATMs not operated by their bank, for more than eight 

withdrawals, and use of other charge services. BBR, 8/1/94, p. 158; 10/31, p. 633; AB, 11/10, p. 4. 

Derivatives and Foreign-Exchange Contracts 

New York: An amended law, closing a legal loophole, provides that agreements involving oral telephone 

trades and screen-to-screen trades cannot be nullified and are enforceable if there is an admissible tape 

recording or similar electronic evidence. These transactions now comprise 99 percent of the market. Also, 

a written confirmation within five days of the trade not objected to within three days results in a legally 

binding trade. Under the state's existing law, agreements for trades that could not be performed within a 

year, and foreign-exchange contracts of any length, must be in writing to be enforceable. BBR, 8/1/94, p. 

157. 

Low-Income Loan Program 

New York: The New York Mortgage Coalition, a group comprising 14 New York-area banks, announced 

that in its first year it had made 191 mortgage loans to low-income and moderate-income borrowers 

totaling more than $215 million. Of loan applicants referred to the Coalition from community groups 

through April 1994, 78 percent have been approved and some are pending. The denial rates -- 16 percent 

for black applicants, 13 percent for Hispanics, and ten percent for whites are well below the national 

averages in Home Mortgage Disclosure Act (HMDA) data compiled by the FFIEC. AB, 8/23/94, p. 9. 

Mutual Thrift Conversions 

New York: The Banking Department proposed regulations which in mutual-to-stock conversions would: 

limit stock-based compensation for officials of converting institutions; place restrictions on the proxy 

process; require a detailed explanation of stock-appraisal methodology; require in-depth information on 

the planned use of the stock offering proceeds; and require a justification for any planned stock 

repurchases, which would be subject to limitations contained in the guidelines of OTS. BBR, 8/29/94, p. 

289. 

The Banking Board proposed amendments to its savings bank conversion regulation that, in these 

conversions would specifically prohibit special interest payments to depositors. Only depositors would be 

allowed to conduct proxy solicitations against management. Stock grants and stock options for officers, 

trustees, and directors at the time of a conversion would be prohibited, but stockholders could approve 

these actions at the firm's first annual meeting. The Banking Department noted that the regulation 

generally conforms to a new interim rule adopted by the OTS. BBR, 8/1/94, p. 157. 

Interstate Banking 

South Carolina: As a result of amendments to become effective July 1, 1996, to the state's bank holding 

company statute, bank holding companies outside the region will have the same acquisition options in the 

state as holding companies in the states within the Southeast regional banking compact. Similar 

extensions of interstate banking rights to states outside the region have been enacted as of July 1994 in 

Georgia, North Carolina, and Virginia. BBR, 7/25/94, p. 121. 

Credit Union Expansion Policy 

Washington: Since taking office in November 1993, the Director of Financial Institutions has allowed eight 

state-chartered credit unions to take communities into their customer base. The credit unions serve 13 

communities with a population of about 324,000. The official said the state wants to create an 

environment that promotes competition and eliminates unnecessary barriers to business. Previously, 

these expansions were permitted only in exceptional cases, such as when a credit union's sponsor was 

undergoing an employment reduction. AB, 8/19/94, p. 7. 

BANK AND THRIFT PERFORMANCE 
 

 

 

 

 

 

 

 

 

 

Commercial Banks' Nine-Month Earnings Set Record 

Commercial banks earned a record $11.8 billion (preliminary) in the third quarter of 1994, and for the first 

nine months their profits totaled $34 billion, a record for any nine-month period and $1.4 billion ahead of 

the first nine months of last year. The third quarter's performance reflected strong loan growth, which 

increased the industry's interest-earning assets and raised the average yields on those assets. Loan 

growth was led by increases in home mortgages, consumer loans and loans to businesses. Banks 

reduced their securities holdings for the second consecutive quarter. Provisioning for loan losses, 

reflecting continuing declines in troubled loans, was the lowest in ten years. Charge-offs of $2.4 billion 

were the least since the first quarter of 1985. 

Commercial banks' average return on assets (ROA) rose to an annualized 1.21 percent in the third 

quarter, from 1.16 percent in the second quarter. Nearly 96 percent of all commercial banks reported a 

profit in the third quarter. Chairman Ricki Helfer said the data indicate that the commercial banking 

industry has never been in better shape, but as the insurer of banks and thrifts, the FDIC will be 

monitoring such areas as derivatives investments and loan approval standards. 

FDIC-insured, private-sector savings banks and savings-and-loan associations reported earnings of $2.1 

billion in the third quarter, an improvement of $349 million from the previous quarter and $950 million from 

a year ago. Lower overhead expenses and reduced provision for future loan losses were the main factors 

contributing to the earnings improvement. The thrift industry's average ROA rose to an annalized 0.86 

percent in the third quarter, from 0.73 percent in the previous quarter and 0.48 percent a year ago. 

Ninety-three percent of all savings institutions were profitable in the third quarter. FDIC Quarterly Banking 

Profile, Third Quarter, 1994; PR-81-94, FDIC, 12/15/94. 

One in Five Banks Selling Mutual Funds or Annuities 

Data from Call Reports show that in the first quarter of 1994, about one in five insured commercial banks 

in the U.S. (2,261 banks) sold mutual funds or annuities to their customers. Of that group, 51 percent sold 

both mutual funds and annuities, while 30 percent sold only mutual funds and the remaining 19 percent 

sold only annuities. 

Approximately 14 percent of banks with assets of less than $100 million sold mutual funds or annuities, 

compared with 66 percent of banks with assets of $1 billion to $15 billion, and 100 percent of banks with 

assets of more than $15 billion. While bank sales of money-market mutual funds were far larger than 

sales of long-term (equity and bond) funds $97.7 billion versus $9.5 billion many more banks sold longterm funds than money-market funds, and this was true for all asset categories except the largest (above 

$15 billion in assets). 

Sales of mutual funds and annuities still account for a small portion of bank revenue. On average, fees 

and other income from sales of these products represented slightly less than four percent of noninterest 

income at selling banks in the first quarter. There were, however, significant variations among institutions. 

Fifty-one banks, all of which had assets of less than $400 million and most were below $100 million, 

reported mutual fund and annuity income of at least 20 percent of their noninterest income. More than 

500 banks reported ratios of five percent to 20 percent. 

One limitation of the study is that the gross sales data are not adjusted for redemptions, reinvested 

dividends, or transfers among funds, thus banks' involvement may be overstated. Also, the revenue data 

may reflect income and fees earned on sales from previous quarters, and they do not separate income 

from mutual funds and income from annuities. AB, 8/25/94, p. 12; Central Banker, Federal Reserve Bank 

of St. Louis, Summer 1994. 

Only Small Minority of Buyers Think Bank-Sold Mutual Funds Are Insured 

A survey released in December 1994 by the Consumer Bankers Association showed that 21 percent of 

household financial decision makers and five percent of bank mutual fund customers thought investments 

in mutual funds are federally insured. However, the Association said customers need more information 
 

 

 

 

 

 

 

 

 

 

 

about other risks in mutual funds, such as variable rates of return, possible loss of principal, and 

commission or management charges, whether the funds are purchased from banks or other sources. 

The survey, conducted by the Roper Organization, included interviews with a random group of 700 

financial decision makers at households with at least $30,000 in annual income, and 139 bank mutual 

fund customers randomly selected from lists supplied by banks. BBR, 12/19/94, p. 916; The Arkansas 

Banker Magazine, 12/94, p. 15. 

Decline in Credit Union Assets 

Assets of the nation's largest federally insured credit unions those with over $50 million in assets fell 0.7 

percent in the third quarter of 1994 to $199.5 billion, according to the NCUA. It was the first quarterly 

decline since the third quarter of 1988. Deposits fell by 1.1 percent, while total loans grew 3.4 percent. An 

industry analyst attributed the decline in deposits mainly to a healthy economy in which consumers are 

spending more and saving less. He predicted that developing liquidity pressures may result in credit 

unions raising their loan rates in the coming months. The capital-to-assets ratio increased from 9.5 

percent to 9.8 percent in the quarter. AB, 11/18/94, p. 3. 

Check Fraud Problem Getting More Attention 

Check fraud at banks rose by 136 percent in the two years through 1993, to 1.27 million cases, and 

banks' losses from check fraud rose by 43 percent to $815 million, according to a survey by the American 

Bankers Association. Regionally, the percentage of banks experiencing losses ranged from more than 80 

percent in the Northeast to just under 50 percent in the Midwest. The proportion of banks experiencing 

check fraud losses also varied by the size of the institution -- almost 90 percent of banks with more than 

$5 billion in assets compared to 54 percent of banks with $500 million or less in assets. Discussing the 

causes for the rapid increase in check fraud losses, the ABA cited the availability to forgers of 

inexpensive desktop publishing software and laser printing equipment. Also, customers are not properly 

safeguarding account information. AB, 12/1/94, p. 1. 

In an earlier report, the ABA said that only 1.7 percent of banks above $1 billion in assets in a survey 

verified signatures on all checks before payment. About one-third of the banks with assets of less than 

$100 million verified all check signatures. AB, 8/25/94, p. 14. 

Kmart Corp. is installing electronic check readers that determine if a check is genuine based on the 

strength of its magnetic ink line. The firm has completed a 200-store pilot program with the MICR 

identification device and plans to install them in all its 2,400 stores by late Spring. 

Use of 'positive pay' programs to protect against fraudulent checks is increasing among corporate clients 

of large banks. In these programs the corporate customer sends informaton electronically to the financial 

institution on items it has issued, enabling that institution to notify the customer if items are presented 

which it may not have issued. Some institutions are initiating systems in which images of questionable 

checks are sent over the phone lines back to the customer. AB, 1/18/94, p. 20. 

NASD Bans Members' Use of Bank Logos 

The National Association of Securities Dealers is prohibiting the use of bank logos on advertisements and 

sales literature for member firms. Bank names may appear non-prominently in members' advertising and 

sales literature solely for the purpose of identifying the location where broker-dealer services are 

available. Notice to Members, NASD, November 1994; AB, 12/2/94, p. 1. 

Credit Life Insurance Called Too Expensive 

A report of the National Insurance Consumer Organization and the Consumer Federation of America said 

that the premiums charged for credit life insurance are too high, and that only three states -- New York, 

Maine, and Vermont -- and the District of Columbia, meet the standard set by the National Association of 

Insurance Commissioners of a 60 percent payout-to-premium ratio. If all states achieved that standard, 

consumers would save an additional $530 million annually, the report estimated. In most states, the 
 

 

 

 

 

 

 

 

 

 

payout rate is 44 cents per dollar, up from 37 cents five years ago. During that period, 18 states took 

action to lower their credit life insurance rates. Over 60 percent of the savings, estimated at $200 million, 

went to consumers in Georgia, Texas, Vermont and North Carolina. 

A CFA official noted that instances of discrimination against borrowers who choose not to purchase credit 

life insurance are declining. AB, 7/26/94, p. 2; BBR, 8/1, p. 153. 

Off-Premises ATMs Show Strong Growth 

The 50 largest U.S. banking firms increased the number of ATMs outside their offices by 20.6 percent in 

the 12 months ending June 30, 1994, and their branch-based ATMs by only 5.4 percent, according to a 

survey by the American Banker, bringing the number of the two categories of ATMs held by these 

institutions to nearly 8,000, and more than 21,000, respectively. The top five banking organizations in 

numbers of ATMs were BankAmerica Corp., Nations- Bank Corp., Wells Fargo & Co., Citicorp, and First 

Interstate Corp. An estimated 75 percent of all ATM transactions are cash withdrawals. AB, 11/30/94, p. 

1. 

More Credit Unions Issuing Debt Cards 

Debit cards are first among new products planned by credit unions for next year, according to a recent 

survey of 800 institutions by the Credit Union National Association. About 500 credit unions issue debit 

cards, a CUNA official said, including 200 that issued the cards through a CUNA services subsidiary. The 

cards have advantages to credit unions of avoiding the costs associated with paper check processing, 

and they generate interchange income in fees from merchants based on card transactions. About 29 

percent of credit union member households have a debit card. AB, 9/16/94, p. 6. 

U.S. Financial-Services Transactions With Foreign Persons 

The Bureau of Economic Analysis of the U.S. Department of Commerce will conduct a survey in which, 

for the first time, comprehensive information will be collected on trade in financial services between U.S. 

financial-services providers and unaffiliated foreign persons. The information collected will be used in 

monitoring U.S. services trade and formulating U.S. international trade policy, compiling the U.S. balance 

of payments and national income and product accounts, assessing U.S. competitiveness in international 

trade in services and improving the ability of U.S. businesses to identify and evaluate market 

opportunities. 

Reporting is required from U.S. financial-services providers who have sales to or purchases from 

unaffiliated foreign persons in all covered financial services combined in excess of $1 million during the 

reporting year. The providers meeting these criteria must supply data on the amount of their sales or 

purchases of each covered type of service, disaggregated by country. Providers that have covered 

transactions of less than $1 million during the reporting year are asked to provide, on a voluntary basis, 

estimates of their total sales or purchases by type of financial service. Beginning with the year 1994, the 

surveys will be conducted every five years, and it is anticipated that in the interim year the information will 

be updated by the use of more limited surveys based on a sample of companies. FR, 7/28/94, p. 38387. 

Internal Controls Reporting Fails Cost-Benefit Test 

A recent study found that banks spent about $100 million in 1993 complying with a provision of FDICIA 

that requires banks with assets in excess of $500 million to file a report with regulators each year, the 

accuracy of which must be attested to by a certified public accountant, regarding their internal controls in 

place. The costs include amounts paid for documentation, training, and accountants' fees. A total of 48 

banks were surveyed, including 16 of the largest in the nation. Costs in these institutions, which ranged 

from $50,000 to $3.5 millon per bank, were projected to estimate the costs for the industry. In the view of 

Dr. Curtis C. Verschoor of DePaul University, who conducted the study in conjunction with the Bank 

Administration Institute, the costs far outweigh the benefits to managements for preventing loan losses. 

AB, 10/6/94, p. 8. 

RECENT ARTICLES AND STUDIES 
 

 

 

 

 

 

Uses and Regulation of Financial Derivatives 

This study by the U.S. General Accounting Office notes that derivatives have enabled commercial 

corporations, governments, financial firms, and other institutions in the United States and worldwide to 

reduce their exposure to fluctuations in interest rates, currency exchange rates, and the prices of equities 

and commodities. Derivatives also have enabled users to reduce funding costs and speculate on changes 

in market rates and prices. There are concerns, heightened by recent reports of major losses from 

derivatives, that knowledge of how to manage and oversee risks associated with derivatives may not 

have kept pace with their increased use. The principal objectives of this study were to determine: (a) what 

risks derivatives might pose to individual firms and to the financial system and how firms and regulators 

are attempting to control these risks, (b) whether gaps and inconsistencies exist in U.S. regulation of 

derivatives, (c) whether under existing accounting rules market participants and investors are provided 

adequate information about firms' use of derivatives, and (d) the regulatory implications of the 

international use of derivatives. The four basic types of derivative products, which can be combined to 

create more complex derivatives, focused upon here were forwards, futures, options, and swaps. 

While thousands of institutions use derivatives, over-the-counter (OTC) dealing in forwards, options and 

swaps is concentrated among a relatively few financial firms worldwide. As of December 1992, the top 

seven domestic bank OTC derivatives dealers accounted for more than 90 percent of total U.S. bank 

derivatives activity. The top five U.S. securities firms dealing in OTC derivatives accounted for about 87 

percent of total derivatives activity for all U.S. securities firms. U.S. dealers were a major part of world 

activity and accounted for about half of the total volume of OTC derivatives activity worldwide. The 

combination of global involvement, concentration, and linkages means that the sudden failure or abrupt 

withdrawal from trading of any of these large dealers could cause liquidity problems in the markets and 

could also pose risks to the others, including federally insured banks and the financial system as a whole. 

While the supervision of banks' derivatives activities has improved, weaknesses remain, including 

insufficient regulatory reporting, inadequate documentation and testing of internal controls. Significant 

gaps and weaknesses exist in the regulation of many major OTC derivatives dealers. For example, 

securities regulators have limited authority to oversee the financial activities of securities firm affiliates that 

conduct the OTC derivatives activities. Insurance companies' OTC derivatives affiliates are subject to 

limited state regulation and have no federal oversight, yet OTC derivatives affiliates of securities and 

insurance firms constitute a rapidly growing component of the derivatives markets. The GAO found also 

that accounting standards for derivatives, particularly those used for hedging purposes by end-users, 

were incomplete and inconsistent and have not kept pace with business practices. 

Among the GAO's recommendations was that Congress require federal regulation for the safety and 

soundness of all major U.S. OTC derivatives dealers. Congress should bring the currently unregulated 

OTC derivatives activities of securities and insurance companies' affiliates under the supervision of one or 

more of the existing federal financial regulators. It is recommended that the appropriate authorities work 

closely with industry representatives to: (a) develop and maintain accurate, current, and centralized 

information that is accessible to all regulators, including information on the extent of major OTC dealers' 

counterparty concentrations and the sources and amounts of their derivatives earnings; (b) develop and 

adopt a consistent set of capital standards for OTC derivatives dealers sufficient to ensure that all of the 

major risks associated with derivatives are reflected in capital; (c) establish specific requirements for 

independent, knowledgeable audit committees and internal control reporting for all major OTC derivatives 

dealers; and (d) perform comprehensive annual examinations of the adequacy of major OTC derivatives 

dealers' risk-management systems using a consistent set of standards established for this purpose and 

including consideration of the internal control assessments performed by boards of directors, 

management, and auditors. Financial Derivatives Actions Needed to Protect the Financial System, U.S. 

General Accounting Office, May 1994. 

The strong growth in derivatives market activity continued in the second quarter of 1994, based on 

regulatory report data for such off-balance-sheet instruments as swaps, options and forward contracts, 

but not including some types of derivatives such as collateralized mortgage obligations. During the 

quarter, 704 banks had derivatives in their portfolios, down from 713 banks in the first quarter but 661 
 

 

 

 

 

 

 

 

 

more than a year earlier. Depending upon the method of measurement used, the ten banks with the 

largest derivatives holdings accounted for between 92.7 percent and 95 percent of the total for the 

industry. AB, 9/30/94, p. 1. 

Home-Buying Process Studied For Sources of Discrimination 

The Cuyahoga County Department of Community Development, the Federal Reserve Bank of Cleveland, 

the Greater Cleveland Roundtable, and the Ohio Civil Rights Commission are major participants in the 

Cleveland Residential Housing and Mortgage Credit Project, which is conducting a comprehensive study 

of the home-buying process in its mission to ensure non-discriminatory access to residential mortgage 

credit in the Greater Cleveland area. 

Initially, task groups were assigned to analyze specifically identified decision points in the home-buying 

process for discriminatory acts that could potentially occur in each stage of the process. The studies have 

focused on four critical decision points: (1) the initial contact with the real-estate agent; (2) the initial 

contact with the lender; (3) the interface with the secondary market; and (4) the appraisal process. The 

analyses and recommendations of the four task groups were presented in June 1994. 

In the realtor-contact phase, one problem is that agents, because of lack of knowledge about certain 

types of financing, may inappropriately refer the purchaser to a loan source with which they are familiar 

while omitting other available options. The seller, typically given the decision as to acceptable financing, 

may specify conventional only or a similar exclusion. But the purchaser, because of the down payment, 

past credit problems or other reasons, may find conventional financing impossible to obtain, or it may be 

less appropriate then other sources of loans. Among the %-3 group's recommendations is that restrictions 

should not appear in multiple listing service information regardless of the type of financing being 

proposed. All offers ought to be presented for the seller's consideration, regardless of the type of 

financing being proposed. A comprehensive summary of available financing programs, written in 'user 

friendly' terminology will be prepared by the study group for use by real-estate agents. Also, a continuing 

education class for real-estate agents will be developed that will emphasize the variety of financing 

options and the potential for discrimination when advising buyers and sellers of financing. 

Initial contacts with lenders can result, because of deliberate prescreening or inadequate lender training, 

in customers not being given full information about credit availability. The analysis focuses on the many 

ways that discrimination may occur before the loan process begins, for example, by offering more 

information options to some customers than others, or asking some to wait longer than others. It is noted 

that when loan originators provide general information about loan products, it is considered to be an 

inquiry; however, responses to specific questions about an applicant's eligibility for a mortgage loan are 

reported as applications under federal guidelines. Lenders obviously may have an incentive for treating 

potential borrowers differently because of the variance in the cost of servicing the customer. Loans of a 

nontraditional type may take longer to process. The practice of taking applications in central locations 

rather than through outlying offices, can cause discrimination. Officials in the central offices will probably 

not be as familiar with many of these customers, and there may be feelings of intimidation on the part of 

the latter. The report recommends that an industry-wide training and certification program be developed 

for loan originators, reinforced by an ongoing evaluation process. A code of conduct should be 

established by which institutions would commit themselves to the program. 

Guidelines issued by Fannie Mae or other agencies to provide information to lenders for determining 

whether a particular loan will qualify for inclusion in a loan pool, for sale on the secondary market, are 

often interpreted incorrectly, especially by smaller institutions, which can result in the elimination of some 

potential borrowers. The guidelines require, for example, that lenders verify the source of a down 

payment, and details about the borrower's credit history. However, the standard requirements may not be 

appropriate for some potential customers, and representatives from Fannie Mae have noted that, with 

proper documentation, loans with exceptions in these areas can be acceptable in the secondary market. 

It is recommended that a formal, ongoing plan should be adopted for the training and education of 

officials of lending institutions about the programs offered by, and the guidelines of, secondary-market 

companies. A curriculum should be instituted in high schools to educate students about the importance of 
 

 

 

 

 

 

 

 

a good credit rating, the importance of a good savings pattern, the home-buying process and related 

topics. 

Property appraisals play a 'pivotal role' in the economic health of neighborhoods: in individual cases, an 

appraisal that is too low can result in inadequate loan availability for the customer. The report discusses 

the interacting process of market values and appraisals, from the perspective of the impact that individual 

appraisals can have on values throughout a community, currently and over time. The recommendation of 

the task group was that an industry group be formed to address the education of appraisers and the 

process of identifying qualified appraisers. Another task group representing the lending institutions should 

be concerned with the training for evaluating appraisals and the review process for low appraisals. 

Community Reinvestment Forum, Federal Reserve Bank of Cleveland, Special Issue 1994. 

Defining the Roles of Accountants, Bankers and Regulators 

This report observes that despite the advantages found in the experience in other countries in respect to 

a close working relationship among regulators, bankers, and external auditors, such a relationship has 

not been the norm in the U.S. The role of external auditors in banking began to expand in the late 1960s 

as most major banks adopted a holding company structure subject to broader public disclosure and audit 

requirements and the banking agencies expanded the financial reporting required for regulatory 

purposes. At the same time, the managing of banks was becoming increasingly complex, with increasing 

competition, rapid financial innovation and technological change. New banking laws increased the cost 

and complexity of bank regulation and reporting. The information needs of managers, the financial 

markets and regulators grew in scope and complexity. While these developments would indicate a need 

for closer cooperation, the relationship among regulators, bankers and external auditors has suffered in 

the past several years from the effects of the savings-and-loan industry debacle, large loan losses among 

U.S. banks and the aggressive legislative and regulatory responses to those events. As a result, the 

working relationships among regulators, bank management and external auditors have become 

increasingly contentious. 

Under FIRREA, regulatory scrutiny of management decisions was greatly expanded. For example, the 

hiring of directors and senior officers was subjected to regulatory approval not only at troubled institutions 

but at any institution chartered or undergoing a change of control within the previous two years. Removal 

authority by regulators was extended to reach major shareholders and external auditors and other 

advisers, and to permit industry-wide disqualification. Administrative penalties were increased 

substantially, as were maximum prison sentences, and penalties were applied to a broader range of 

offenses. 

FDICIA continued FIRREA's emphasis on enforcement and its approach to mandated, aggressive 

regulatory action against troubled institutions. But while FIRREA focused on savings-and-loan failures, 

FDICIA changed extensively the rules of the regulatory system, expanding its reach into the relationships 

between regulators, bank management and their external advisers. In many cases, legislated rules were 

substituted for regulatory judgment. Federal regulators were given expanded authority over many areas 

of management decision-making, substituting their rulemaking for case-by-case judgment over basic 

operations. Examiners were given much greater authority over regulated banks, and legal penalties and 

examiner sanctions were increased dramatically. FDICIA mandated additional reports by the 

management of larger institutions. External auditors were, in turn, required to attest to management's 

assertions regarding internal controls and safety-and-soundness compliance, and to report any material 

weaknesses and violations. 

To ensure that excessive regulation did not lessen the availability of credit to sound borrowers, the FDIC, 

FRB, and OTS in 1991 issued a series of policy statements on the workout of problem loans, valuation of 

real-estate loans and review and classification of commercial real-estate loans. Steps have been taken to 

improve communication between regulators and external auditors. In July 1992, the regulators issued a 

joint statement that sought to encourage full and candid contacts with external auditors to ensure that 

they are fully informed of all bank interactions with regulators and all documents provided to regulators by 

financial institutions. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In March 1993, the four supervisory agencies announced plans to reduce documentation, encourage 

character loans, reduce appraisal requirements, streamline the appeals and complaint process, and 

reduce the burden of the examination process. Additional actions were announced in May and June, 

including procedures for returning certain nonaccrual loans to accrual status, and procedures for 

eliminating duplicative exams by the primary regulator and the FDIC, as back-up regulator, and 

coordinating exams where duplication is required. In December 1993, the FFIEC issued an inter-agency 

policy statement on loss reserves, including a formula for calculating reserve levels, in an effort to provide 

an objective standard against which bank management and their external auditors can assess the 

adequacy of reserves. Of particular note, the policy represents a guideline rather than a safe harbor. At 

the same time, the policy statement recognized the limits of the examiner's ability to assess asset quality 

and the stronger position of management to accumulate up-to-date information necessary to estimate 

losses accurately on specific loans or classes of loans. 

It may be noted that at the time of this study's completion, the Riegle Community Development and 

Regulatory Improvement Act of 1994 was in the process of enactment. A number of the Act's provisions 

are directly relevant to the study's concerns, among which is a requirement for the federal banking 

agencies to coordinate their examinations and to develop a system for selecting a lead agency to manage 

unified examinations, authority for the federal agencies to establish certain standards by guidelines 

instead of regulations, and a requirement concerning review and elimination of outmoded regulations and 

policies. 

Among the study's overall conclusions and recommendations is that while regulators, management and 

external auditors have different responsibilities and priorities, it is important that there be basic agreement 

in their conclusions in respect to the financial condition of an institution, with reconciliation of any 

differences in assumptions and methodologies in order to reach a common understanding. Financial 

reporting should be based on GAAP accounting rules, and where additional information or more stringent 

reporting standards are essential for regulatory purposes, these additional requirements should consist of 

well-defined and well-publicized adjustments to GAAP reports. Duplicate regulatory examinations should 

be eliminated, and normal regulatory review limited to a single examination, coordinated among the 

various regulatory agencies, in any relevant time period. 

The accounting profession and the regulators should jointly identify areas for reliance on one another's 

work and eliminate duplicative analysis. A first step has already been taken in the area of internal controls 

as a result of the external auditor's report mandated by FDICIA. Another area for consideration would be 

complex computer systems and risk models. As confidence grows, additional opportunities for mutual 

reliance could be identified. 

A final recommendation is for the establishment of a permanent board, consisting of representatives of 

each of the federal bank regulatory agencies, the SEC, the accounting profession and the banking 

industry. Its functions would include: recommending areas in which external auditors and regulators could 

rely on one another's work and achieving consensus on the specific terms and conditions of any such 

division of labor; reviewing regulatory enforcement issues with a view toward encouraging a more open 

and public process of formulating and implementing enforcement policy; and identifying areas in which 

external auditors and regulators require training to keep pace with the evolution of financial institutions 

and instruments and cross-training to understand better the objectives and procedures of the other. 

Defining the Roles of Accountants, Bankers and Regulators in the United States, Group of Thirty, 

Washington, DC, 1994. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Vol. 8 No. 2 - Article III - Published: June 1995 - Full Article 

Recent Developments Affecting Depository Institutions 

by Benjamin B. Christopher 

REGULATORY AGENCY ACTIONS 

Inter-Agency Actions 

The federal bank and thrift regulatory agencies are engaging in joint or coordinated efforts in a number of 

regulatory areas that are mentioned specifically in this issue of the Review , among which are: 

Community Reinvestment Act compliance evaluation; risk-based capital requirements; capitalrequirements accounting; appraisal guidelines; and examinations of bank-affiliate sellers of mutual funds. 

For full information on the inter-agency actions included in this issue, reference is necessary to the pages 

devoted to each of the agencies and the Federal Financial Institutions Examination Council. 

Federal Deposit Insurance Corporation 

Assessments 

The FDIC proposed changes in its risk-related insurance premium system, including a significant 

reduction in rates paid by well-capitalized and well-managed banks. No change is proposed at this time in 

the insurance rates paid by savings associations. Under the proposal, premiums paid by about 90 percent 

of BIF-insured institutions would fall to four cents per $100 of domestic deposits, from their current rate of 

23 cents per $100. The 31-cent rate currently paid by the lowest-rated BIF-institutions would continue. 

Present law requires the BIF to have an average assessment rate of 23 cents per $100 of deposits until 

the Fund amounts to $1.25 per $100 of insured deposits. As of the third quarter of 1994, the Fund 

balance of $19.4 billion represented $1.03 per $100 of insured deposits. The FDIC projects that the 1.25 

ratio will be reached between May 1 and July 31, 1995. Premiums can be reduced 'because of the efforts 

of the banking industry to make their individual institutions stronger' and to make their insurance fund 

stronger, said Chairman Ricki Helfer. The proposed new assessment rate would not be implemented until 

it can be verified that the BIF has been recapitalized. 

The FDIC also is considering a process for adjusting BIF rates quickly in response to changing 

conditions. As proposed, the entire assessment rate schedule could be raised or lowered twice a year, 

within a range of five cents per $100 without first seeking public comment. 

The FDIC proposed retaining the existing assessment rate schedule for the Savings Association 

Insurance Fund (SAIF). Under the existing SAIF assessment rate schedule, which averages 24 cents per 

$100, the Fund is projected to be capitalized in the year 2002. As of the third quarter of 1994, the SAIF 

had an estimated balance of under $2.0 billion, this representing a ratio of 26 cents per $100 of insured 

deposits. The SAIF also will assume from the Resolution Trust Corporation the responsibility for resolving 

failed thrifts, starting July 1, 1995. Comments were requested additionally on the proposal to keep SAIF 

assessment rates unchanged, and on the potential impact of a substantial premium differential between 

BIF-insured and SAIF-insured institutions. PR-6-95, FDIC, 1/31/95. 

The FDIC is seeking comments on whether the deposit insurance assessment base should be redefined 

and, if so, how. Broadly stated, the assessment base is defined as an institution's total domestic deposits 

as of the end of a quarter. The definition of the assessment base has remained substantially the same 

since 1935. Until recently, the FDIC did not have statutory authority to change the definition. However, the 

FDIC Improvement Act of 1991 (FDICIA) gave the agency the ability to determine the assessment base, 

starting January 1, 1994. Among the key questions on which the agency is seeking guidance is whether it 

should begin charging insurance premiums for deposits that U.S. banks have in their foreign offices and 

for certain nondeposit liabilities and 'off-balance-sheet' items. Comments also are sought on whether 
 

 

 

 

 

 

 

 

 

 

 

assessments should be based on an average level of deposits held by the institution rather than quarterend figures. The latter question is intended in part to address situations where institutions temporarily shift 

funds out of the assessment base at the end of a quarter solely to reduce their insurance payments. If the 

FDIC Board finds revisions to be warranted, it will propose specific amendments and invite public 

comment. PR-64-94, FDIC, 9/27/94; FR, 10/5, p. 50710. 

The FDIC is taking steps to modernize the way deposit insurance premiums are collected to make the 

process more efficient and less burdensome. Institutions currently mail a check to the FDIC twice a year 

after determining how much they owe for deposit insurance, based on their assigned risk-related 

assessment rate and their deposit base. Under a new rule scheduled to take effect April 1, 1995: 

(a) The FDIC will compute the assessment owed, thereby improving the accuracy and relieving 

each institution of the burden of performing the calculation; 

(b) The agency will arrange for each institution's payment electronically through the Automated 

Clearing House (ACH) Network; 

(c) Each semiannual insurance assessment will be paid in quarterly installments, based on an 

invoice prepared by the FDIC showing the insurance calculation and information on any 

adjustments from previous quarters. 

The revisions delete from the assessment regulation the existing references to experience factors, which 

are not available for use after 1994. 

The new rule also changes the way insurance premiums are collected from insured institutions that 

acquire deposits through mergers or other transactions in the latter half of a semiannual assessment 

period. When such a transaction occurs, the surviving institution's payments will be adjusted to account 

for the increased insurance risk the deposits may pose. PR-83-94, FDIC, 12/20/94; FR, 12/29, p. 67153. 

Required New Disclosures of 'Pass Through' Coverage 

The FDIC adopted new rules requiring insured institutions to provide timely disclosures to depositors in 

certain retirement accounts and employee benefit plans about whether their funds qualify for ' pass 

through' insurance coverage. In general, ' pass through' insurance means that the share of each 

participant in the account, rather than the total account balance, is insured up to $100,000. A 1991 law 

and FDIC regulations that went into effect in 1992 provide for pass through deposit insurance for 

employee benefit plan accounts if the insured institution satisfies certain capital standards. 

At issue are deposits in accounts such as 401(k) retirement accounts, Keogh plan accounts, and 

corporate pension plan and profit-sharing plan accounts. Among the new required disclosures are the 

institution's 'prompt corrective action' (PCA) category, and whether the deposits are believed to be eligible 

for ' pass through' insurance (must be disclosed in writing when an affected account is opened, and upon 

request of the account manager); and notification if new, rolled-over or renewed deposits will not be 

eligible for 'pass through' insurance (must be disclosed in writing within ten days of when an existing 

account is believed to be no longer eligible for 'pass through' insurance coverage). 

The new rules become effective July 1, 1995; however, holders of employee benefit plan deposits made 

between December 19, 1992 and July 1, 1995, will receive specified disclosures if at the time of deposit 

the account was not eligible for pass through insurance coverage. PR-7-95, FDIC, 1/31/95; FR, 2/9, p. 

770. 

Brochure on Insurance Coverage 

In an effort to reduce continuing customer confusion, the FDIC is now offering a free brochure, 'Insured or 

Not Insured - A Guide to What Is and Is Not Protected by FDIC Insurance.' The brochure explains the 

term mutual funds, advises purchasers to obtain definitive information, states clearly that 'mutual funds' 

are not deposits and therefore are not insured by the FDIC or any federal agency, and explains the 

difference between FDIC coverage of deposits and insurance from other sources that may be available 
 

 

 

 

 

 

 

 

 

on certain other bank products. The brochure also includes a discussion of the insurance aspects of 

Treasury securities, safe deposit boxes and robberies. Institutions that sell nondeposit products either 

directly or through a third party are strongly urged to provide this brochure to anyone who inquires about, 

or purchases, such products. FIL-53-94, FDIC, 7/20/94. 

BIF Rises to $19.4 Billion in Third Quarter; Agency Staff Reduced 

The Bank Insurance Fund (BIF) increased to $19.4 billion as of September 30, 1994, up 48 percent from 

the 1993 year-end level of $13.1 billion. The Fund balance amounted to 1.03 percent of insured deposits 

on September 30. As a result of the improving financial health of the banking industry, the estimated 

liability for the cost of anticipated bank failures declined to $1.46 billion, from $3.00 billion at the end of 

1993. BIF revenue for the nine-month period totaled $5.00 billion, of which $4.22 billion was assessments 

earned. Expenses and losses were a negative $1.23 billion, this amount representing mainly provision for 

insurance losses of minus $1.66 billion. 

The FDIC reported that its current staff of 12,116 is 421 less than the initial projected 1995 year-end staff 

level, and 1,200 below the year-end authorized level. Staff levels decreased by 820 during the third 

quarter, and 2,103 (14.8 percent) for the year-to-date. Most of these reductions were related to office 

closings in Houston, Denver, Orlando, Encino, and San Antonio. Financial Management Report, 3rd 

Quarter 1994, FDIC. 

Thirteen Banks Failed Last Year 

In 1994, there were 13 failures of BIF-insured banks, which had assets of just under $1.6 billion, down 

from 41 failed banks, with assets of $3.5 billion, the year before. The number of closures in 1994 was the 

lowest since the year 1981. 

The FDIC's 'problem' list at the end of the third quarter consisted of 293 commercial banks, with assets of 

$36 billion, and 84 savings institutions, with $59 billion in assets. From year-end 1993, the total number of 

'problem' institutions declined by 195, and their assets were down by $239 billion. FDIC Quarterly 

Banking Profile, Third Quarter 1994; FDIC Office of Corporate Communications. 

Supervisory Guidance on Mortgage Derivative Products 

The FDIC has updated and distributed to FDIC-supervised banks its supervisory guidance to examiners 

on mortgage derivative products. The new guidance incorporates the provisions of the Federal Financial 

Institutions Examination Council's (FFIEC) interim revision to its Supervisory Policy Statement on 

Securities Activities, which addressed the application of Statement No. 115 of the Financial Accounting 

Standards Board (FASB) to mortgage derivative products. 

The FDIC's guidance states that a mortgage derivative product that was non-high-risk at purchase and 

designated as held-to-maturity later becomes high-risk, the security will not be subject to redesignation as 

available-for-sale or trading if the institution can continue to demonstrate a positive intent and ability to 

hold the security to maturity. However, examiners will continue to consider any unrealized net 

depreciation in held-to-maturity, high-risk mortgage derivative products in the evaluation of an institution's 

capital adequacy. Mortgage derivative products that expose an institution to risk of loss of principal or 

book value may be classified in accordance with the provisions in attached exhibits. The entire amount of 

unrealized losses (not just any amounts scheduled as loss) on available-for-sale debt securities that are 

adversely classified must be deducted from Tier 1 capital before calculating regulatory capital ratios. No 

such adjustment to regulatory capital calculations is necessary for adversely classified trading securities, 

as unrealized gains and losses on trading securities are included in an institution's earnings. FIL-82-94, 

FDIC, 12/13/94. 

Supervisory Guidance For Structured Notes 

The FDIC issued a supervisory guidance to the agency's examiners and to FDIC-supervised banks on the 

characteristics, risks and examination treatment of structured notes. Since 1990, U.S. Governmentsponsored enterprises, private corporations, and multilateral development banks have issued structured 
 

 

 

 

 

 

 

 

 

 

notes, with the Federal Home Loan Banks the most predominant issuers. Banks have increased their 

investment in structured notes. These securities typically contain embedded options such as caps, calls, 

and floors and have cash flows that are linked to indices such as interest rates, foreign-exchange rates, 

commodities prices, prepayment rates, and other financial variables. The cash-flow uncertainty of 

structured notes, caused by movements in interest rates, foreign-exchange rates, and other indices, may 

expose banks to greater market risk, liquidity risk, operating risk, or interconnection risk than traditional 

medium-term notes. As a result, bank investments in structured notes warrant increased supervisory 

attention to ensure that bank management understands the nature of the risks in the securities and has 

the ability to measure, monitor, and manage these risks. Specific examination guidance regarding the 

characteristics and risks in structured notes is provided. FIL-61-94, FDIC, 8/31/94. 

Management of Interest-Rate Risk 

The FDIC issued a guidance to its examiners and to FDIC-supervised banks on the assessment and 

management of interest-rate risk in financial institutions. The guidance considers such factors as the size 

of the institution, capital adequacy, earnings and the complexity of the institution's business. The 

management of interest-rate risk may range from the formation of formal management committees and 

the use of complex measurement systems to informal management oversight and the use of simple 

measurement tools in smaller, more basic, bank operations. 

Interest-rate-risk management can be defined as the management of the potential impact of interest-rate 

movements on an institution's net interest income and market value. Applicable to all banks in various 

degrees, interest-rate risk management in larger institutions can be segmented into several parts which 

are discussed in the guidance: (a) the establishment of an interest-rate-risk management committee that 

is approved by and reports to the board of directors or assumption of such responsibility by the full board; 

(b) written policies and procedures, including risk limits; (c) a written interest-rate-risk management 

strategy or strategies; (d) an appropriate measurement and monitoring system(s) to quantify interest-raterisk exposure; (e) the evaluation of interest-rate-risk exposure. FIL-60-94, FDIC, 8/26/94. 

Rapid-Growth Rule Rescinded 

Effective November 7, 1994, the FDIC rescinded a section of its regulations on notification of rapid 

growth. Currently, all insured banks, except insured bankers' banks, are required to give the FDIC prior 

notice of planned rapid growth as a result of any 'special funding plan or arrangement.' For purposes of 

this requirement, such a funding plan is any effort to increase the assets of a bank through the solicitation 

and acceptance of fully insured deposits obtained from or through the mediation of brokers or affiliates 

(which would include insured brokered deposits); the solicitation of fully insured deposits outside a bank's 

normal trade area; or secured borrowings, including repurchase agreements. The recission will lessen the 

regulatory burden on banks which are currently also required to comply with the FDIC's brokered deposit 

regulation and the prompt corrective action rule, both of which were designed in part to address the same 

risks resulting from rapid growth. FR, 10/6/94, p. 50826. 

Task Force on Risks From Capital Market Instruments 

FDIC Chairman Ricki Helfer announced the creation of a special task force to analyze and make 

recommendations regarding the potential risks posed to the federal deposit insurance funds by capital 

market instruments, including derivatives. The recommended actions will include those necessary to 

enhance the agency's ability to respond appropriately to the possibility that failed banks could be involved 

in these capital market activities and to situations in which these activities could pose a systemic risk that 

threatens the deposit insurance funds or the financial system. The FDIC noted the unprecedented growth 

in capital market instruments and the advances in technology that enable practitioners, including insured 

depository institutions, to condition their income streams on increasingly complex financial relationships. 

To the extent that these complexities including the global nature of the inter-linkages between market 

participants are not well-understood or are mismanaged, capital market instruments can result in losses 

that may take management and regulators by surprise. The agency said there is no reason to believe that 

the capital market activities of any insured financial institution pose a significant risk at this time to the 

deposit insurance funds. PR-72-94, FDIC, 11/7/94. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

Early-Warning System on Loan Underwriting Standards 

The FDIC plans to establish a system designed to identify any relaxation in the underwriting standards for 

bank lending before problems occur. The new program will commence with pilot projects in all eight of the 

agency's supervisory regions, and will involve periodic surveys of bank examiners to identify changes in 

underwriting standards as they occur. Chairman Ricki Helfer said 'this effort will allow the FDIC to analyze 

systematically the findings of our field personnel who observe lending practices on a day-to-day basis, 

and then to work with banking institutions to correct any problems before they are serious.' 

FDIC personnel at selected, regularly-scheduled bank examinations during the first quarter of 1995 will be 

asked to report on the prevalence of specific lending and investment practices that have led to difficulties 

in the past, such as commercial real-estate loans based on unrealistic cash-flow projections, and to 

identify new practices that could have implications for the safety and soundness of the banking system. 

PR-79-94, FDIC, 12/13/94. 

Revised Proposal on CRA Compliance Evaluation 

The FDIC, the Office of the Comptroller of the Currency (OCC), the Federal Reserbe Board (FRB) and 

the Office of Thrift Supervision (OTS) modified a proposal that the agencies published in December 1993, 

(see this Review , Spring/Summer 1994, p. 40) to change the way institutions are evaluated under the 

Community Reinvestment Act (CRA). The revised proposal retains the structure and principles of the 

December plan; for example, both would replace the 12 factors now used to evaluate an institution's CRA 

performance with a more objective, performance-based system. However, the revised plan would make 

the performance tests more flexible, simplify data reporting requirements and increase the importance of 

community development lending, such as loans for affordable housing and economic development in lowand moderate-income areas. The revised proposal gives greater recognition to the importance of all types 

of lending to low- and moderate-income individuals and neighborhoods, treats community development 

lending as a principal component of lending performance, and clarifies that an institution's loans outside 

its service area to low- and moderate-income individuals and to small businesses and small farms could 

be considered as part of its CRA performance. 

As in the December proposal, large financial institutions (generally those with $250 million or more in 

assets) would be evaluated for their CRA performance under three 'tests' -- a lending test, an investment 

test and a service test. However, under the revised proposal, the tests would be less rigid and would 

allow the examiner more flexibility to take into account the characteristics and needs of a community and 

the capacity and limits of an institution. Large institutions also would be required to file new data about 

their lending and investments, but less than what was proposed in December. A new reporting 

requirement is data on an institution's loans to small businesses and small farms that would include 

information on the race and gender of the borrowers. Small banks and thrifts would be evaluated under a 

streamlined method that would not subject them to additional reports of loan data. The revised proposal 

would not require, as initially proposed, a small institution to have at least a 60 percent loan-to-deposit 

ratio in its community in order to be given a 'satisfactory' CRA rating. The agencies instead propose to 

consider each institution's financial condition and the credit needs of the community in evaluating lending 

performance under CRA. PR-135-93, FDIC, 12/9/93; FIL-67-94, 10/12/94; FR, 10/7, p. 51232. 

Self-Testing Guide on Fair Lending 

The FDIC issued a 56-page booklet on self-testing for fair lending practices. The guide is designed to 

help lenders compare the treatment of loan applicants and identify differences that may be discriminatory, 

and offers suggestions on how to correct discriminatory practices and improve lending performance. 

Among the topics included are: 

(a) How to plan and manage a pre-application testing program. The focus here is the point where 

an applicant inquires about a loan, gathers information and receives counseling or an invitation to 

apply. Financial institutions are encouraged to take whatever steps are necessary, including 

some form of pre-application testing, to inspect the treatment of potential applicants, as a means 

of helping to prevent illegal discrimination, improving customer service and attaining lending 

goals. 
 

 

 

 

 

 

 

 

 

 

 

(b) Treatment of applicants after submission of an application through a comparative analysis of 

loan files. Examples are provided of how loan product features, underwriting standards, or 

instances of lender assistance to borrowers can be compared to identify unequal treatment that 

may constitute discrimination. The use of comparative file analysis is discussed with reference to 

applications where disparate treatment may occur regarding applicants who are neither clearly 

qualified nor clearly unqualified for a loan. 

(c) How to identify and correct specific forms of discrimination, that may occur as overt or subtle 

discrimination, disparate treatment, disparate impact, an individual instance of discrimination or a 

pattern or practice of discrimination. 

(d) Criteria used by the regulatory agencies in taking enforcement actions and seeking remedial 

measures. 

(e) The importance of providing training on multicultural awareness, and on race, gender, and 

handicap sensitivity, to all levels of an institution's staff. Side By Side: A Guide to Fair Lending, 

FDIC, August 1994. 

Audit Reports 

Under an FDIC proposal that could affect approximately 70 institutions, annual audit reports on a 

separate, bank-only basis would be eliminated for institutions with over $9 billion in assets, if they are 

rated '1' or '2' on the CAMEL system and are subsidiaries of multibank holding companies. Instead, these 

institutions could be included in the holding company's annual report. 

Another proposal relating to procedures for determining compliance with certain laws and regulations, 

that would affect about 1,000 banks, includes new formatting and modifications of certain procedures so 

that they are more efficient and less burdensome. PR-9-95, FDIC, 2/2/95. 

FDIC Will Test Consumer Disclosures in Bank Sales of Mutual Funds 

The FDIC announced that it has hired a market research firm to study whether institutions are doing a 

good job explaining to consumers the distinctions between FDIC-insured deposits and uninsured 

products being offered by banks and thrifts, such as mutual funds. The agency's action is in response to 

concerns from lawmakers, bank customers and other regulators that confusion still exists despite various 

educational efforts by the industry and regulators about insured and uninsured bank products. To 

implement the study, trained representatives of the research firm, in person and by telephone, will pose 

as consumers asking typical questions about mutual funds, annuities and other nondeposit investment 

products, in the process of surveying a random, nationwide sample of several thousand locations of 

FDIC-insured banks and thrifts that sell these products. While the study is not intended to be used as an 

enforcement tool, if significant problems are found at an FDIC-supervised institution, the agency will seek 

appropriate corrective measures, and will refer problems found at other institutions to their primary 

regulator for follow-up. Results of the study are expected to be publicly available by mid-1995. PR-80-94, 

FDIC, 12/13/94. 

Mutual-to-Stock Conversions The FDIC issued a final rule, to become effective January 1, 1995, that 

addresses the conversion by mutual savings banks to stock form of ownership. The rule, applicable to the 

approximately 600 state-chartered mutual savings banks supervised by the FDIC, combines elements of 

an interim rule adopted in February 1994 and a rule proposed in June. A proposed policy statement 

issued in February, and a separate request for comment issued in May on certain fundamentals of the 

conversion process have been withdrawn. 

Among the requirements, which, under the final rule, a bank that proposes to convert must meet are: 

provide 60 days' advance notice to the FDIC of plans to convert, and if the FDIC finds any features to be 

unfair or unsafe it can object to and prevent the transaction; submit a full, independent appraisal report on 

the institution's value; and obtain a favorable vote on the conversion by depositors. Proxies are not 

permitted that are obtained from depositors in advance when they open an account. Eligible depositors 

must be given a priority over other buyers, including employee stock ownership plans, in purchasing stock 

when it is first offered, and bank management is permitted, but not required, to give preference to eligible 

local depositors. A bank generally is not permitted to buy back its stock within the first year after 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

conversion. After one year, stock repurchases are subject to case-by-case review by the FDIC. The bank 

must submit a business plan detailing the use of capital to be acquired in the conversion and expected 

earnings. 

The final regulation does not prohibit conversions through a merger with an existing institution or an 

acquisition by a holding company; however, because of the abuses that have been associated with such 

conversions, the FDIC will scrutinize closely these proposed transactions. PR-77-94, FDIC, 11/22/94; FR, 

11/30, p. 61233. 

Capital Rule For Unrealized Gains and Losses on Securities 

The FDIC adopted a final rule, effective January 27, 1995, that clarifies the regulatory capital treatment 

for unrealized gains and losses on securities that are 'available for sale.' Statement No. 115 of the 

Financial Accounting Standards Board requires institutions to recognize as a separate component of 

stockholders' equity any holding gains and losses on securities that are deemed available-for-sale. In 

general, this refers to securities that a bank does not have a positive intent and ability to hold to maturity 

but also does not intend to actively trade. Banks already are required by the banking regulators to follow 

FASB 115 for the quarterly Reports of Condition and Income (Call Report), under instructions issued in 

1993 by the FFIEC. At issue, however, has been the application of FASB 115 to regulatory capital 

standards. 

The FDIC and the other banking regulators previously proposed to require that net unrealized gains or 

losses on all available-for-sale securities (debt as well as equity securities) be included in determining 

Tier 1 capital (see this Review , Winter 1995, p. 35). The FDIC has joined with the FRB and OCC in 

rejecting that earlier proposal. Instead, the FDIC is adopting only technical changes to conform the 

wording in its leverage and risk-based capital rules with the terminology used in FASB 115. A similar rule 

is expected to be issued by the OTS for the institutions it regulates. FDIC Chairman Ricki Helfer said: We 

believe bank regulatory capital levels would be unnecessarily volatile, without appreciable benefits to the 

safety and soundness of the banking system, if institutions were required to include all unrealized 

securities losses in their regulatory capital calculations. 

The new rule closely tracks an interim guidance jointly issued by the three bank regulatory agencies in 

December 1993, and the capital treatment recommended by an inter-agency task force of the FFIEC in 

November 1994. Under the final rule, net unrealized holding losses on available-for-sale equity securities 

(but not debt securities) with readily determinable fair values will be deducted from the elements that 

determine Tier 1 capital. All other unrealized holding gains or losses on available-for-sale securities will 

be excluded from the definition of Tier 1 capital. However, the extent of any unrealized appreciation or 

depreciation on securities will continue to be a factor that FDIC examiners consider in their overall 

assessment of an institution's capital adequacy. The amortized cost rather than the fair value of availablefor-sale debt securities generally will continue to be used when calculating leverage and risk-based 

capital ratios. Banks also should continue to use the amortized cost of available-for-sale debt securities 

when reporting average total assets and risk-based capital data in the Call Report. PR-85-94, FDIC, 

12/20/94; FR, 11/25, p. 60552; 12/28, p. 66662. 

Proposed New Appeals Process 

The FDIC proposed guidelines for a new process that institutions could use to appeal supervisory 

decisions involving examination ratings, adverse classifications of significant assets, and the adequacy of 

loan-loss reserves. An 'independent' appeals process for 'material supervisory determinations' is required 

by Section 309 of the Riegle Community Development and Regulatory Improvement Act of 1994 for the 

FDIC as well as the other federal regulators of banks, thrifts and credit unions. The law defines an 

independent appeals process as one where the review is by an agency official who does not directly or 

indirectly report to the person who made the supervisory determination being questioned. 

The new program would replace a less formal appeals process adopted by the FDIC in February 1992. 

Under the proposed guidelines, an institution first would be encouraged to attempt to resolve the disputed 

matter with the regional office of the agency's division that made the supervisory determination. However, 
 

 

 

 

 

 

 

 

 

 

 

 

 

the institution could file an appeal with the Washington-based director of the appropriate division within 60 

days after receiving written notification of the initial FDIC decision. That division director either would 

grant the change requested by the institution or promptly refer the matter to a special committee 

consisting of the FDIC's Vice Chairman, General Counsel, an internal ombudsman and supervisory 

division directors. This committee would decide the appeal and notify the institution of its decision. From 

the time the FDIC receives an appeal, it would reach a final decision and notify the institution within 60 

days. 

Certain types of determinations would not be subject to this appeals process, including decisions to 

appoint a conservator or receiver for a failing institution; 'prompt corrective action' taken when an 

institution's capital falls below specified levels; formal enforcement actions; and risk classifications for 

deposit insurance premiums (review of these determinations is covered by other FDIC procedures). The 

proposed guidelines also contain safeguards against possible retaliation by FDIC examiners. PR-84-94, 

FDIC, 12/20/94; FR, 12/28, p. 66965. 

The OCC has issued a similar request for comments. FR, 12/22/94, p. 66067. 

Applications For Merger Transactions 

The FDIC amended its requirements to provide that in emergency cases necessitating prompt action, an 

applicant for a transaction under the Bank Merger Act will be required to publish only twice during the 

statutory ten-day period, with the second publication on the tenth day or the newspaper's publication date 

closest to ten days after the first publication, instead of daily for ten days as presently required. In nonemergency cases, publication will be required only three times at approximately two-week intervals. The 

regulation brings the FDIC's notice requirements into greater conformance with those of the other federal 

banking agencies, gives applicants more flexibility, and lessens regulatory burden. 12/28/94, p. 66653. 

Remote Service Facilities 

The FDIC is revising its requirements, effective immediately, for the establishment and relocation of 

remote service facilities (RSFs) in order to lessen the regulatory burden on state nonmember banks and 

state-licensed branches of foreign banks. Prior to the revisions, banks desiring to establish an initial RSF 

were required to comply with all the application and publication requirements applicable to the 

establishment of a 'brick and mortar' branch office. Successive RSFs could be established or relocated 

without a formal application under somewhat less involved requirements. The amended regulation 

provides that a state nonmember bank or an insured state-licensed branch of a foreign bank whose 

recent CRA rating is Satisfactory or better may establish and operate or relocate an RSF by filing a letter 

with the appropriate FDIC regional director. The letter must state the location of the RSF and information 

indicating compliance with the National Historic Preservation Act. Unless the institution is notified 

otherwise by the FDIC within seven days of receipt of the letter, the institution may establish or relocate 

the RSF. The public notice requirements are being dispensed with in this case. 8/23/94, p. 43281; FIL-59-

94, FDIC, 8/24. 

Loans to Executive Officers 

The FDIC amended its regulations to except loans which are fully secured by certain types of collateral 

from the general limit on 'other purpose' loans to executive officers of insured nonmember banks. The 

FDIC's rules place limits on loans that a bank can make to its executive officers for purposes other than 

an education or a home, such as commercial loans, farm loans and other types of consumer loans. When 

secured by any of the specified types of collateral, which in part include a perfected security interest in a 

segregated deposit account in the lending bank, a loan may be made in any amount and will not be 

subject to the limit for other purpose loans set forth elsewhere in the regulation. The amendment parallels 

recent changes by the FRB to that agency's regulations on insider loans. FR, 8/16/94, p. 41990; 12/28, p. 

66666; FIL-5-95, FDIC, 1/5/95. 

Foreign Banks 

The FDIC is amending its regulations, effective January 1, 1995, concerning applications procedures and 

plans for divestiture or cessation of activities by state-licensed insured branches of foreign banks. FDICIA 
 

 

 

 

 

 

 

 

 

provides that after December 19, 1992, such a branch may not engage in any activity that is not 

permissible for a federal branch of a foreign bank without the approval of the FRB and the FDIC. In the 

event that an application to begin or to continue to engage in an activity is denied by the FRB or FDIC, or 

the foreign bank elects not to continue the activity, a plan of divestiture or cessation must be submitted 

and the transaction completed within one year, or sooner if the FDIC so directs. 11/28/94, p. 60703. 

Courts Again Decide For Gross Negligence Standard 

The U.S. Court of Appeals for the Sixth Circuit, in the case of FDIC v. Bates , ruled that the Financial 

Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) requires regulators to meet a 

gross negligence standard in suits against officers and regulators. It was the third federal appeals court 

decision upholding the gross negligence standard, which generally makes it more difficult for regulators to 

prove negligence than would a simple negligence standard.AB, 12/29/94, p. 2. 

Agency Uses Self-Appointment Authority 

The FDIC appointed itself receiver of the $3.2 million-deposit The Meriden Trust and Safe Deposit 

Company, Meriden, Connecticut, and on July 7, 1994, took possession of and closed the bank. This was 

the first exercise of the agency's self-appointment authority which it received in 1991. The announcement 

said the bank would reopen the following day as a 'bridge bank,' New Meriden Trust and Safe Deposit 

Company, National Association. Meriden Trust's closing was the direct result of the 1991 failure of an 

affiliated institution, Central Bank of Meriden. The FDIC used its 'cross guaranty' authority to assess 

Central Bank's affiliated insured depository institution for potential losses to the deposit insurance fund, 

resulting in Meriden Trust's insolvency. PR-41-94, FDIC, 7/7/94. 

Real-Estate Recovery Less Widespread Than Earlier 

While reports of improvement in real-estate conditions continued overall to substantially exceed reports of 

decline, the margin of difference diminished in the FDIC's quarterly survey for the third consecutive time. 

The national composite index of survey results fell to 62 in January from 67 in October and 72 in July 

1994. Values of the index above 50 indicate more respondents believed conditions were improving than 

declining, compared to the previous quarter, while values below 50 indicate the opposite. The surveys, 

which began in April 1991, are based on interviews across the country with senior examiners and asset 

managers of federal bank and thrift regulatory agencies. The 407 participants in the latest survey were 

polled in late January. 

In residential markets, the index declined to 58 in January from 64 in October. Over half of the January 

respondents reported local housing conditions unchanged, while 32 percent saw continuing improvement 

down from 41 percent in October and 17 percent reported a decline. The recovery continued to be 

somewhat more widespread in commercial real-estate markets, as 38 percent of the respondents in 

January reported gains in that sector, while only 4 percent saw worsening conditions. These results were, 

however, somewhat less favorable than in October, when the percentages were 44 and less than one, 

respectively. 

As another indicator of the recovery in real estate, where the results were better than in the previous 

surveys, 28 percent of the respondents assessing local housing markets, and slightly over one-half for 

commercial real estate, reported an excess supply in the markets. 

Regionally, respondents in January reported small differences in the overall indexes, as the index for the 

West mirrored the national average. The evaluations for the South and Northeast were slightly more 

positive than for the nation as a whole, but were below the average in the Midwest, where the 22 percent 

of responses indicating improvement in local housing markets was down from 40 percent in the October 

survey. More than three-fourths of reports in California indicated commercial property sales were below 

average for that area. Survey of Real Estate Trends, FDIC, January 1995. 
 

 

 

 

 

 

 

 

 

 

Agency Will Sell Mortgage-Backed Securities 

The FDIC will issue approximately $761.4 million of securities backed by commercial mortgage loans. 

The issue is the FDIC's first entry into the mortgage-backed securities market. The certificates will 

evidence beneficial ownership interests in real-estate loans that were originated by failed depository 

institutions nationwide that were insured by the Bank Insurance Fund (BIF). The issue consists of $264.0 

million of floating-rate Class I certificates and $497.4 million of fixed-rate Class II certificates. The 

certificates include a limited FDIC guaranty provided solely by the BIF against credit losses and other 

shortfalls due to credit defaults. The guaranty will be limited to a maximum of 32.5 percent of the principal 

amount of the collateral outstanding; any additional losses will be borne by the holders of the certificates. 

Except under the limited guaranty, the certificates are not guaranteed by the FDIC or any other 

government agency. The offering of the securities will be made only by means of a prospectus. PR-51-94, 

FDIC, 8/9/94. 

Standards of Ethical Conduct For FDIC Employees 

The FDIC, with the concurrence of the Office of Government Ethics (OGE), proposes to issue regulations 

for the employees of the Corporation that would supplement the Standards of Ethical Conduct for 

Employees of the Executive Branch issued by the OGE. The proposed rule would establish prohibitions 

on borrowing and extensions of credit; prohibitions on the ownership of certain financial interests; 

prohibitions on the purchase of property controlled by the Corporation or the Resolution Trust 

Corporation; limitations on official dealings with former employers and clients; disqualification 

requirements relating to employment of family members outside the Corporation; and limitations on 

outside employment activities. FR, 7/12/94, p. 35480. 

Treasury Reduces BSA Information Requirements 

The Treasury Department issued a final rule, effective immediately, rescinding a requirement adopted 

pursuant to the Bank Secrecy Act for financial institutions to maintain a chronological log, and reducing 

substantially the amount of information required to be recorded. The BSA prohibits financial institutions 

from issuing or selling bank checks or drafts, cashier's checks, money orders or traveler's checks for 

$3,000 or more in currency unless the financial institution verifies and records the identity of the 

purchaser. Treasury also withdrew a proposal that would have required banks with deposits over $100 

million, and certain nonbank financial institutions, regardless of asset size, to maintain specific systems to 

aggregate currency transactions, and would have required financial institutions that file more than 1,000 

Currency Transaction Reports per year to file by magnetic media. FR, 10/17/94, pp. 52250, 52275. 

Resolution Trust Corporation
 

Audit Report by the General Accounting Office (GAO)
 

A GAO report of its audit of the RTC's statements of financial position as of December 31, 1993 and 

1992, found that: (a) the Corporation's financial statements were reliable in all material respects; (b) 

internal controls as of December 31, 1993, were effective in safeguarding assets against unauthorized 

acquisition, use, or disposition; (c) there was no material noncompliance with laws and regulations that 

were tested; and (d) the Corporation adequately addressed the material weakness and reportable 

conditions that were identified in the GAO's 1992 audit. The report noted that although the Corporation 

used the best available information to estimate securitization credit losses and future losses arising from 

representations and warranties, significant uncertainties exist. The limited claims experience raises the 

risk that the amount of future losses may significantly increase or decrease. These future losses will be 

affected by the behavior of the economy, interest rates, and real-estate markets as well as the 

performance of the collateral underlying the transactions. The Chairman of the Thrift Depositor Protection 

Oversight Board announced a management reform agenda in March 1993, which included requirements 

that the Corporation strengthen its internal controls in several areas. Among the steps the Corporation 

has taken to enhance its internal controls is the oversight of contractors that perform services for 

receiverships. However, audits of some contractors are continuing to identify contractor performance 

problems, such as poor asset management and disposition practices and questionable billings, which 

could result in increased expenses or reduced recoveries on assets. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

The report contains estimates of unused loss funds after completion of the RTC's resolution activities. 

Based on total loss funding made available of $105 billion, and estimated loss funding needs of $92 

billion, the estimated unused loss funds would total $13 billion. However, if actual asset recoveries are 

less than estimated or future resolution costs are greater than anticipated, the RTC will need to use 

additional loss funds. Loss funds not used by the Corporation are available for losses incurred by the 

Savings Association Insurance Fund (SAIF), subject to the conditions set forth in the RTC Completion 

Act. Funds in excess of the amounts needed by both the RTC and SAIF will be returned to the general 

fund of the Treasury. Under the RTC Completion Act, the Corporation will terminate on or before 

December 31, 1995. All remaining assets and liabilities will be transferred to the FSLIC Resolution Fund, 

which is managed by the FDIC. Annual Management Report, RTC, submitted to Congress on June 30, 

1994, containing Opinion Letter from the U.S. General Accounting Office. 

Operations Update 

The resolution, in December 1994, of one institution under the Accelerated Resolution Program brought 

the total number of resolutions to 774 since the inception of the RTC in 1989. As of December 31, the 

RTC had one institution to be resolved. 

As of November 30, 1994, the assets under RTC management had decreased to $31 billion, consisting of 

$4 billion in cash and securities, $5 billion in performing 1-4 family mortgages, $5 billion in other 

performing loans, $7 billion in delinquent loans, $2 billion in real estate, $5 billion in investments in 

subsidiaries, and $3 billion in other assets. The conservatorship program held $3 billion in gross assets 

on November 30. Assets in receiverships remaining from the institutions closed by the RTC amounted to 

$28 billion. Because many of the relatively marketable assets have been sold before an institution enters 

a receivership, most of the assets retained by the RTC in receivership consisted of lower-quality, lessmarketable assets. Thus, real estate and delinquent loans represented 32 percent of receivership assets. 

From inception through November, the RTC collected $156 billion from securities, $103 billion from 1-4 

family mortgages, $54 billion from other mortgages, $30 billion from non-mortgage loans, $16 billion from 

real estate, and $21 billion from other assets. The recoveries, which have amounted to 88 percent of 

book value reductions, included 98 percent from securities, 96 percent from 1-4 family mortgages, 77 

percent from other mortgages, 90 percent from non-mortgage loans, 55 percent from real estate, and 65 

percent from other assets. Through the end of November the RTC also had collected $19.3 billion in 

receivership income. The thrifts closed through November held $240 billion in assets at the time of 

closure. Estimated resolution costs for these closures totaled $88.2 billion. RTC Review , January 1995. 

Marketing Real Property on an Individual Basis 

In September 1994, the RTC adopted an interim rule, implementing the marketing provisions contained in 

the FHLBank Act and the RTC Completion Act, to provide policies and procedures for the marketing of 

real-estate-owned (REO) assets on an individual basis, and for the disposition of REO assets with a book 

value of more than $400,000 and nonperforming real-estate loans with a book value of more than $1 

million. The agency subsequently adopted the interim rule without change as a final rule to be effective 

December 23, 1994. FR, 9/19/94, p. 47790; 11/23, p. 60304. 

Affordable Housing Disposition Program 

The RTC is amending its regulations to implement provisions of the Resolution Trust Corporation 

Refinancing, Restructuring and Improvement Act of 1991 and other statutes enacted in 1992 and 1993 

that changed the manner in which the RTC is to identify, market and sell certain affordable housing 

properties. The regulations as amended will enhance the availability and affordability of residential real 

property for very-low-income, lower-income and moderate-income families and individuals. An interim 

final rule became effective October 19, 1994, and this rule was adopted in October without change as a 

final rule to be effective January 12, 1995. FR, 10/19/94, p. 52669; 12/13, p. 64111. 

Affordable Housing Unification Plan 

The RTC reported that in the four-month period beginning in June 1994, RTC-FDIC joint sales of singlefamily and multifamily affordable housing properties totalled over $6.8 million. In April 1994, the FDIC 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Board approved the unification plan of the affordable housing programs of the two agencies, which would 

implement the merger approved in March by the newly-formed Affordable Housing Advisory Board, in 

accordance with the RTC Completion Act of 1993. The FDIC will assume full control of both affordable 

housing programs by October 1, 1995. 

Among the key elements of the unification plan are: (a) FDIC will use RTC seller financing to underwrite 

its single-family and condominium sales through the transition period 1994-1995; (b) the agencies will 

consolidate their clearing house notices of available single-family and condominium properties; (c) the 

agencies will hold joint sales events, including at least two auctions in 1994 and two in 1995; (d) the 

agencies will use the same purchaser eligibility certification forms, and will develop a standard system of 

purchaser incentives for single-family sales, such as direct discounts and buyer counseling. The Silver 

Lining, RTC, Spring 1994, Summer 1994. 

Minority Thrift Sales 

As of June 14, 1994, the RTC had sold 14 savings-and-loan associations to minority bidders during the 

year. The RTC Completion Act, enacted in December 1993, requires the RTC to provide minorities a 

distinct preference to purchase failed savings-and-loan institutions. By April 1994, the agency had 

finalized new assistance terms for minority acquirers purchasing thrifts or branches that serve minority 

neighborhoods. Under these assistance provisions, minority acquirers can obtain financing for up to twothirds of the required regulatory capital and any premium, provided that the total amount financed does 

not exceed the tangible book value of the institution. Minority acquirers can obtain performing assets to 

offset deposit liabilities, giving them an option to acquire assets of up to 100 percent of net deposits. The 

RTC will make owned branch facilities located in minority neighborhoods available on a rent-free basis to 

minority acquirers for up to five years. 

The RTC permits the highest minority bidder to match the highest non-minority bidder's offer if, after a 

competitive bid process, the minority bidder's offer is within ten percent of the highest non-minority bid. If 

the minority bidder matches the high bid, it will be considered the winning bid. In order to acquire 

branches in minority neighborhoods, minority investors do not have to make an initial bid. They can 

acquire these branches from a majority acquirer that purchased the minority branches from the RTC. In 

effect, minority acquirers can work in consortium with majority bidders and still receive the full benefits of 

the minority assistance. The RTC Investor, 8/94, p. 4. 

RTC's Power to Subpoena Information 

A federal appeals court in early 1994 limited the RTC's power to issue subpoenas for personal financial 

information to persons that the RTC may reasonably suspect may be liable for an institution's failure (see 

this Review , Winter 1995, p. 38). In December the U.S. Court of Appeals for the District of Columbia, in a 

case stemming from the 1990 failure of San Jacinto Savings and Loan Association, ruled that the agency, 

having sued a person, cannot use an administrative subpoena solely to determine that individual's net 

worth. AB, 12/29/94, p. 2. 

Gross Negligence Standard Upheld in Bank Officials' Liability 

The U.S. Court of Appeals for the Fifth Circuit ruled that bank officers and directors cannot be held 

personally liable under federal common law for anything less than gross negligence (RTC v. Miramon, 

6/21/94). The Court said that the federal common law, which the RTC claimed would allow bank officers 

to be held liable for simple negligence, was preempted by FIRREA. The Act specifically provides that 

directors and officers of federally insured institutions may be held personally liable for damages in cases 

of 'gross negligence,' but that this provision does not impair any right of the RTC 'under other applicable 

law.' Stressing the limited role of the federal common law, the Court found that Congress spoke directly to 

the issue and thus preempted the federal common law. 

The Court made no ruling on whether FIRREA preempts state common law that allows actions against 

bank directors and officials based on simple negligence. Several courts have held that such suits are not 

preempted. BBR, 7/18/94, p. 94. 
 

 

 

 

 

 

 

 

 

 

 

 

Federal Reserve Board 

Capital Guidelines 

The FRB is amending, effective December 31, 1994, its capital guidelines for state member banks and 

bank holding companies to generally direct institutions to not include in regulatory capital the 'net 

unrealized holding gains (losses) on securities available for sale.' Net unrealized losses on equity 

securities with readily determinable fair market values will continue to be deducted from Tier 1 capital. 

The rule has the general effect of valuing available-for-sale securities at amortized cost, rather than at fair 

value (generally at market value), for purposes of calculating the risk-based and leverage capital ratios. 

The OCC and the OTS have adopted a similar rule for the institutions under their regulatory authority. FR, 

11/25/94, p. 60552; 12/8, p. 63241; Press Release, FRB, 12/5. 

The FRB adopted amendments, to be effective April 1, 1995, to its capital adequacy guidelines for state 

member banks and bank holding companies to establish a limitation on the amount of certain deferred tax 

assets that may be included in Tier 1 capital for risk-based and leverage capital purposes. The rule was 

developed in response to FASB Statement No. 109. 

Under the final rule, deferred tax assets that can only be realized if an institution earns taxable income in 

the future are limited for regulatory capital purposes to the amount the institution expects to realize within 

one year of the quarter-end report date -- based on its projection of taxable income -- or ten percent of 

Tier 1 capital, whichever is less. Deferred tax assets that can be realized from taxes paid in prior 

carryback years would generally not be limited. Press Release, FRB, 12/19/94. 

The FDIC has adopted these amendments with respect to banks subject to its supervisory authority. PR8-95, FDIC, 1/31/95. 

The FRB is amending its risk-based capital guidelines to recognize the risk-reducing benefits of qualifying 

bilateral netting contracts, implementing a recent revision to the Basle Accord. The effect of the final rule, 

to be effective December 31, 1994, is that state member banks and bank holding companies may net 

positive and negative mark-to-market values of interest-rate and exchange-rate contracts in determining 

the current exposure portion of the credit-equivalent amount of such contracts to be included in riskweighted assets. The OCC, FDIC, and OTS have issued parallel rules. FR, 12/7/94, p. 62987; Press 

Release, FRB, 12/2; AB, 12/30, p. 2; FIL-6-95, FDIC, 1/6/95; NEWS, OTS, 12/28/94. 

As part of its payment system risk-reduction program, the FRB, effective December 21, 1994, is 

integrating its policies on privately operated large-dollar multilateral netting systems into a single policy 

statement. Multilateral netting systems, including clearinghouse arrangements, have the potential to 

improve the efficiency of interbank settlements by reducing the costs of credit, liquidity and operations. 

However, these systems concentrate settlement and operational risks at a single point in the financial 

system. The FRB's statement incorporates the minimum standards for the design and operations of such 

systems contained in a report of the central banks of the Group of Ten countries published in November 

1990 by the Bank for International Settlements. These standards are designed to provide a set of 

minimum standards that permit the advantages of multilateral netting to be gained, while controlling 

systemic risks. FR, 12/29/94, p. 67534; Press Release, FRB, 12/21. 

The FRB modified its Policy Statement on Payment System Risk, doubling from 20 to 40 percent of riskbased capital the multiple associated with the de minimis net debit cap. Previously, an institution could 

request this cap which permitted daylight overdrafts up to 20 percent of risk-based capital. The FRB's 

action increases that limit to 40 percent. It is estimated that the change will eliminate 85 to 90 percent of 

cap overruns by institutions that currently have 'exempt from filing' or 'de minimis' caps. 

The FRB also approved administrative counseling flexibility for institutions that continue to exceed their 

net debit caps due to the posting of non-Fedwire transactions. Under this flexibility, the Reserve Banks 

will work with affected institutions on means of avoiding daylight overdrafts, but will not subject these 
 

 

 

 

 

 

 

 

 

 

 

institutions to routine counseling for daylight overdrafts. Effective: 10/13/94. FR, 11/2/94, p. 54915; BBR, 

11/7. p. 660. 

Bank Settlement on Derivatives' Risk Disclosure 

Bankers Trust New York Corp. signed a 'written agreement' under which the banking firm is required by 

the Federal Reserve to take measures for ensuring that its customers are able to understand the risks 

and price fluctuations involved with leveraged derivatives. Several Bankers Trust customers, including 

Gibson Greetings Inc. and Proctor and Gamble Co., have suffered heavy losses on derivatives contracts. 

Among the requirements under the agreement, Bankers Trust will disclose the risks of the derivatives 

prior to their purchase. For some derivatives after purchase, the bank will report their value to the 

customer each day. Previously, the bank provided this information only after the customer requested it. 

The agreement also calls for the bank to take actions to improve internal training, supervision and 

controls for leveraged derivatives activities. Several employees have been suspended by the bank for 

violations of internal rules regarding the selling of leveraged derivatives. The New York Times, 12/6/94, p. 

A1; WSJ, 12/6, p. A3. 

International Banking Operations 

The FRB proposed amending its Regulation K to provide criteria for use in evaluating the operations of 

any foreign bank in the United States that is not subject to comprehensive supervision or regulation by its 

home-country supervisor. The Foreign Bank Supervision Enhancement Act requires the FRB to develop 

these criteria in consultation with the Treasury Department. When the FRB has determined that a foreign 

bank is not subject to comprehensive, consolidated, home-country supervision, the criteria will be used to 

decide whether the bank should be permitted to continue its U.S. operations with or without supervisory 

restraints, or whether these operations should be terminated. Press Release, FRB, 12/9/94; FR, 12/13, p. 

64171. 

Activities of State-Licensed Branches and Agencies of Foreign Banks 

The FRB amended its Regulation K to set forth the application procedures for state-licensed branches 

and agencies of foreign banks seeking the Board's permission to engage in or continue to engage in an 

activity that is not permissible for a federal branch of a foreign bank and the requirements of divestiture 

and cessation plans. Section 202(a) of FDICIA provides that after December 19, 1992, a state-licensed 

branch or agency of a foreign bank may not engage in any activity that is not permissible for a federal 

branch of a foreign bank unless the FRB has determined that the activity is consistent with sound banking 

practice, and in the case of an insured branch, the FDIC has determined that the activity would pose no 

significant risk to the affected deposit insurance fund. The regulation is effective on January 1, 1995, 

except for one part effective December 5, 1994. FR, 11/3/94, p. 55026. 

Tying Restrictions Are Revised 

The FRB is adopting a final rule, effective January 23, 1995, amending its Regulation Y to permit a bank 

holding company or its nonbank subsidiary to offer a discount on its product or service on condition that a 

customer obtain any other product or service from that company or from any of its nonbank affiliates. The 

final rule would generally remove FRB-imposed restrictions on tying when no bank is involved in the 

arrangement and the products are separately available for purchase by the customer. The purposes of 

the amendment are to relieve bank holding companies of a competitive disadvantage, promote efficiency 

in the delivery of services, and provide benefits for consumers. FR, 12/20/94, p. 65473. 

Banking Firm's Investment Powers Are Widened 

The FRB approved a request for subsidiary banks of Norwest Corp. to inform customers about the 

products offered by Norwest Investment Services, a Section 20 subsidiary, through joint seminars, direct 

mail, letters on bank stationery, and statement stuffers. Among the offerings of Norwest Investment are 

stocks, bonds and mutual funds. About 30 banking firms operate Section 20 subsidiaries, through which 

since 1987 they have been granted limited powers by the FRB to underwrite and deal in securities. The 

FRB also gave approval for Norwest Investment to underwrite and deal in certain unrated municipal 

revenue bonds. This action should assist in broadening the market for the bonds of small municipalities. 

AB, 12/6/94, p. 5; BBR, 12/12, p. 862. 
 

 

 

 

 

 

 

 

 

 

 

Applications Under Regulation Y 

The FRB issued interim rules, with request for comments, implementing changes to the FRB's application 

procedures established by the Riegle Community Development and Regulatory Improvement Act of 1994 

(RCDRIA). The RCDRIA makes certain revisions to the procedures that bank holding companies must 

follow to gain approval of bank and nonbank acquisition proposals under the Bank Holding Company Act. 

The RCDRIA establishes a prior notice procedure to replace the current application process for all 

proposals by bank holding companies to engage in nonbanking activities. It establishes a streamlined 

notice procedure for the formation of a new bank holding company as part of a reorganization by the 

existing shareholders of a bank. Also, it eliminates the need for prior FRB approval of certain 'Oakar' 

transactions whereby a bank acquires a thrift or thrift's assets. Because these amendments became 

effective upon enactment of the RCDRIA, the FRB has adopted interim rules implementing these 

changes. Press Release, FRB, 10/27/94; FR, 11/2/94, pp. 54801, 54805. 

Appeals of Supervisory Decisions 

The FRB requested comment on an internal appeals process for institutions wishing to appeal an adverse 

material supervisory determination. Section 309 of the RCDRIA requires the FRB (as well as other federal 

banking regulators) to establish an independent, intra-agency appellate process, which will be available to 

review material supervisory determinations made at insured depository institutions, such as an adverse 

examination report. The FRB is proposing guidelines for appeals that are consistent with current practice 

at the Reserve Banks and the specific requirements of Section 309. Press Release, FRB, 12/22/94; FR, 

12/29, p. 67297. 

Home Mortgage Disclosure 

The FRB amended its Regulation C and the instructions and reporting forms that financial institutions 

must use in complying with the annual reporting requirements. The amendments respond to the statutory 

provisions regarding earlier availability of the Home Mortgage Disclosure Act (HMDA) disclosure 

statements to the public; provide clarifications; and are intended to help improve the quality of the HMDA 

data. The amendments require reporting in machine-readable format, except for institutions reporting 25 

or fewer line entries, require institutions to update their loan application registers quarterly during the year 

as data are being collected; and make a number of other changes. 

The rule is effective January 1, 1995, with required compliance for certain data beginning in calendar year 

1995 and in 1996. FR, 12/9/94, p. 63698; Letter to Financial Institutions, FFIEC, 12/9. 

The federal bank and thrift regulatory agencies have proposed changes to their regulations implementing 

the Community Reinvestment Act (CRA) under which the banks and savings associations that report data 

about their home mortgage lending pursuant to HMDA, and which have assets of $250 million or more, or 

are subsidiaries of a holding company with total banking and thrift assets of $250 million or more, would 

collect and report geographic information on loans and loan applications relating to property located 

outside the 'metropolitan statistical areas' (MSAs) in which these lenders have an office. Currently, 

geographic information is required only within MSAs where these lenders have an office. The new data 

would facilitate complete CRA assessments for institutions that do not qualify as small banks or thrifts. 

FR, 10/7/94, p. 51323. 

Truth in Lending 

The FRB proposed amendments to its Regulation Z to implement changes made to the Truth in Lending 

Act by the Riegle Community Development and Regulatory Improvement Act of 1994 that imposes new 

disclosure requirements and substantive limitations on mortgages bearing high rates or fees. More 

protections would be provided to consumers entering into high-rate, high- fee mortgages. The law also 

imposes new disclosure requirements for comparing the cost of reverse mortgages, which provide for 

periodic payments, based principally on a home's value, to primarily elderly homeowners. FR, 12/2/94, p. 

61832; Press Release, FRB, 11/29. 

The FRB proposed revisions to its official staff commentary to Regulation Z. The proposals relate to 

several issues of general interest, such as the treatment of various fees and taxes associated with real-
 

 

 

 

 

 

 

 

 

 

 

 

 

 

estate-secured loans, and a creditor's responsibilities when investigating a claim of unauthorized use of a 

credit card. FR, 12/14/94, p. 64351. 

The FRB solicited comments on whether consumers would benefit from having greater flexibility in 

waiving the right of recision in transactions with new creditors to refinance or consolidate home-secured 

loans (where no additional debt is incurred). Under present law, consumers may waive the right of 

recision in refinancings or consolidations with new creditors only when a bona fide personal emergency 

exists. FR, 12/21/94, p. 65771; Press Release, FRB, 12/20. 

Truth in Savings 

The FRB is reconsidering its action on January 4, 1995, in amending its Regulation DD requiring that the 

annual percentage yield (APY) reflect the frequency of interest payments. The original regulation is being 

left in place pending final action on the issue, except as indicated below. The FRB is seeking comment on 

the amendment, as well as the interest rate of return formula that was previously proposed but withdrawn 

last year. It adopted as an interim rule a narrowly drawn amendment to the Regulation to permit 

institutions to disclose an APY equal to the contract interest rate for time accounts with maturities greater 

than one year that do not compound but require interest distributions at least annually. Press Release, 

FRB, 1/18/95; FR, 1/26, pp. 5128, 5142. 

The FRB amended its Regulation DD and the official staff commentary to implement changes made to 

the Truth in Savings Act by the Riegle Community Development and Regulatory Improvement Act of 

1994. RCDRIA narrows the scope of accounts covered by TISA to accounts held by individuals for a 

personal, family or household purpose. Accounts held by unincorporated nonbusiness associations of 

individuals are no longer subject to TISA requirements. Effective date: September 23, 1994. FR, 

10/19/94, p. 52657. 

Equal Credit Opportunity 

The FRB proposed revisions to the official staff commentary to its Regulation B. The proposed revisions 

provide guidance on several issues including disparate treatment, special-purpose credit programs, credit 

scoring systems, and marital status discrimination. FR, 12/29/94, p. 67235; Press Release, FRB, 12/21. 

Public Welfare Investments 

The FRB adopted revisions, effective January 9, 1995, under which bank holding companies that have 

received approval to engage in activities that promote community welfare may make similar investments 

permissible for state member banks. These investments would primarily benefit low- and moderateincome persons or small businesses, and address demonstrated community needs by providing housing, 

services, and jobs to low- and moderate-income communities. Investments that comply with specified 

requirements, and do not exceed five percent of the total consolidated capital stock and surplus of the 

bank holding company when aggregated with similar investments made by depository institutions 

controlled by the holding company, may be made without additional FRB or Federal Reserve Bank 

approval. FR, 12/9/94, p 63712; Press Release, FRB, 12/7. 

Investment Advisor Activities 

The FRB is seeking comment on a proposal that would allow a bank holding company and its bank and 

nonbank subsidiaries to purchase in their sole discretion in a fiduciary capacity, securities of an 

investment company advised by the holding company if this purchase is specifically authorized by the 

terms of the instrument creating the fiduciary relationship, by court order, or by the law of the jurisdiction 

under which the trust is administered. The OCC and FDIC recently have granted this authority to the 

banks they regulate. Many states have amended their laws to allow banks to engage in these types of 

transactions. FR, 12/30/94, p. 67654; Press Release, FRB, 12/27. 

Recordkeeping For FundsTransfers 

The Department of the Treasury and the FRB adopted a final rule, effective January 1, 1996, that requires 

each domestic financial institution involved in a wire transfer to collect and retain certain information for 
 

 

 

 

 

five years. The amount and type of information depend upon the type of financial institution, its role in the 

particular wire transfer, the amount of the wire transfer, and the relationship of the parties to the 

transaction with the financial institution. The rule exempts wire transfers below $3,000. 

Under the Bank Secrecy Act of 1970, as amended in 1992, the FRB and the Treasury are authorized to 

impose recordkeeping requirements for domestic wire transfers by insured depository institutions 

whenever the agencies determine that such records have a high degree of usefulness in criminal, tax, or 

regulatory investigations or proceedings. In addition, the 1992 amendment requires the Treasury and the 

Board to issue final regulations with regard to international transactions. FR, 1/3/95, pp. 220, 231; Press 

Release, FRB, 12/22/94. See also related statement by OCC. FR, 1/3/95, p. 234. 

Disclosure Requirement Eliminated 

The FRB adopted an interim rule, effective December 1, 1994 and with a request for comments, 

eliminating from its Regulation E the requirement that an electronic terminal receipt disclose a number or 

code that 'uniquely' identifies the consumer, the consumer's account, or the access device. This 

requirement currently poses a significant security risk for consumers and financial institutions. The 

Electronic Fund Transfer Act (EFTA) requires that when a consumer initiates an EFT at an electronic 

terminal, the financial institution must make a written receipt available to the consumer that identifies the 

consumer's account with the financial institution from or to which funds are transferred. To ensure 

adequate identification, the FRB's regulation has required since 1979 that the receipt show a number or 

code that is 'unique.' Under the amendment, the receipt will still provide sufficient information, such as the 

date, amount, and type of the transfer, and the location of the terminal, to allow the consumer to identify 

transfers. Each transaction on the periodic statement could be matched with the transaction receipt. FR, 

12/2/94, p. 61787. 

Imputed Income on Clearing Balances 

The FRB proposed to modify the methodology for imputing clearing balance income to more closely 

parallel the practices of a private-sector provider. Specifically, comment is requested on changing the rate 

used to impute clearing balance income from the 90-day Treasury bill coupon- equivalent yield to a 

longer-term Treasury rate based on the earning asset maturity structure of the largest bank holding 

companies. 

The Monetary Control Act of 1980 requires the Federal Reserve Banks to establish fees for their services 

similar to those of private-sector service providers. In establishing fees, the FRB considers the objectives 

of fostering competition, improving the efficiency of the payments mechanism, and providing financial 

services nationwide. The Federal Reserve imputes costs in the private-sector adjustment factor (PSAF) 

that are intended to mirror private-sector sales taxes, income taxes, cost of funds, and FDIC 

assessments. Capital structure, equity and debt rates, and an income-tax rate are derived from a model 

of the largest (in asset size) 50 bank holding companies. The intended effect of the proposal is to promote 

competitive equity with private-sector practices by matching the maturity structure for investment of 

clearing balances to the structure revealed in bank holding company data on investments. Press Release, 

FRB, 8/16/94; FR, 8/19, p. 42832. 

Report Publication Requirement Eliminated 

The FRB amended its Regulation H to remove the requirement that state member banks publish their 

Reports of Condition. The amendment, effective November 10, 1994, implements Section 308 of the 

Riegle Community Development and Regulatory Improvement Act of 1994. Banks' Call Reports, including 

their Reports of Condition, will continue to be publicly available through the National Technical 

Information Service of the U.S. Department of Commerce. Additionally, state member banks will continue 

to be required to advise shareholders, customers, and the general public of the availability of year-end 

Call Reports and other financial information. FR, 11/10/94, p. 55987. 

Applications Approved For Firms to Operate in Mexico 

The FRB approved applications for a number of U.S. banking companies to establish operations in 

Mexico, the first such approvals since a provision of the North American Free Trade Agreement (NAFTA) 
 

 

 

 

 

 

 

 

 

 

 

became effective allowing U.S. and Canadian investors to acquire Mexican bank subsidiaries and 

establish financial holding companies. The firms receiving approval included Citibank Overseas 

Investment Corp., Morgan Guaranty International Finance Corp., Chemical International Finance Ltd., 

Republic National Bank of New York, Chase Manhattan Overseas Banking Corp., NationsBank Overseas 

Corp., and BankAmerica International Finance Corp. 

Among the requirements set by Mexico, foreign banks must have a business plan showing how their 

operations would benefit the nation's economy. Foreign banks cannot comprise more than eight percent 

of the total Mexican banking system in the first year, increasing to 15 percent in 1999, and no one 

institution can comprise more than 1.5 percent until the year 2000. BBR, 8/1/94, p. 173; Press Release, 

FRB, 7/27/94. 

Office of the Comptroller of the Currency 

Policies and Procedures For Corporate Activities 

The OCC is proposing to revise its rules governing corporate applications and notices, in order to 

modernize and clarify the rules, reduce regulatory burden, and eliminate unnecessary rules. The proposal 

would extensively revise and reorganize the agency's rules for national bank corporate activities. 

Among its provisions, the proposal provides for a new expedited review procedure for many types of 

applications submitted by healthy, well-managed banks which should entail low levels of risk. A national 

bank that is well-capitalized, has a rating of 1 or 2 under the CAMEL rating system, has a Community 

Reinvestment Act rating of 'outstanding' or 'satisfactory,' and is not subject to a cease and desist order or 

other enforcement actions, would be defined as an 'eligible bank'. Eligible banks submitting filings for 

branches, corporate reorganizations, operating subsidiaries to engage in certain activities, and other 

specified filings would qualify to use the expedited approval process. FR, 11/29/94, p. 61034. 

Concentrations of Credit and Nontraditional Activities 

The OCC, FRB, FDIC and OTS issued a final rule to implement Section 305 of FDICIA requiring the 

agencies to revise their risk-based capital standards for insured depository institutions to ensure that 

those standards take adequate account of concentration of credit risk and risks of nontraditional activities. 

The final rule, to be effective January 17, 1995, explicitly identifies such risks, as well as an institution's 

ability to manage them, as important factors in assessing an institution's overall capital adequacy. 

Concentrations of credit typically refer to situations when a lender has a relatively large portion of loans 

involving one borrower, industry, location, collateral or loan type. Nontraditional activities are considered 

those that have not customarily been part of the banking business but that start to be conducted as a 

result of developments in, for example, technology or financial markets. No mathematical formulas or 

explicit capital requirements for these two risks were adopted. Rather, a case-by-case approach will be 

used in assessing an institution's risks and overall capital adequacy. As an institution begins or 

significantly expands its participation in a nontraditional activity, the primary federal regulator will analyze 

the risks and request the appropriate capital and supervisory treatment. FR, 12/15/94, p. 64561; FIL-85-

94, FDIC, 12/19. 

Management of Derivatives 

The OCC released a 93-page booklet of examination procedures that expand on the guidelines on 

derivatives activities of banks which the agency issued in October 1993. The procedures specify the 

responsibilities of a bank's board and senior management in managing derivatives activities, 

distinguishing between different types of derivatives users. There are procedures for evaluating each of 

several types of risk, including market, credit, liquidity, operations and legal risks. The procedures will 

'give examiners detailed guidance for assessing whether banks have the necessary expertise, controls 

and procedures to manage the risks inherent in these complex instruments and use them in a safe and 

sound manner,' an OCC official said. Risk Management of Financial Derivatives, OCC, October 1994; 

BBR, 10/31/94, p. 620; AB, 10/24, p. 1. 
 

 

 

 

 

 

 

 

 

Disclosures in Mutual Fund Sales 

The OCC announced in May 1994, that in response to an interest expressed by a number of national 

banks in having the agency review disclosure materials they use in sales of mutual fund and annuity 

products, the agency would offer the opportunity for a one-time review of these disclosure materials. The 

OCC reported in September that it had completed a review of the materials. More than 700 national 

banks voluntarily submitted over 8500 different documents. 

Each national bank that participated in the review will receive a personalized letter that will include a 

document-by-document analysis of the materials it submitted. All national banks were sent a summary of 

the types of problems identified in the review and the type of action the OCC believes will correct the 

problems. Some of the specific areas where problems and corrections were discussed are: 

conspicuousness of disclosure displays; nondeposit products and bank obligations; investment risk; 

disclosure of bank and affiliate relationships; and annuities disclosures. Letter to National Banks, OCC, 

5/4/94; Disclosure Materials Used in Selling Mutual Funds and Annuities, OCC, 9/12/94. 

The FDIC distributed copies of the OCC's study to FDIC-supervised banks. The agency endorses the 

recommendations in the study, and encourages each bank that sells mutual funds or annuities to the 

public to review the report and correct any problems they find in their own disclosures. FIL-64-94, FDIC, 

9/27/94. 

Examinations of Noncomplex Community Banks 

The OCC adopted a policy and examination procedures for noncomplex community banks applicable only 

to the safety-and-soundness examinations of these banks. The new procedures are intended to improve 

efficiency and consistency in examinations, and reduce regulatory burden. 

Noncomplex community banks are banks that have composite ratings of 1 or 2 under the Uniform Interagency Bank Rating System, and operate under stable conditions demonstrated by stable bank 

management and ownership, no significant change in operations since the last examination, and a local 

economy that poses no material threat to operations. The definition also includes having management 

that is effective and responsive in addressing risks and conditions facing the institution, consistent and 

strong financial performance, and few or limited nontraditional products. Use of the new procedures is 

mandatory, beginning October 1, 1994. Bulletin 94-40, OCC, 6/20/94. 

State Regulation of Insurance Sales Upheld 

A panel of the U.S. Court of Appeals for the 11th Circuit, affirming a trial court's decision, ruled that the 

McCarran-Ferguson Act overrides other federal laws and gives states the right to regulate bank insurance 

sales. Barnett Banks Inc. argued in this Florida case that the National Bank Act supersedes state 

insurance law. The state allows independent state-chartered banks to sell insurance, but as a result of the 

decision it can deny insurance licenses to national banks. AB, 2/2/95, p. 1. 

Supreme Court Says Banks Can Sell Annuities 

The U.S. Supreme Court in a unanimous opinion in the case of NationsBank Corp. v. Variable Annuity 

Life Insurance Co . (Valic), upheld a decision of the OCC in the case that began in 1990 that selling 

annuities is 'incidental' to banking and a permissible activity under the National Bank Act. The Court's 

ruling is said to mark the first time it has explicitly stated that the OCC has the authority to grant powers 

not expressly included in the National Bank Act. An OCC spokesperson said the decision establishes a 

framework for the OCC to extend additional powers to banks. She said that in order that the grant of a 

new power is 'reasonable' as required by the Court, it would be necessary for the agency to show that the 

new power resembles an existing one. AB,<-3> 1/19/95, p. 1. 

Court Rules Banks Can Tie CD Rate to Stock Index 

A U.S. district court judge upheld a 1988 decision by the OCC allowing Chase Manhattan Bank to offer a 

CD tied to the performance of the Standard and Poor's 500 composite index. In his ruling the judge cited 

the case of NationsBank v. Valic, (see above), in which the Supreme Court concluded that the OCC has 
 

 

 

 

 

 

 

 

 

 

 

 

broad authority to decide what powers can be exercised by national banks. The Chase case is said to be 

the last of a series of challenges to bank securities powers that were carried over from the late 1980s. 

AB, 1/27/95, p. 2. 

Court Rules Bank Cannot Export Fees 

In a case involving late fees on credit cards, the Superior Court of Pennsylvania ruled against their 

interstate export by a Bank One unit. In 1978, the U.S. Supreme Court ruled that a national bank could 

export interest rates outside its home state. The Pennsylvania court said that late fees, and charges for 

exceeding credit limits and for insufficient funds, which are not levied on a percentage basis, cannot be 

defined as interest. The decision runs contrary to the rulings of a number of other courts, including seven 

different appellate courts. AB, 12/20/94, p. 14. 

Court Limits Banks' Sale of Insurance 

A federal magistrate judge in Indiana, in the case of NBD Bank v. Bennett, ruled that the National Bank 

Act does not empower banks to sell insurance outside the small towns where they operate. She said that 

Congress, in allowing national banks to sell insurance from offices in towns with fewer than 5,000 

residents, wanted to provide an incentive for banks to maintain their small-town branches. 

The U.S. Court of Appeals for the District of Columbia ruled in 1993 that banks may sell insurance 

anywhere from a branch in a small town. AB, 12/30/94, p. 1. 

CRA Enforcement Authority 

The Justice Department, responding to a request from the OCC, issued a legal opinion on use of 

regulatory general enforcement authority against institutions rated in substantial noncompliance with the 

CRA. Justice said the Act empowers the regulators to deny applications from these institutions for 

changes in corporate structure. Because of the sanctions explicitly provided, the regulators cannot utilize 

their general enforcement authority. Bank News, 1/95, p. 43. 

Appraisal Guidelines 

The OCC, FDIC, FRB, and OTS jointly issued appraisal and evaluation guidelines, superseding 

guidelines issued in 1992. Title XI of FIRREA requires the agencies to adopt regulations on the 

preparation and use of appraisals by federally regulated financial institutions. Such real-estate appraisals 

are to be in writing and performed in accordance with uniform standards. Although the agencies' appraisal 

regulations exempt certain categories of real-estate-related financial transactions from the appraisal 

requirements, most real-estate transactions over $250,000 are considered federally related transactions 

and thus require appraisals. An agency may impose more-stringent appraisal requirements than the 

appraisal regulations require. 

Among the specific topics addressed in the guidelines are elements of an effective real-estate appraisal 

and evaluation program, selection of individuals who may perform appraisals and evaluations, minimum 

appraisal standards, and program compliance. Inter-agency Appraisal and Evaluation Guidelines, OCC, 

FDIC, FRB, and OTS, 10/27/94; Joint Release, PR-73-94, FDIC, 11/7/94. 

NASD and Regulatory Agencies Agree on Coordinating Examinations 

The National Association of Securities Dealers (NASD) and the OCC, FRB, FDIC and OTS agreed in 

principle to coordinate their examinations of registered broker dealers selling mutual funds and other 

nondeposit investment products on the premises of depository institutions. The agreement is intended to 

ensure that their common interest in the supervision of broker dealers affiliated with depository institutions 

is addressed with a minimum of duplication of activity, and to promote regulatory consistency and reduce 

unnecessary burdens. 

Among other things, the NASD and banking agencies will share examination schedules for depository 

institutions that have affiliated broker dealers, and they may request that an observer be present at each 

other's examination. The NASD will provide the banking agencies with access to findings and workpapers 
 

 

 

 

 

 

 

 

 

 

 

from its most recent examination of affiliated broker dealers. There is a reciprocal agreement for referrals 

of apparent violations of apparent securities laws, and banking laws and regulations, among the NASD 

and the banking agencies. Joint Release, OCC, FDIC, FRB, OTS, NASD, 1/3/95. 

It was announced earlier that planning is under way to subject bank-employed brokers who sell mutual 

funds and other securities to the same licensing requirements as govern other such brokers. The NASD 

would administer entrance exams to bank brokers but have no further disciplinary authority. Comptroller 

of the Currency Eugene Ludwig expressed hope that a testing program can be established within the next 

year. AB, 9/28/94, p. 2. 

Risk-Based Capital 

The OCC and the FRB proposed amending their risk-based capital guidelines to modify the definition of 

the OECD-based group of countries, in which claims on governments and banks generally receive lower 

risk-weights than corresponding claims on these entities in non-OECD-based countries. The revisions are 

based on an announcement by the Basle Committee of a planned modification to the Basle Accord, the 

effect of which would be to exclude from the so-defined group of countries any country that has 

rescheduled its external sovereign debt within the previous five years. FR, 10/14/94, p. 52100. 

The OCC issued a final rule to amend its risk-based capital guidelines to lower the risk-weight from 20 

percent to zero percent for securities lending, repurchase agreement transactions, and certain 

collateralized accounts and financial exposures. One purpose of the rule is to ensure that the risk-weight 

assigned to transactions collateralized with cash or government securities more accurately reflects the 

minimal operational risk and near absence of credit risk in those transactions. FR, 12/28/94, p. 66642. 

Equity Derivative Swaps Approved 

The OCC gave approval, in a letter to Citibank N.A., for national banks and their operating subsidiaries to 

engage in equity swaps and equity index swaps. The agency said the equity swaps are essentially 

activities that have been approved for national banks in other forms. It said equity derivative swaps are 

incidental to the express power of national banks to receive deposits, make loans, and to the business of 

banking. BBR, 9/19/94, p. 375. 

Approval For D.C. Bank to Branch Into MD 

The OCC gave approval for the $77 million-asset Capital Bank in the District of Columbia to move its 

headquarters to Maryland and retain its existing offices in D.C. Under the OCC's regulations, a national 

bank may move its head office up to 30 miles even if the move crosses a state line. This is the first such 

approval for branching into a state where the banking firm had no existing operations. AB, 10/21/94, p. 2. 

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, which was signed into law on 

September 29, 1994, authorizes a bank holding company, beginning one year after enactment, to acquire 

a bank located in any state. It authorizes an insured bank, beginning June 1, 1997, to merge across state 

lines unless the affected states have 'opted-out' of interstate branching by enacting laws that prohibit 

interstate branching. Also, it authorizes, among other things, an insured bank to establish a de novo outof-state branch if the host state expressly permits interstate branching through the establishment of de 

novo branches. 

Securities-Offering Disclosures 

The OCC adopted amendments, effective April 3, 1995, to replace rules detailing the contents of offering 

documents covering national bank securities, and to require that offering documents conform to the 

information requirements contained in the Securities and Exchange Commission (SEC) registration form. 

The amendments are intended to reduce unnecessary regulatory burdens on national banks and 

enhance their ability to raise capital, while maintaining the %4 quality of disclosures provided to investors. 

The final rule generally treats national bank securities comparably to those of other corporations. 

Because the OCC rules will now actually reference the SEC rules, rather than parallel or copy them, the 

OCC rules will automatically remain current. FR, 11/2/94, p. 54789. 
 

 

 

 

 

 

 

 

Contracting Outreach Program 

The OCC adopted a rule, effective October 11, 1994, that is intended to ensure that businesses owned 

and controlled by members of minority groups, women and individuals with disabilities are provided the 

opportunity to participate in the agency's contracting processes. It also designates the official responsible 

for implementing the Outreach Program and its oversight. FR, 9/8/94, p. 46325. 

Assessments and Fees to Be Reduced 

The OCC adopted an interim rule, and requested comments on changing the method for the calculation 

of fees for examinations of fiduciary activities, and certain other examinations and investigations, to give 

the agency more flexibility for reducing existing rates. 

The agency also has announced several reductions, among which are the supervision hourly rate, from 

$102 to $50, applications for ATMs, from $1,500 to $400, and applications for branch or head office 

changes, from $900 to $700, all to be effective January 1, 1995. FR, 11/18/94, p. 59640; BBR, 11/7, p. 

659; 11/18, p. 776; AB, 11/17, p. 2. 

Office of Thrift Supervision 

Mergers and Charter Conversions 

The OTS, effective September 29, 1994 and pursuant to Sections 501 and 502 of FDICIA, amended its 

regulations governing mergers and combinations involving federal savings associations to give 

associations more flexibility to change charters, either by charter conversion or by merging. For example, 

the rule allows federally chartered savings associations to convert directly to state or national banks, and 

establishes procedures non-thrifts must follow to convert to a federal savings association or savings bank. 

With the new rule, well-managed, well-capitalized savings associations that wish to change charters need 

only notify the OTS. Applications, subject to OTS approval or denial, are still required when the savings 

association has a CAMEL or Compliance rating of 3, 4, or 5; a less than satisfactory CRA rating; or fails 

its capital requirements. 

The final regulations authorize federal stock associations to combine with any FDIC-insured depository 

institution, and authorizes federal mutual associations to combine with any FDIC-insured institution, 

provided that a mutual association is the resulting institution. In addition, certain combinations are 

authorized that involve federal associations and depository institutions not insured by the FDIC. Other 

amendments concern the procedures regarding applications to engage in the above-described actions. 

NEWS, OTS, 8/30/94; FR, 8/30, p. 44615. 

Conversions From Mutual to Stock Form 

On May 3, 1994, the OTS issued an interim final rule and a proposed rule, each with a request for 

comments (see this Review , Winter 1995, p. 46), on conversions from mutual to stock form and mutual 

savings-and-loan holding companies. A final rule, issued on November 22 and effective January 1, 1995, 

revised the interim rule by making local depositor preference in stock purchases optional rather than a 

requirement. A companion rule proposed in May requires a converting institution to meet the 

'convenience and needs' of its community. The OTS will henceforth consider a conversion applicant's 

CRA performance and other related factors in evaluating such an application. Among other changes, the 

final rule deletes the 100-mile local area definition of the local community for purposes of local depositor 

preference. FR, 11/30/94, p. 61247; NEWS, OTS, 11/22/94. 

Investments in Structured Notes 

The OTS alerted savings associations to potential risks inherent in structured notes. These notes are debt 

securities with derivative-like characteristics that are issued by corporations and government-sponsored 

enterprises, including the Federal National Mortgage Association, the Federal Home Loan Mortgage 

Corporation, and the Federal Home Loan Banks. Structured notes take various forms and often contain 

complex rate-adjustment formulas and embedded options. They may be customized to meet the needs of 

a particular investor, or issued in a more generic form to meet the needs of a broader range of investors. 
 

 

 

 

 

 

 

 

 

 

 

 

The agency said that while structured notes can be useful investments, they may, because of their 

complexity, be inappropriate for unsophisticated investors. Steps are indicated that savings associations 

should take before buying structured notes. For example, thrifts should make sure structured notes are 

consistent with their investment policy, that they thoroughly understand the risk/return characteristics of 

the instruments, and that they evaluate the effect of the investment on the institution's net portfolio value 

and earnings under different interest-rate scenarios. NEWS, OTS, 8/16/94; Thrift Bulletin 65, 8/15. 

Manual Explains Interest-Rate- Risk Measurement 

The OTS released a 300-page manual describing the computer model it uses to measure interest-rate 

risk (IRR) at the savings associations it regulates. Under the agency's capital regulation, savings 

institutions are required to hold capital as a cushion against potential losses if they have IRR above a 

certain level. The manual explains how the model is used to assess institutions' IRR and to calculate their 

capital requirements based on that risk. There is a general, non-technical discussion of OTS' approach to 

measuring IRR, and a detailed technical description of how the interest-rate sensitivity of institutions' 

assets, liabilities and off-balance- sheet items are estimated. NEWS, OTS, 12/22/94. 

Interest-Rate-Risk Appeals Process 

In August 1993, the OTS issued its final rule concerning the interest-rate-risk component of the risk-based 

capital requirement. The agency now proposes a process by which certain savings associations may 

appeal their IRR component calculated by the OTS. Three methods are proposed by which savings 

associations could be authorized to deviate from the interest-rate-risk methodology now in use by OTS. 

An institution could appeal its IRR component using appeals procedures described in the notice. An 

abbreviated certification process is available for certain highly capitalized institutions under specified 

conditions. This certification process may result in authorization for the institution to calculate its own IRR 

component for regulatory purposes. Finally, an institution could petition the OTS to change the 

methodology used in OTS' Net Portfolio Value Model. 

Under the proposal, the agency would consider appeals related to the IRR component only from 

institutions whose capital level would fall to a lower prompt corrective action (PCA) category as a result of 

their IRR component. An institution would have to show that the IRR exposure calculated by the OTS 

would be made more accurate through the use of either more refined data or more appropriate 

assumptions than those used in the NPV model. Certain fundamental parameters and scenarios used in 

constructing the computer model could not be the basis of an appeal. An institution would have to file its 

appeal within six months after the end of the quarter on which the disputed interest-rate-risk component is 

based. An OTS appeals committee would issue a decision within 60 days. 

The FRB, OCC, and the FDIC have published proposed rules to incorporate interest-rate-risk components 

in the risk-based capital requirements of commercial banks and expect to finalize these rules during the 

next year. NEWS, OTS, 8/16/94. 

Inter-Affiliate Banking Expanded 

The OTS Chief Counsel issued an opinion that federal savings associations regulated by the agency no 

longer must file a branch application to enter into inter-affiliate banking arrangements. Thus, affiliated 

federal associations may offer basic banking services to each other's customers without the need to 

obtain regulatory approval, even when the services are provided across state lines. NEWS, OTS, 2/9/95. 

Annual Independent Audits 

The OTS amended its annual independent audit requirements for savings associations to be more 

consistent with those applicable to other federally insured depository institutions. Pursuant to Section 112 

of FDICIA, all insured depository institutions with total assets of $500 million or more are required to 

obtain an annual independent audit. The agency's rules are amended also to eliminate the mandatory 

annual independent audit requirement for small savings associations with composite CAMEL ratings of '1' 

or '2'. The OTS still can require an independent audit of any savings association with assets of less than 

$500 million, as needed for purposes of safety and soundness. Effective date:December 23, 1994 . FR, 

11/23/94, p. 60300. 
 

 

 

 

 

 

 

 

 

 

Capital Distributions 

The OTS proposed amending its capital distributions regulation to conform to the system of prompt 

corrective action (PCA) established by FDICIA and by implementing its own regulations and those of 

other federal banking agencies. Under the proposal, which incorporates the PCA definition of capital 

distributions, a savings association that is not held by a savings-and-loan holding company and that has a 

composite CAMEL rating of '1' or '2' need not notify the OTS before making a capital distribution. 

Associations that would be at least adequately capitalized after making a capital distribution would be 

required to provide notice to the OTS. 'Troubled' associations and undercapitalized associations may 

make capital distributions only by filing for and receiving OTS approval, which may be granted only under 

certain limited conditions. The proposed regulation defines 'troubled condition' as a function of a savings 

association's composite examination rating, its capital condition, or on the basis of supervisory directives 

or designation by the OTS. FR, 12/5/94, p. 62356. 

Funds-Cost Index May Be Eliminated 

The OTS announced that its monthly median cost of funds, which is one of several indexes used to 

change interest rates on adjustable-rate mortgages (ARMs), may be terminated or modified. The index, 

compiled since December 1982, reflects the median interest rate that thrift institutions pay on deposits 

and on borrowed money. Comments are requested on whether the monthly index should be retained in 

light of a recent survey indicating relatively few ARM loans with rates tied to the index are made, and 

because other indexes, such as Treasury bills, are currently available to take its place. NEWS, OTS, 

10/17/94. 

Agency's Authority Upheld on Receivership 

A federal appeals court ruled that the courts may not review a decision by the OTS to replace a 

conservator of a failed savings association with a receiver. The decision by the Tenth Circuit Court of 

Appeals came on an appeal by Franklin Savings Association, Ottawa, Kansas, and its holding company, 

Franklin Savings Corporation. The RTC was first appointed conservator for the association by the OTS in 

February 1990, and had its status changed to receiver in September 1992. The association was resolved 

by the RTC in June 1994. The court cited FIRREA as providing for judicial review of an 'appointment' of a 

conservator or receiver, but not for a 'replacement' of a conservator with a receiver. NEWS, OTS, 9/21/94. 

Court Orders New Rulemaking in Conversion Regulation 

A U.S. district judge found that the OTS failed to seek the required public comment on the local-depositor 

provision of an 'interim final rule' it issued in late April that, in mutual-to-stock conversions, gave priority 

stock purchase rights to depositors who live in a thrift's 'local community' or within 100 miles of a home or 

branch office (see this Review , Winter 1995, p. 46). The OTS' objective in adopting the rule was to 

restrict windfall profits for insiders, and speculators who deposit funds in distant thrifts in which they could 

purchase stock should the institution later convert. The judge nullified this part of the broader rule issued 

by the OTS, and ordered the agency to conduct new rulemaking, including seeking public comment. 

WSJ, 10/3/94, p. A4. 

Application Decision Deferred Based on CRA Performance 

The OTS deferred action on an application by Avondale Federal Savings Bank, Chicago, to convert from 

a mutual to stock association, based on 'needs to improve' CRA ratings the thrift has received. An OTS 

official said it was the agency's first deferral of a conversion application based on an institution's CRA 

compliance record. An Avondale spokesperson said the institution has taken steps to improve its CRA 

performance, including establishing special marketing plans for low-income neighborhoods, and 

improving its community relations. BBR, 8/22/94, p. 247. 

Agency Continues to Reduce Staff 

The OTS announced consolidations and realignments of certain functions and a year-end 1995 staffing 

target of 1,500. The projected cut in staff is a continuation of annual reductions that have shrunk the 

agency from 3,389 at year-end 1989 to 1,771 in September 1994. The 48-percent reduction in staff over 

the past five years has been achieved through a combination of attrition and formal reduction-in-force 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

actions. The OTS projects expenses for 1994 of $178.1 million, compared with $296.9 million for 1990. 

NEWS, OTS, 9/13/94. 

Federal Financial Institutions Examination Council 

Capital Treatment of Unrealized Gains/Losses 

A task force of the FFIEC recommended to the member agencies that the net unrealized holding gains 

(losses) on available-for-sale debt securities not be included in regulatory capital for purposes of 

computing the leverage and risk-based capital ratios. Accordingly, when calculating these ratios, the 

amortized cost rather than the fair value of available-for-sale debt securities generally would be used. 

With regard to equity securities that have readily determinable fair values, it is recommended that they 

continue to be valued at the lower of cost or fair value for regulatory capital purposes. Examiners should 

continue their longstanding practice of considering any unrealized appreciation and depreciation on debt 

and equity securities not recognized in capital ratios when evaluating the adequacy of an institution's 

capital. These recommendations would continue the interim policies adopted by the FRB, FDIC, and OCC 

when FASB Statement No. 115 became effective, but would represent a reversal of the interim OTS 

policy issued in August 1993 to follow the Statement in computing savings associations' regulatory 

capital. Press Release, FFIEC, 11/10/94; Accounting for Certain Investments in Debt and Equity 

Securities, Financial Accounting Standards Board, May 1993. 

The FFIEC issued a statement regarding the regulatory reporting treatment of allowances established 

under Statement No. 114, ' Accounting by Creditors' for Impairment of a Loan, FASB, and regulatory 

capital issues arising from Statement No. 109, 'Accounting for Income Taxes.' Press Release, FFIEC, 

11/18/94. 

Information on Reporting Changes 

The FFIEC issued a 17-page booklet, for distribution to all insured banks, detailing the deletions and 

additions in the preparation of Call Reports for March 31, 1995. Among the changes thus far are: 

expansion of disclosures about a bank's involvement with off-balance-sheet derivatives; providing data on 

investments in high-risk mortgage securities and structured notes and on sales of proprietary mutual 

funds and annuities; reducing the level of detail regarding certain restructured loans and leases; and 

deleting items for total risk-based capital and average loans to states and political subdivisions. BBR, 

11/28/94, p. 780. 

National Credit Union Administration 

Mergers or Conversions of Credit Unions 

The NCUA is issuing an interim final rule, effective immediately, to clearly establish the agency's 

jurisdiction over all conversions by insured credit unions (see this Review , Winter 1995, p. 49). The 

interim rule requires that all mergers or conversions, involving one or more federally insured credit unions, 

including those where the resulting institution is not a credit union, must be approved by the NCUA Board. 

The rule also specifies that all notices are subject to NCUA approval. Comments on a number of related 

issues are requested. FR, 9/23/94, p. 48790. 

Corporate Credit Unions 

The NCUA amended, effective January 1, 1996, its regulations governing corporate credit unions to 

reduce the close ties between many corporate credit unions and credit union trade associations. Among 

the requirements in the final rule is that at least a majority of a corporate credit union's directors, including 

the chair, be representatives of member credit unions. A majority of a corporate credit union's directors 

may not be individuals who also serve as officers, directors, or employees of the same trade association 

or affiliated trade associations. The rule requires that the chief executive officer of a corporate credit union 

answer solely to the board of directors and not also serve as an employee of a trade association. 

Corporate officials must distance themselves from any decision involving another organization to which 

they belong. Corporate membership may not be linked to membership in a trade group. 
 

 

 

 

 

 

 

 

 

 

 

 

As of early 1994 there were 44 corporate credit unions serving the nation's 13,000 natural person credit 

unions. The corporate credit union system provides liquidity, investment and payment services to credit 

unions. FR, 4/19/94, p. 18503,; 11/17, p. 59357; AB, 11/14, p. 1. 

The NCUA placed the $1.4 billion-asset Capital Corporate Federal Credit Union into conservatorship, 

after Capital suffered large losses and was unable to meet withdrawals. The Corporate, based in a 

Maryland suburb of Washington, D.C., had invested heavily in collateralized mortgage obligations, whose 

value fell sharply when interest rates rose. The agency reportedly has moved quickly to sell off the 

investment portfolio, causing concern in the industry that the Corporate, which has 483 credit union 

members, will be liquidated. Latest information indicates that the credit union's $74 million in capital will 

cover any loss. AB, 2/2/95, p. 1; 2/17, p. 1. 

CAMEL Rating System Is Revised 

The NCUA is restructuring its credit union rating system to give examiners more flexibility to consider both 

qualitative and quantitative factors when assigning supervisory ratings to federally insured credit unions. 

Changes in the new system focus in particular on evaluating the condition and performance of credit 

unions in absolute terms rather than against peer averages or predetermined benchmarks. Numerous 

revisions are made in the various financial ratios used for evaluation purposes. Other changes include 

expansion of management review to include business strategy/financial performance; internal controls; 

management conduct; and service to members. Letter to Credit Unions, No. 161, NCUA, 12/94; BBR, 

1/9/95, p. 78. 

Courts Uphold the NCUA on Credit Union Expansions 

The U.S. Court of Appeals for the Sixth Circuit, in Cincinnati, upheld a NCUA decision permitting Portland 

Federal Credit Union, Portland, Michigan, to expand its service area from Portland, which has a 

population of 4,000, to a surrounding area having a population of about 70,000. The decision comes from 

the highest court yet to rule on the 'common bond' issue, following losses by bankers of decisions in three 

states. They have sued the NCUA in six states, and state regulators in two, charging excessively liberal 

policies in allowing credit unions to expand their territories. Some of these cases involve the ability of 

credit unions to serve unrelated groups of people, not communities. Also, the appellate court in the 

Portland case said its decision is confined to the facts of that case. AB, 12/9/94, p. 1; BBR, 12/12, p. 882. 

The U.S. District Court for the District of Columbia agreed with the NCUA's interpretation of the common 

bond, saying it was 'a reasonable construction of an ambiguous statute.' The case began in 1990 when 

four North Carolina banks and the American Bankers Association sued the NCUA, claiming a violation of 

the Federal Credit Union Act, for permitting AT&T Family Federal Credit Union to enroll employees of 

groups unrelated to its original sponsor. AB, 9/16/94, p. 4. 

Truth in Savings 

The NCUA published its official staff commentary to Part 707 of its Regulations. As required by the Riegle 

Community Development and Regulatory Improvement Act of 1994, the accounts of unincorporated 

business associations are exempted from coverage of Part 707. Effective date: 1/1/95. FR, 11/21/94, p. 

59887. 

The NCUA early in 1994 extended the date for compliance with its Truth-in-Savings regulation, to March 

31, 1995 for credit unions of an asset size between $500,000 and $1 million as of December 31, 1993, 

that are not automated, and to June 30, 1995 for credit unions of less than $500,000 that are not 

automated. The compliance date for all other credit unions remained January 1, 1995. Subsequently, the 

agency extended compliance to January 1, 1996 for credit unions of an asset size of $2 million or less as 

of December 31, 1993, that are not automated. FR, 8/3/94, p. 39425. 

Supervisory Review Committee 

The NCUA proposed a review process pursuant to a requirement of the Riegle Community Development 

and Regulatory Improvement Act of 1994 that the federal banking agencies each establish an appeals 
 

 

 

 

 

 

 

 

 

 

process to review material supervisory determinations made with respect to insured institutions . FR, 

11/17/94, p. 59437. 

Loan Interest Rates 

The NCUA is continuing an 18 percent federal credit union loan rate ceiling for the period from September 

9, 1994 through March 8, 1996. Loans and line of credit balances existing prior to May 15, 1987 may 

continue to bear their contractual rate of interest, not to exceed 21 percent. The current rate ceiling was 

scheduled to revert to 15 percent on September 9, 1994, unless otherwise provided by the NCUA Board. 

The Board said a 15 percent ceiling would restrict certain categories of credit and adversely affect the 

financial condition of a number of federal credit unions. FR, 8/3/94, p. 39423. 

Federal Housing Finance Board 

FHLBank System Membership Now Over 5,000 

The Federal Home Loan Bank System has increased by 1,800 members since the enactment of FIRREA 

in August 1989, which made it possible for commercial banks and credit unions to voluntarily join the 

System. As of July 31, 1994, a total of 4,936 financial institutions were members of the System, including 

2,736 commercial banks, 2,112 thrifts, 70 credit unions and 18 insurance companies. Currently, System 

members hold $925 billion in residential mortgage loans, about one-third of all home mortgage debt 

outstanding in the United States. After approval, an institution becomes a member by purchasing District 

Bank stock. Members receive a competitive dividend return on their stock investment. Included among 

the statutory requirements for membership in the System are that an institution must make long-term 

mortgage loans, and it must have at least ten percent of its total assets in residential mortgage loans. 

Through the 12 member-owned, FHFB-regulated District FHLBanks, the System provides long-term loans 

on many types of mortgage collateral, and provides liquidity for housing finance by means of advances 

(loans) to member institutions. Advances are made at interest rates that are lower than those in the 

commercial market, particularly on longer-term funds. The System raises funds by selling consolidated 

obligations to retail and institutional investors. Because the System has a stand-alone Triple-A credit 

rating and is a government-sponsored enterprise, it can raise debt at rates only slightly higher than rates 

on Treasury securities. NEWS, FHFB, 9/93; 7/94; News Release, FHLBank System, 9/30/94. 

Under FIRREA, the FHLBanks were required to implement an Affordable Housing Program with 

subsidized loans to member institutions for financing housing projects in low-income communities. At mid1994, outstanding commitments under the program amounted to $272 million, for nearly 1,900 projects 

involving construction or rehabilitation of about 72,000 housing units for low-income families. Also, the 

program's resources have leveraged $3.8 billion in development funds to date, with a leveraging ratio of 

over 13 to 1. BBR, 8/29/94, p. 286. 

STATE LEGISLATION AND REGULATION 

Bank Loses Insurance Power in BHC Takeover 

Arkansas: The state's Supreme Court ruled that the Arkansas Bank and Trust Company, with total assets 

of about $400 million, lost its right to operate an insurance company, which had been grandfathered when 

the bank was acquired in 1990 by First Commercial Corp., a multibank holding company. The Court, in a 

split decision, held that First Commercial acts as a bank and thus a provision of the law preventing 

transfer of the right to another bank is applicable. Divestiture is required under the decision. AB, 11/17/92, 

p. 2. 

Acquisitions of Banks 

Illinois: A new law, effective June 29, 1994, eliminates the current prohibition, which has threatened 

Illinois' reciprocal banking status with other states, on purchases by bank holding companies of banks in 

the state that are less than ten years old. Illinois Banker, 9/94, p. 24. 

Lending Limits 

Illinois: New legislation, effective June 29, 1994, raises the lending limits for state banks consistent with 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

changes being made for national banks. While state banks have a higher lending limit (currently 20 

percent) than national banks (currently 15 percent), the state's lending limit is based on definitions of 

capital and surplus that do not include numerous capital-related accounts that have been added to the 

federal definition over time. Illinois Banker, 9/94, p. 24. 

Kansas: An amendment, effective July 1, 1994, increases the lending limit for active officers and 

employees of state-chartered banks from five percent to 15 percent of unimpaired capital stock and 

unimpaired surplus. 

The amount of any loan in excess of which the prior approval of a bank's board of directors is required is 

raised to $50,000 from $10,000. The Kansas Banker, 7/94, p. 31. 

Reverse Mortgage Loans 

Illinois: An omnibus banking law, effective January 1, 1995, authorizes banks to make reverse mortgage 

loans for any purpose to persons under age 62. Presently, these loans can be made to persons of this 

age only for home improvements and repairs or the payment of insurance premiums and residential realestate taxes. The loans are not similarly restricted for those 62 and over. Illinois Banker, 9/94, p.20. 

Credit Cards Accepted For Taxes 

Kansas: A new law, effective July 1, 1994, permits the state Director of Taxation and county treasurers to 

accept credit-card payment for any taxes or fees assessed by these offices. The type of cards accepted is 

subject to the discretion of the state and local officials. The Kansas Banker, 7/94, p. 31. 

Credit Union's Membership Base Expanded 

Maine: The Banking Superintendent approved the conversion of the $15 million-asset Saco Valley 

Federal Credit Union to a state charter, under which the institution's membership base will widen to 

include persons who live or work in ten communities. The official said the larger base would help Saco 

Valley survive cutbacks by its membership's employers, and that competitor banks should not be 

materially impacted. The agency denied six communities requested by Saco Valley, some of which are 40 

miles from its headquarters, for reasons of the lack of a common bond, and doubts concerning Saco's 

ability to serve the towns. AB, 9/9/94, p. 11. 

Depositor Reimbursement Law Ruled Unconstitutional 

Nebraska: The state Supreme Court ruled that a 1993 state law that appropriated $16.5 million to 

reimburse depositors of three failed industrial loan companies is unconstitutional. Deposits of the 

companies were insured by the Nebraska Depository Institution Guaranty Corp., which did not have the 

assets to meet its insurance commitments. The basis for the Court's decision was the fact, which the 

state did not contest, that the depositors' claims were not legal obligations of the state. BBR, 7/25/94, p. 

132. 

Bank Protection Against Foreign Government Actions 

New York: New legislation, effective immediately, protects state-chartered banks and trust companies and 

national banks in the state from repayment claims of depositors in their foreign subsidiaries, if payment is 

made impossible by war, civil strife or an act of a foreign government, unless the deposit contract 

specifically provides that the home office would pay off these deposits. Legislation enacted initially by the 

state in 1937 has protected banks in such circumstances, but the courts have ruled in two recent cases 

that this protection does not cover the claims of depositors in their foreign branches. BBR, 8/1/94, p. 158. 

Basic Checking Services 

New York: The state Banking Board approved a proposal for low-cost checking accounts at statechartered banking institutions, as required under the state's Omnibus Consumer Protection and Banking 

Deregulation Act of 1994. Basic checking accounts would require an initial deposit of no more than $25, 

and with no minimum required balance. Banks could impose a $3 maximum monthly maintenance 

charge, and would provide at no additional cost a minimum of eight withdrawal transactions per month, 
 

 

 

 

 

 

 

 

 

 

 

including institution-operated automated teller machine transactions. Extra fees could be charged to 

customers for withdrawals or deposits at ATMs not operated by their bank, for more than eight 

withdrawals, and use of other charge services. BBR, 8/1/94, p. 158; 10/31, p. 633; AB, 11/10, p. 4. 

Derivatives and Foreign-Exchange Contracts 

New York: An amended law, closing a legal loophole, provides that agreements involving oral telephone 

trades and screen-to-screen trades cannot be nullified and are enforceable if there is an admissible tape 

recording or similar electronic evidence. These transactions now comprise 99 percent of the market. Also, 

a written confirmation within five days of the trade not objected to within three days results in a legally 

binding trade. Under the state's existing law, agreements for trades that could not be performed within a 

year, and foreign-exchange contracts of any length, must be in writing to be enforceable. BBR, 8/1/94, p. 

157. 

Low-Income Loan Program 

New York: The New York Mortgage Coalition, a group comprising 14 New York-area banks, announced 

that in its first year it had made 191 mortgage loans to low-income and moderate-income borrowers 

totaling more than $215 million. Of loan applicants referred to the Coalition from community groups 

through April 1994, 78 percent have been approved and some are pending. The denial rates -- 16 percent 

for black applicants, 13 percent for Hispanics, and ten percent for whites are well below the national 

averages in Home Mortgage Disclosure Act (HMDA) data compiled by the FFIEC. AB, 8/23/94, p. 9. 

Mutual Thrift Conversions 

New York: The Banking Department proposed regulations which in mutual-to-stock conversions would: 

limit stock-based compensation for officials of converting institutions; place restrictions on the proxy 

process; require a detailed explanation of stock-appraisal methodology; require in-depth information on 

the planned use of the stock offering proceeds; and require a justification for any planned stock 

repurchases, which would be subject to limitations contained in the guidelines of OTS. BBR, 8/29/94, p. 

289. 

The Banking Board proposed amendments to its savings bank conversion regulation that, in these 

conversions would specifically prohibit special interest payments to depositors. Only depositors would be 

allowed to conduct proxy solicitations against management. Stock grants and stock options for officers, 

trustees, and directors at the time of a conversion would be prohibited, but stockholders could approve 

these actions at the firm's first annual meeting. The Banking Department noted that the regulation 

generally conforms to a new interim rule adopted by the OTS. BBR, 8/1/94, p. 157. 

Interstate Banking 

South Carolina: As a result of amendments to become effective July 1, 1996, to the state's bank holding 

company statute, bank holding companies outside the region will have the same acquisition options in the 

state as holding companies in the states within the Southeast regional banking compact. Similar 

extensions of interstate banking rights to states outside the region have been enacted as of July 1994 in 

Georgia, North Carolina, and Virginia. BBR, 7/25/94, p. 121. 

Credit Union Expansion Policy 

Washington: Since taking office in November 1993, the Director of Financial Institutions has allowed eight 

state-chartered credit unions to take communities into their customer base. The credit unions serve 13 

communities with a population of about 324,000. The official said the state wants to create an 

environment that promotes competition and eliminates unnecessary barriers to business. Previously, 

these expansions were permitted only in exceptional cases, such as when a credit union's sponsor was 

undergoing an employment reduction. AB, 8/19/94, p. 7. 

BANK AND THRIFT PERFORMANCE 
 

 

 

 

 

 

 

 

 

 

Commercial Banks' Nine-Month Earnings Set Record 

Commercial banks earned a record $11.8 billion (preliminary) in the third quarter of 1994, and for the first 

nine months their profits totaled $34 billion, a record for any nine-month period and $1.4 billion ahead of 

the first nine months of last year. The third quarter's performance reflected strong loan growth, which 

increased the industry's interest-earning assets and raised the average yields on those assets. Loan 

growth was led by increases in home mortgages, consumer loans and loans to businesses. Banks 

reduced their securities holdings for the second consecutive quarter. Provisioning for loan losses, 

reflecting continuing declines in troubled loans, was the lowest in ten years. Charge-offs of $2.4 billion 

were the least since the first quarter of 1985. 

Commercial banks' average return on assets (ROA) rose to an annualized 1.21 percent in the third 

quarter, from 1.16 percent in the second quarter. Nearly 96 percent of all commercial banks reported a 

profit in the third quarter. Chairman Ricki Helfer said the data indicate that the commercial banking 

industry has never been in better shape, but as the insurer of banks and thrifts, the FDIC will be 

monitoring such areas as derivatives investments and loan approval standards. 

FDIC-insured, private-sector savings banks and savings-and-loan associations reported earnings of $2.1 

billion in the third quarter, an improvement of $349 million from the previous quarter and $950 million from 

a year ago. Lower overhead expenses and reduced provision for future loan losses were the main factors 

contributing to the earnings improvement. The thrift industry's average ROA rose to an annalized 0.86 

percent in the third quarter, from 0.73 percent in the previous quarter and 0.48 percent a year ago. 

Ninety-three percent of all savings institutions were profitable in the third quarter. FDIC Quarterly Banking 

Profile, Third Quarter, 1994; PR-81-94, FDIC, 12/15/94. 

One in Five Banks Selling Mutual Funds or Annuities 

Data from Call Reports show that in the first quarter of 1994, about one in five insured commercial banks 

in the U.S. (2,261 banks) sold mutual funds or annuities to their customers. Of that group, 51 percent sold 

both mutual funds and annuities, while 30 percent sold only mutual funds and the remaining 19 percent 

sold only annuities. 

Approximately 14 percent of banks with assets of less than $100 million sold mutual funds or annuities, 

compared with 66 percent of banks with assets of $1 billion to $15 billion, and 100 percent of banks with 

assets of more than $15 billion. While bank sales of money-market mutual funds were far larger than 

sales of long-term (equity and bond) funds $97.7 billion versus $9.5 billion many more banks sold longterm funds than money-market funds, and this was true for all asset categories except the largest (above 

$15 billion in assets). 

Sales of mutual funds and annuities still account for a small portion of bank revenue. On average, fees 

and other income from sales of these products represented slightly less than four percent of noninterest 

income at selling banks in the first quarter. There were, however, significant variations among institutions. 

Fifty-one banks, all of which had assets of less than $400 million and most were below $100 million, 

reported mutual fund and annuity income of at least 20 percent of their noninterest income. More than 

500 banks reported ratios of five percent to 20 percent. 

One limitation of the study is that the gross sales data are not adjusted for redemptions, reinvested 

dividends, or transfers among funds, thus banks' involvement may be overstated. Also, the revenue data 

may reflect income and fees earned on sales from previous quarters, and they do not separate income 

from mutual funds and income from annuities. AB, 8/25/94, p. 12; Central Banker, Federal Reserve Bank 

of St. Louis, Summer 1994. 

Only Small Minority of Buyers Think Bank-Sold Mutual Funds Are Insured 

A survey released in December 1994 by the Consumer Bankers Association showed that 21 percent of 

household financial decision makers and five percent of bank mutual fund customers thought investments 

in mutual funds are federally insured. However, the Association said customers need more information 
 

 

 

 

 

 

 

 

 

 

 

about other risks in mutual funds, such as variable rates of return, possible loss of principal, and 

commission or management charges, whether the funds are purchased from banks or other sources. 

The survey, conducted by the Roper Organization, included interviews with a random group of 700 

financial decision makers at households with at least $30,000 in annual income, and 139 bank mutual 

fund customers randomly selected from lists supplied by banks. BBR, 12/19/94, p. 916; The Arkansas 

Banker Magazine, 12/94, p. 15. 

Decline in Credit Union Assets 

Assets of the nation's largest federally insured credit unions those with over $50 million in assets fell 0.7 

percent in the third quarter of 1994 to $199.5 billion, according to the NCUA. It was the first quarterly 

decline since the third quarter of 1988. Deposits fell by 1.1 percent, while total loans grew 3.4 percent. An 

industry analyst attributed the decline in deposits mainly to a healthy economy in which consumers are 

spending more and saving less. He predicted that developing liquidity pressures may result in credit 

unions raising their loan rates in the coming months. The capital-to-assets ratio increased from 9.5 

percent to 9.8 percent in the quarter. AB, 11/18/94, p. 3. 

Check Fraud Problem Getting More Attention 

Check fraud at banks rose by 136 percent in the two years through 1993, to 1.27 million cases, and 

banks' losses from check fraud rose by 43 percent to $815 million, according to a survey by the American 

Bankers Association. Regionally, the percentage of banks experiencing losses ranged from more than 80 

percent in the Northeast to just under 50 percent in the Midwest. The proportion of banks experiencing 

check fraud losses also varied by the size of the institution -- almost 90 percent of banks with more than 

$5 billion in assets compared to 54 percent of banks with $500 million or less in assets. Discussing the 

causes for the rapid increase in check fraud losses, the ABA cited the availability to forgers of 

inexpensive desktop publishing software and laser printing equipment. Also, customers are not properly 

safeguarding account information. AB, 12/1/94, p. 1. 

In an earlier report, the ABA said that only 1.7 percent of banks above $1 billion in assets in a survey 

verified signatures on all checks before payment. About one-third of the banks with assets of less than 

$100 million verified all check signatures. AB, 8/25/94, p. 14. 

Kmart Corp. is installing electronic check readers that determine if a check is genuine based on the 

strength of its magnetic ink line. The firm has completed a 200-store pilot program with the MICR 

identification device and plans to install them in all its 2,400 stores by late Spring. 

Use of 'positive pay' programs to protect against fraudulent checks is increasing among corporate clients 

of large banks. In these programs the corporate customer sends informaton electronically to the financial 

institution on items it has issued, enabling that institution to notify the customer if items are presented 

which it may not have issued. Some institutions are initiating systems in which images of questionable 

checks are sent over the phone lines back to the customer. AB, 1/18/94, p. 20. 

NASD Bans Members' Use of Bank Logos 

The National Association of Securities Dealers is prohibiting the use of bank logos on advertisements and 

sales literature for member firms. Bank names may appear non-prominently in members' advertising and 

sales literature solely for the purpose of identifying the location where broker-dealer services are 

available. Notice to Members, NASD, November 1994; AB, 12/2/94, p. 1. 

Credit Life Insurance Called Too Expensive 

A report of the National Insurance Consumer Organization and the Consumer Federation of America said 

that the premiums charged for credit life insurance are too high, and that only three states -- New York, 

Maine, and Vermont -- and the District of Columbia, meet the standard set by the National Association of 

Insurance Commissioners of a 60 percent payout-to-premium ratio. If all states achieved that standard, 

consumers would save an additional $530 million annually, the report estimated. In most states, the 
 

 

 

 

 

 

 

 

 

 

payout rate is 44 cents per dollar, up from 37 cents five years ago. During that period, 18 states took 

action to lower their credit life insurance rates. Over 60 percent of the savings, estimated at $200 million, 

went to consumers in Georgia, Texas, Vermont and North Carolina. 

A CFA official noted that instances of discrimination against borrowers who choose not to purchase credit 

life insurance are declining. AB, 7/26/94, p. 2; BBR, 8/1, p. 153. 

Off-Premises ATMs Show Strong Growth 

The 50 largest U.S. banking firms increased the number of ATMs outside their offices by 20.6 percent in 

the 12 months ending June 30, 1994, and their branch-based ATMs by only 5.4 percent, according to a 

survey by the American Banker, bringing the number of the two categories of ATMs held by these 

institutions to nearly 8,000, and more than 21,000, respectively. The top five banking organizations in 

numbers of ATMs were BankAmerica Corp., Nations- Bank Corp., Wells Fargo & Co., Citicorp, and First 

Interstate Corp. An estimated 75 percent of all ATM transactions are cash withdrawals. AB, 11/30/94, p. 

1. 

More Credit Unions Issuing Debt Cards 

Debit cards are first among new products planned by credit unions for next year, according to a recent 

survey of 800 institutions by the Credit Union National Association. About 500 credit unions issue debit 

cards, a CUNA official said, including 200 that issued the cards through a CUNA services subsidiary. The 

cards have advantages to credit unions of avoiding the costs associated with paper check processing, 

and they generate interchange income in fees from merchants based on card transactions. About 29 

percent of credit union member households have a debit card. AB, 9/16/94, p. 6. 

U.S. Financial-Services Transactions With Foreign Persons 

The Bureau of Economic Analysis of the U.S. Department of Commerce will conduct a survey in which, 

for the first time, comprehensive information will be collected on trade in financial services between U.S. 

financial-services providers and unaffiliated foreign persons. The information collected will be used in 

monitoring U.S. services trade and formulating U.S. international trade policy, compiling the U.S. balance 

of payments and national income and product accounts, assessing U.S. competitiveness in international 

trade in services and improving the ability of U.S. businesses to identify and evaluate market 

opportunities. 

Reporting is required from U.S. financial-services providers who have sales to or purchases from 

unaffiliated foreign persons in all covered financial services combined in excess of $1 million during the 

reporting year. The providers meeting these criteria must supply data on the amount of their sales or 

purchases of each covered type of service, disaggregated by country. Providers that have covered 

transactions of less than $1 million during the reporting year are asked to provide, on a voluntary basis, 

estimates of their total sales or purchases by type of financial service. Beginning with the year 1994, the 

surveys will be conducted every five years, and it is anticipated that in the interim year the information will 

be updated by the use of more limited surveys based on a sample of companies. FR, 7/28/94, p. 38387. 

Internal Controls Reporting Fails Cost-Benefit Test 

A recent study found that banks spent about $100 million in 1993 complying with a provision of FDICIA 

that requires banks with assets in excess of $500 million to file a report with regulators each year, the 

accuracy of which must be attested to by a certified public accountant, regarding their internal controls in 

place. The costs include amounts paid for documentation, training, and accountants' fees. A total of 48 

banks were surveyed, including 16 of the largest in the nation. Costs in these institutions, which ranged 

from $50,000 to $3.5 millon per bank, were projected to estimate the costs for the industry. In the view of 

Dr. Curtis C. Verschoor of DePaul University, who conducted the study in conjunction with the Bank 

Administration Institute, the costs far outweigh the benefits to managements for preventing loan losses. 

AB, 10/6/94, p. 8. 

RECENT ARTICLES AND STUDIES 
 

 

 

 

 

 

Uses and Regulation of Financial Derivatives 

This study by the U.S. General Accounting Office notes that derivatives have enabled commercial 

corporations, governments, financial firms, and other institutions in the United States and worldwide to 

reduce their exposure to fluctuations in interest rates, currency exchange rates, and the prices of equities 

and commodities. Derivatives also have enabled users to reduce funding costs and speculate on changes 

in market rates and prices. There are concerns, heightened by recent reports of major losses from 

derivatives, that knowledge of how to manage and oversee risks associated with derivatives may not 

have kept pace with their increased use. The principal objectives of this study were to determine: (a) what 

risks derivatives might pose to individual firms and to the financial system and how firms and regulators 

are attempting to control these risks, (b) whether gaps and inconsistencies exist in U.S. regulation of 

derivatives, (c) whether under existing accounting rules market participants and investors are provided 

adequate information about firms' use of derivatives, and (d) the regulatory implications of the 

international use of derivatives. The four basic types of derivative products, which can be combined to 

create more complex derivatives, focused upon here were forwards, futures, options, and swaps. 

While thousands of institutions use derivatives, over-the-counter (OTC) dealing in forwards, options and 

swaps is concentrated among a relatively few financial firms worldwide. As of December 1992, the top 

seven domestic bank OTC derivatives dealers accounted for more than 90 percent of total U.S. bank 

derivatives activity. The top five U.S. securities firms dealing in OTC derivatives accounted for about 87 

percent of total derivatives activity for all U.S. securities firms. U.S. dealers were a major part of world 

activity and accounted for about half of the total volume of OTC derivatives activity worldwide. The 

combination of global involvement, concentration, and linkages means that the sudden failure or abrupt 

withdrawal from trading of any of these large dealers could cause liquidity problems in the markets and 

could also pose risks to the others, including federally insured banks and the financial system as a whole. 

While the supervision of banks' derivatives activities has improved, weaknesses remain, including 

insufficient regulatory reporting, inadequate documentation and testing of internal controls. Significant 

gaps and weaknesses exist in the regulation of many major OTC derivatives dealers. For example, 

securities regulators have limited authority to oversee the financial activities of securities firm affiliates that 

conduct the OTC derivatives activities. Insurance companies' OTC derivatives affiliates are subject to 

limited state regulation and have no federal oversight, yet OTC derivatives affiliates of securities and 

insurance firms constitute a rapidly growing component of the derivatives markets. The GAO found also 

that accounting standards for derivatives, particularly those used for hedging purposes by end-users, 

were incomplete and inconsistent and have not kept pace with business practices. 

Among the GAO's recommendations was that Congress require federal regulation for the safety and 

soundness of all major U.S. OTC derivatives dealers. Congress should bring the currently unregulated 

OTC derivatives activities of securities and insurance companies' affiliates under the supervision of one or 

more of the existing federal financial regulators. It is recommended that the appropriate authorities work 

closely with industry representatives to: (a) develop and maintain accurate, current, and centralized 

information that is accessible to all regulators, including information on the extent of major OTC dealers' 

counterparty concentrations and the sources and amounts of their derivatives earnings; (b) develop and 

adopt a consistent set of capital standards for OTC derivatives dealers sufficient to ensure that all of the 

major risks associated with derivatives are reflected in capital; (c) establish specific requirements for 

independent, knowledgeable audit committees and internal control reporting for all major OTC derivatives 

dealers; and (d) perform comprehensive annual examinations of the adequacy of major OTC derivatives 

dealers' risk-management systems using a consistent set of standards established for this purpose and 

including consideration of the internal control assessments performed by boards of directors, 

management, and auditors. Financial Derivatives Actions Needed to Protect the Financial System, U.S. 

General Accounting Office, May 1994. 

The strong growth in derivatives market activity continued in the second quarter of 1994, based on 

regulatory report data for such off-balance-sheet instruments as swaps, options and forward contracts, 

but not including some types of derivatives such as collateralized mortgage obligations. During the 

quarter, 704 banks had derivatives in their portfolios, down from 713 banks in the first quarter but 661 
 

 

 

 

 

 

 

 

 

more than a year earlier. Depending upon the method of measurement used, the ten banks with the 

largest derivatives holdings accounted for between 92.7 percent and 95 percent of the total for the 

industry. AB, 9/30/94, p. 1. 

Home-Buying Process Studied For Sources of Discrimination 

The Cuyahoga County Department of Community Development, the Federal Reserve Bank of Cleveland, 

the Greater Cleveland Roundtable, and the Ohio Civil Rights Commission are major participants in the 

Cleveland Residential Housing and Mortgage Credit Project, which is conducting a comprehensive study 

of the home-buying process in its mission to ensure non-discriminatory access to residential mortgage 

credit in the Greater Cleveland area. 

Initially, task groups were assigned to analyze specifically identified decision points in the home-buying 

process for discriminatory acts that could potentially occur in each stage of the process. The studies have 

focused on four critical decision points: (1) the initial contact with the real-estate agent; (2) the initial 

contact with the lender; (3) the interface with the secondary market; and (4) the appraisal process. The 

analyses and recommendations of the four task groups were presented in June 1994. 

In the realtor-contact phase, one problem is that agents, because of lack of knowledge about certain 

types of financing, may inappropriately refer the purchaser to a loan source with which they are familiar 

while omitting other available options. The seller, typically given the decision as to acceptable financing, 

may specify conventional only or a similar exclusion. But the purchaser, because of the down payment, 

past credit problems or other reasons, may find conventional financing impossible to obtain, or it may be 

less appropriate then other sources of loans. Among the %-3 group's recommendations is that restrictions 

should not appear in multiple listing service information regardless of the type of financing being 

proposed. All offers ought to be presented for the seller's consideration, regardless of the type of 

financing being proposed. A comprehensive summary of available financing programs, written in 'user 

friendly' terminology will be prepared by the study group for use by real-estate agents. Also, a continuing 

education class for real-estate agents will be developed that will emphasize the variety of financing 

options and the potential for discrimination when advising buyers and sellers of financing. 

Initial contacts with lenders can result, because of deliberate prescreening or inadequate lender training, 

in customers not being given full information about credit availability. The analysis focuses on the many 

ways that discrimination may occur before the loan process begins, for example, by offering more 

information options to some customers than others, or asking some to wait longer than others. It is noted 

that when loan originators provide general information about loan products, it is considered to be an 

inquiry; however, responses to specific questions about an applicant's eligibility for a mortgage loan are 

reported as applications under federal guidelines. Lenders obviously may have an incentive for treating 

potential borrowers differently because of the variance in the cost of servicing the customer. Loans of a 

nontraditional type may take longer to process. The practice of taking applications in central locations 

rather than through outlying offices, can cause discrimination. Officials in the central offices will probably 

not be as familiar with many of these customers, and there may be feelings of intimidation on the part of 

the latter. The report recommends that an industry-wide training and certification program be developed 

for loan originators, reinforced by an ongoing evaluation process. A code of conduct should be 

established by which institutions would commit themselves to the program. 

Guidelines issued by Fannie Mae or other agencies to provide information to lenders for determining 

whether a particular loan will qualify for inclusion in a loan pool, for sale on the secondary market, are 

often interpreted incorrectly, especially by smaller institutions, which can result in the elimination of some 

potential borrowers. The guidelines require, for example, that lenders verify the source of a down 

payment, and details about the borrower's credit history. However, the standard requirements may not be 

appropriate for some potential customers, and representatives from Fannie Mae have noted that, with 

proper documentation, loans with exceptions in these areas can be acceptable in the secondary market. 

It is recommended that a formal, ongoing plan should be adopted for the training and education of 

officials of lending institutions about the programs offered by, and the guidelines of, secondary-market 

companies. A curriculum should be instituted in high schools to educate students about the importance of 
 

 

 

 

 

 

 

 

a good credit rating, the importance of a good savings pattern, the home-buying process and related 

topics. 

Property appraisals play a 'pivotal role' in the economic health of neighborhoods: in individual cases, an 

appraisal that is too low can result in inadequate loan availability for the customer. The report discusses 

the interacting process of market values and appraisals, from the perspective of the impact that individual 

appraisals can have on values throughout a community, currently and over time. The recommendation of 

the task group was that an industry group be formed to address the education of appraisers and the 

process of identifying qualified appraisers. Another task group representing the lending institutions should 

be concerned with the training for evaluating appraisals and the review process for low appraisals. 

Community Reinvestment Forum, Federal Reserve Bank of Cleveland, Special Issue 1994. 

Defining the Roles of Accountants, Bankers and Regulators 

This report observes that despite the advantages found in the experience in other countries in respect to 

a close working relationship among regulators, bankers, and external auditors, such a relationship has 

not been the norm in the U.S. The role of external auditors in banking began to expand in the late 1960s 

as most major banks adopted a holding company structure subject to broader public disclosure and audit 

requirements and the banking agencies expanded the financial reporting required for regulatory 

purposes. At the same time, the managing of banks was becoming increasingly complex, with increasing 

competition, rapid financial innovation and technological change. New banking laws increased the cost 

and complexity of bank regulation and reporting. The information needs of managers, the financial 

markets and regulators grew in scope and complexity. While these developments would indicate a need 

for closer cooperation, the relationship among regulators, bankers and external auditors has suffered in 

the past several years from the effects of the savings-and-loan industry debacle, large loan losses among 

U.S. banks and the aggressive legislative and regulatory responses to those events. As a result, the 

working relationships among regulators, bank management and external auditors have become 

increasingly contentious. 

Under FIRREA, regulatory scrutiny of management decisions was greatly expanded. For example, the 

hiring of directors and senior officers was subjected to regulatory approval not only at troubled institutions 

but at any institution chartered or undergoing a change of control within the previous two years. Removal 

authority by regulators was extended to reach major shareholders and external auditors and other 

advisers, and to permit industry-wide disqualification. Administrative penalties were increased 

substantially, as were maximum prison sentences, and penalties were applied to a broader range of 

offenses. 

FDICIA continued FIRREA's emphasis on enforcement and its approach to mandated, aggressive 

regulatory action against troubled institutions. But while FIRREA focused on savings-and-loan failures, 

FDICIA changed extensively the rules of the regulatory system, expanding its reach into the relationships 

between regulators, bank management and their external advisers. In many cases, legislated rules were 

substituted for regulatory judgment. Federal regulators were given expanded authority over many areas 

of management decision-making, substituting their rulemaking for case-by-case judgment over basic 

operations. Examiners were given much greater authority over regulated banks, and legal penalties and 

examiner sanctions were increased dramatically. FDICIA mandated additional reports by the 

management of larger institutions. External auditors were, in turn, required to attest to management's 

assertions regarding internal controls and safety-and-soundness compliance, and to report any material 

weaknesses and violations. 

To ensure that excessive regulation did not lessen the availability of credit to sound borrowers, the FDIC, 

FRB, and OTS in 1991 issued a series of policy statements on the workout of problem loans, valuation of 

real-estate loans and review and classification of commercial real-estate loans. Steps have been taken to 

improve communication between regulators and external auditors. In July 1992, the regulators issued a 

joint statement that sought to encourage full and candid contacts with external auditors to ensure that 

they are fully informed of all bank interactions with regulators and all documents provided to regulators by 

financial institutions. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In March 1993, the four supervisory agencies announced plans to reduce documentation, encourage 

character loans, reduce appraisal requirements, streamline the appeals and complaint process, and 

reduce the burden of the examination process. Additional actions were announced in May and June, 

including procedures for returning certain nonaccrual loans to accrual status, and procedures for 

eliminating duplicative exams by the primary regulator and the FDIC, as back-up regulator, and 

coordinating exams where duplication is required. In December 1993, the FFIEC issued an inter-agency 

policy statement on loss reserves, including a formula for calculating reserve levels, in an effort to provide 

an objective standard against which bank management and their external auditors can assess the 

adequacy of reserves. Of particular note, the policy represents a guideline rather than a safe harbor. At 

the same time, the policy statement recognized the limits of the examiner's ability to assess asset quality 

and the stronger position of management to accumulate up-to-date information necessary to estimate 

losses accurately on specific loans or classes of loans. 

It may be noted that at the time of this study's completion, the Riegle Community Development and 

Regulatory Improvement Act of 1994 was in the process of enactment. A number of the Act's provisions 

are directly relevant to the study's concerns, among which is a requirement for the federal banking 

agencies to coordinate their examinations and to develop a system for selecting a lead agency to manage 

unified examinations, authority for the federal agencies to establish certain standards by guidelines 

instead of regulations, and a requirement concerning review and elimination of outmoded regulations and 

policies. 

Among the study's overall conclusions and recommendations is that while regulators, management and 

external auditors have different responsibilities and priorities, it is important that there be basic agreement 

in their conclusions in respect to the financial condition of an institution, with reconciliation of any 

differences in assumptions and methodologies in order to reach a common understanding. Financial 

reporting should be based on GAAP accounting rules, and where additional information or more stringent 

reporting standards are essential for regulatory purposes, these additional requirements should consist of 

well-defined and well-publicized adjustments to GAAP reports. Duplicate regulatory examinations should 

be eliminated, and normal regulatory review limited to a single examination, coordinated among the 

various regulatory agencies, in any relevant time period. 

The accounting profession and the regulators should jointly identify areas for reliance on one another's 

work and eliminate duplicative analysis. A first step has already been taken in the area of internal controls 

as a result of the external auditor's report mandated by FDICIA. Another area for consideration would be 

complex computer systems and risk models. As confidence grows, additional opportunities for mutual 

reliance could be identified. 

A final recommendation is for the establishment of a permanent board, consisting of representatives of 

each of the federal bank regulatory agencies, the SEC, the accounting profession and the banking 

industry. Its functions would include: recommending areas in which external auditors and regulators could 

rely on one another's work and achieving consensus on the specific terms and conditions of any such 

division of labor; reviewing regulatory enforcement issues with a view toward encouraging a more open 

and public process of formulating and implementing enforcement policy; and identifying areas in which 

external auditors and regulators require training to keep pace with the evolution of financial institutions 

and instruments and cross-training to understand better the objectives and procedures of the other. 

Defining the Roles of Accountants, Bankers and Regulators in the United States, Group of Thirty, 

Washington, DC, 1994.