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Review 

Spring/Summer 1991 

Vol.4, No. 1 

Table of Contents 

The Anatomy of the LDC Debt Crisis page I 

by Gary S. Fissel 

The structural factors that have caused the economies of certain less-developed countries to 

become heavily dependent on commercial bank borrowing are examined in this paper. In addition, 

balance sheet information is presented regarding the exposure of the money-center banks arising 

from their loans to these developing countries. 

Resolution Costs of Thrift Failures page 15 

by Joseph B. Blalock, Timothy J. Curry and Peter J'. Elmer 

The determinants of resolution costs for 97 thrifts resolved by FSLIC from 1984 to 1987 are 

examined in this paper. The authors conclude that the assec mix of the institutions was the primary 

determinant of resolution costs. "High-risk" assets such as land, development and construction 

loans are found to increase resolution costs, while the operation of a more ttaditional franchise is 

found to reduce resolution costs. 

Summary of Proceedings: International Conference on Deposit Insurance 

and Problem-Bank Resolution Policies page 27 

by lane K. Moysich 

Representatives from various countries met at the FDIC on September 26, 1990, to discuss 

alternative approaches to deposit insurance, bank-failure resolution strategies and the bank "safety 

net." A summary of the fottt panel discussions is presented in this paper. 

Recent Developments Affecting Depository Institutions page 35 

by Benjamin 8. Christopher 

This regular feature oft he FDiC BankingReview con tains information on regulatory agency actions, 

state legislation and regulation, and articles and studies pertinent to banking and deposit insurance 

issues. 
The Anatomy of the LOC Debt Ctisis 

The Anatomy 

of the 

International Debt Crisis 

by Gary S. Fissel1 

"Neither a borrower nor a lender be. " 

William Shakespeare, Hamlet 

Developing economics must 

look back with great longing 

to those halcyon days when 

foreign capital funds flowed freely 

into their countries, and commercial 

banks were the most generous of 

creditors.1 At the end of 1982, $313 

billion in long-term debt, with a 

maturity greater than one year, was 

owed to commercial banks by the 

most severely-indebted developing 

economies. This represented 63 

percent of their total long-term debt 

outstanding. Moreover, commercial 

bank loans accounted for 

approximately 79 percent of the 

increase in long-term debt 

outstanding from 1975 through 1982 

for four of the largest developing 

country debtors (Brazil, Mexico, 

Argentina and Venezuela). 

Developing economies rely upon 

foreign credit to assist in financing the 

investment projects that form the un 

derpinnings for economic growth. 

This was the best, but certainly not 

the only, rationale for commercial 

banks worldwide to extend vast 

amounts of credit to developing econ 

omies in the late 1970s and early 

1980s. However, by 1982, the heavilyindebted developing economies were 

not realizing the growth that would 

support the weight of their accumu 

lated debts. With many developing 

economies unable to fully service 

their debt obligations, commercial 

banks were left holding a large vol 

ume of assets of uncertain, and subse 

quently diminishing, value. These 

events were crystalized in the public 

eye by the Mexican debt moratorium 

in August 1982, and labelled "The 

International Debt Crisis."' 

The international debt crisis has 

two intimately related facets: the 

creditor problem and the debtor prob 

lem. On the one hand, the debt crisis 

involves the many large commercial 

banks that hold sizable volumes of 

loans to debt-burdened developing 

economies. The uncertain value of 

these loans, combined with the large 

volumes of these assets on the balance 

sheets of many large banks, have the 

potential to make financial markets 

nervous about the financial condition 

of these institutions, thereby destabi 

lizing these markets. This is the cred 

itor problem. For example, at the end 

of 1982, the combined book value of 

loans outstanding from the nine larg 

est U.S. commercial banks (hereafter 

referred to as the money-center 

banks) to the four largest Latin Amer 

ican debtors (Brazil, Mexico, Venezu 

ela and Argentina) was 143 percent of 

their solvency buffer or their com 

bined stock of equity capital plus 

loan-loss reserves." 

On the other side of the debt crisis 

are the heavily-indebted developing 

economies that have been unreliable 

debtors but that remain reliant upon 

the foreign financing of worthy in

* Gary S. Kissel is a financial economist in 

the FDIC's Division of Rcseatch and Statistics. 

The author would like to thank George French 

and Frederick Cams for their helpful com 

ments and suggestions, Kenneth Walsh for his 

assistance with the database, and Jeanine Rossi 

for her research assistance. 

The term "developing economies" in this 

paper will refer to middle-income developing 

economies, unless otherwise noted. The World 

Bank defines the criterion used to identify a 

middle-income developing economy thar is 

based upon its per capita national income. This 

paper focuses on middle-income developing 

economies because of their more extensive ac 

cess and use of private capital markets (i.e., 

commercial bank loans), as compared to low-in 

come developing economies. 

" Of course, Mexico was not the only devel 

oping economy at the time that was being 

squeezed to make even the intetest payments 

on its external debt. 

The money-center banks are Bankers 

Trust, Chase Manhattan, Chemical, Citibank, 

Manufacturers Hanover, Morgan Guaranty, 

Kirst Chicago, Bank of America and Continen 

tal Illinois. 
FDIC Banking Review 

vestment projects. This is the debtor 

problem. For these heavily-indebted 

economies, access to private credit 

markets effectively meant being able 

to receive credit from commercial 

banks4 However, from 1982 to 1983, 

net flows or disbursements of credit 

minus principal repayments to the 

most heavily-indebted economies 

from commercial banks fell from $20 

billion to $9.7 billion. By 1988, this 

figure was at $347 million. In the con 

text of the international debt crisis, 

the debtor and creditor problems are 

interrelated parts of the same whole. 

The dilemma is that these developing 

economies have been dependent 

upon credit that banks no longer have 

been as willing or able to provide, 

while the heavily-exposed banks 

have been weakened by the inability 

of these economies to otherwise ser 

vice their debt. 

A detailed look in the next section 

at the debtor problem shows that de 

veloping economies have a need for 

foreign financing, and that commer 

cial banks have been an important 

source of private-sector funding in re 

cent history for these economies. In 

addition, some specific macroeco

nomic factors that increased the heav 

ily-indebted developing economies1 

needs for foreign financing, leading to 

the debt crisis, are discussed. The 

creditor problem is then examined. 

The analysis shows that the large 

commercial banks in the U.S., and 

most likely in many of the other large 

industrialized countries, have had sig 

nificant exposures relative to capital 

and loan-loss reserves to the heavilyindebted developing economies. Bal 

ance sheet information on moneycenter banks' exposure to these loans 

is presented under a variety of as 

sumptions about the amount of loanloss reserves available to allocate to 

these loans, and liquidation values of 

the loans are estimated using second 

ary market prices. 

The Debtor Problem 

defining characteristic of a devel 

oping economy is its need for foreign 

credits to finance necessary invest 

ment projects for economic develop 

ment and growth. This is denoted as 

the debtor problem. The private cred 

its that sated many of these econo 

mies in the late 1970s and early 1980s 

became a nagging addiction after the 

onset of the debt crisis, as these econ 

omies became excessively reliant 

upon this inflow of foreign funds. The 

debtor problem will be examined 

using the national income and bal

ance-of-payments frameworks, which 

provide the most objective basis tc 

study the issue. 

The analysis begins with a general 

review of the national income and bal

ance-of-payments relationships. 

The national income identity for an 

open economy is: 

where 'Y' is Gross National Product 

(GNP), 'C is total domestic con 

sumption expenditures, T is domes 

tic investment expenditures, 'G' is 

government expenditures, 'X' is total 

exports of goods and services, and 'M' 

is total imports of goods and services. 

Equation (1) states that national in 

come is identically equal to the sum 

of domestic and foreign expenditures 

on goods and services produced by 

domestic factors of production. An 

open economy is, by definition, able 

to engage in foreign trade, and this 

external component is represented by 

the current account: 

(2) CAt = Xc Me. 

The current account (CA) is im 

portant because it not only measures 

the net flow of goods and services 

between a country and the rest of the 

world, it also measures the net flow of 

assets (i.e., capital). For example, if an 

economy has a current account deficit 

(CA < 0), it is buying more goods and 

services from foreigners than it is sell 

ing to them, and so it must finance this 

additional spending. The economy as 

a whole can finance this excess of im 

ports over exports by borrowing from 

foreigners or using previously accu 

mulated wealth such as international 

reserves or selling ownership rights to 

domestic assets. Either way, a current 

account deficit results in an increase 

in the economy's net foreign liabili 

ties, which is a decrease in its net 

foreign wealth. In the same way, an 

economy with a current account sur 

plus is accruing assets against the rest 

of the world, resulting in an increase 

in its net foreign wealth. Therefore, 

an economy's current account surplus 

equals the change in its net foreign 

wealth. In the context of the current 

discussion the important point is that 

a current account deficit is directly 

tied to a need for inflows of foreign 

capital funds (or a decrease in net for 

eign wealth), which have been pri 

marily in the form of commercial bank 

loans for most large developing econ 

omies. 

Combining equations (1) and (2), 

and defining national saving, S, to 

equal (Y C G), we get: 

(3)CAt-St-It. 

Equation (3) states that an economy's 

current account surplus is identically 

equal to the difference between its 

national savings and net domestic in 

vestment expenditures. Therefore, it 

provides a direct link between an 

economy's national and international 

accounts. Greater understanding of 

equation (3) can be gained by express 

ing it as St = It + CA[. This states that, 

in the aggregate, an open economy's 

saving is simply its net investment 

and its net accumulation of claims 

against foreigners. 

Since the debtor problem is de 

fined in terms of a developing 

economy's need for inflows of foreign 

capital funds, equation (3) allows us to 

Other private credits include bonds and 

trade-related credits. 

5 See Krugman and Obstfeld (1988) for a 

textbook treatment of these open economy 

macrocconomic relationships. 

fi It should be noted that an identitry refers 

to actual, not planned, values. An identity does 

not represent a behavioral relationship, and so, 

does not imply causality. Rather, an identity 

imposes a consistency requirement between its 

elements. 
The Anatomy of the LOG Debt Crisis 

Table 1 

(Average Annual Percentage of GNP) 

Note: '*'indicates a severely-indebted developing economy as defined by the World Bank 

(1990 World fabl Tables). 

a: The external financing requirement is also the current account deficit. 

Source: 1990 World Development Report, World Bank. 

examine this characteristic by looking see that the need for foreign capital 

at the relationship between the inflows characterizes developing 

economy's national saving and do economies across time and region by 

mestic investment. In terms of the virtue of their low saving relative to 

national accounts, if national saving is investment. 

not sufficient to fund domestic invest The foreign financing require 

ment (i.e., S < I), then the economy ment for all middle-income develop 

must receive financing from abroad ing economies increased from an 

[i.e., CA < 0). Table 1 shows tile for average of 3.4 percent of GNP in the 

eign current account deficits (which 1965-73 period, to 6.4 and 6.6 percent 

are also called the foreign financing of GNP in the 1973-80 and 1980-88 

requirements) of developing econo periods, respectively. More specific 

mies for three periods since 1965. We ally, the foreign financing require 

ment for each region is positive for all 

three periods. The average foreign 

financing requirement for the Latin 

American region, which contains the 

greatest number of heavily-indebted 

developing economies, increased 

from 4.9 percent of GNP in the 1973

80 period to 6.9 percent in the 1980-88 

period. Interestingly, the foreign 

financing requirement increased de 

spite a reduction in domestic invest 

ment expenditures because the 

region's saving declined by even 

more. That is, the Latin American 

region experienced a decrease of 2.8 

percent of GNP in its average domes 

tic investment expenditures between 

these two periods (i.e., 22.7 to 19.9 

percent of GNP) and a decrease of 4.8 

percent of GNP in its national saving 

(i.e., 17.8 to 13.0 percent of GNP). 

This illustrates the case in which for 

eign capital inflows are used to help 

finance domestic consumption. 

The most obvious example of this 

situation is Argentina. Argentina's av 

erage foreign financing requirement 

increased to 4.4 percent of GNP in the 

1980-88 period from 0.8 percent in the 

1973-80 period. This reflects the fact 

that while average domestic invest 

ment expenditures decreased by 9 

percent of GNP between these two 

periods, average national saving de 

creased by 12.6 percent of GNP. This 

situation can be contrasted with that 

of Malaysia, a newly-industrialized 

economy in the East Asia region. 

Malaysia's average external financing 

requirement increased from -0.7 to 

3.3 percent of GNP in the 1973-80 

and 1980-88 periods, respectively. 

While Malaysia's national saving re 

mained relatively large and constant 

over these two periods, its increased 

need for capital inflows can be traced 

to the increase in its domestic invest 

ment expenditures, which increased 

by 3.7 percent of GNP between the 

1973-80 and 1980-88 periods. 

The example provided by Malay 

sia best illustrates the point that de 

veloping economies generally do not 

have levels of national saving that are 

sufficient to finance the available do
FD1C Banking Review 

mestic investment opportunities, and so they must go to foreign markets to obtain the additional capital funds. On the other 

hand, Argentina is a case in which external capital (typically debt-creating) inflows are required largely to compensate for a 

high level of national consumption expenditures or low national saving. This exemplifies the point that an economy can 

develop an appetite for capital inflows that could have been replaced, in part, by greater domestic saving. 

It will be useful to develop more fully the link between the current account and capital flows. Recall that under the 

balance-of-payments accounting framework, a current account surplus corresponds to an increase of net claims against 

foreigners. This amounts to a purchase of foreign assets, or a "net capital outflow." Similarly, a current account deficit entails 

an increase of domestic assets held by foreigners, or a "net capital inflow." These relationships can then be expressed as: 

(4) CAt +Net Capital Inflows,-0. 

Capital inflows can be grouped into (i) debt-creating inflows (which are primarily loans from private and official foreign 

creditors, but also include bonds purchased by foreigners), and (ii) non-debt-creating inflows (such as foreign direct 

investment, official aid, and reserve decumulation). Net capital inflows are obtained by subtracting the exodus (or flight) of 

domestic capital. Using these categories we can rewrite equation (4) as: 

(5) -CAc = Debt Inflowst + Non-Debt Inflowst Capital Flightt. LDOD and official credits had risen 

Table 2 presents a breakdown of different types of capital inflows for Brazil. to 18.47 percent ofLDOD.

Mexico, Argentina and Venezuela. Columns (1) through (5) of Table 2 show two Columns (6) through (10) in Table pictures of the distribution of the stock of total long-term debt outstanding 2 show the capital flow breakdown (LDOD) among creditors. In 1982, commercial bank credits comprised 76.85 over the 1981-88 period for Brazil, percent of the total long-term debt outstanding, with official credits amounting to 

Mexico, Argentina and Venezuela. 10.15 percent. By 1988, the commercial bank share had fallen to 69.64 percent of Comparing columns (6) and (7), debt 

inflows were generally much larger 

Table 2 than non-debt-creating inflows as 

STOCKS measured by net foreign direct invest 

ment over this period. For example, 

debt inflows were 6.7 times larger 

than non-debt inflows in 1981, 5.8 

times larger in 1982, and 9.8 times 

larger in 1983. The only year in this 

period in which net non-debt inflows 

exceeded net debt inflows was 1988. 

As implied by the stock data, the flow 

data show that LDOD from official 

creditors generally increased over the 

1981-88 period and LDOD flows 

from commercial banks were gener 

ally larger in the beginning than later 

in the period. 

The evidence from Table 1 shows 

that developing economies generally 

have a need for financing assistance 

from abroad, and the evidence from 

Table 2 shows that in recent history 

debt-creating capital inflows, particu 

larly from commercial banks, have 

been the dominant source of external 

inflows. Many developing economies 

have struggled in the past decade 

Note: The Nee Debt Inflow is calculated as the change in the stock of external debt. Therefore, 

[his flow measure not only includes the.net disbursement of new credits, but it also could in 

clude items such as interest payments arrears that have been added to principal. A capital inflow is the net movement of 

capital funds conrrolled by nonresidents and a: Sum of values for Brazil, Mexico, Argentina and Venezuela. capital flight (as explained later in this section; b: Ration of the sum of values for Brazil, Mexico, Argentina and Venezuela. 

is the net outflow of capital funds controlled by c: The value for Brazil is unavailable for 1988. 

residents. 

Sources: IMF, Balance ofPayments Statistics; World Bank, World Debt Tables. 
The Anatomy of the LDC Debt Crisis 

under their heavy debt-service obli 

gations. Given chat excessive debt, 

especially external debt, is a drag on 

their economies and that developing 

economies are generally predisposed 

to require foreign capital inflows, it is 

important to consider the factors that 

increased developing economies' re 

quirements for foreign capital inflows. 

We examine this issue in the remain 

der of this section. 

Capital flight can increase a devel 

oping economy's need for external 

capital inflows. As its name implies, 

capital flight involves the outflow of 

capital funds owned by domestic res 

idents from the economy. There are 

different approaches to measuring 

capital flight that involve different 

categorizations of capital outflows. 

An expansive measure of capital flight 

(see World Bank (1985)) is used here. 

This approach defines capital flight as 

the acquisition of net foreign assets, 

with no distinction made on the type 

of asset, by domestic residents. The 

importance of capital flight can be 

seen in equation (5). For a given cur 

rent account deficit, the larger is cap 

ital flight, the larger must be the 

offsetting capital inflows and, to the 

extent the economy relies on debt

creacifig capital inflows, the larger will 

be the accumulation of external debt. 

The flight of domestic capital from 

an economy is an effect of underlying 

economic forces. An economy that 

generates relatively more uncertainty 

about investment returns induces 

greater capital flight. In an open econ 

omy with globally integrated capital 

markets, it is reasonable to expect that 

domestic savers will choose to keep 

some of their wealth at home and in 

vest the remainder abroad in an aty and Levich (1987) for a discus 

sion of the different definitions for capital 

flight and approaches to measuring capital 

night. 

Other approaches distinguish between 

the types of capital outflows ''normal" and 

"capital flight" where the former type of 

capital outflow represents the acquisition of 

foreign assets by domestic residents through 

common financial instruments. 

IC -KwCumby and Levich (1987). 

tempt to diversify their portfolios. 

This is all the more true in developing 

economies with relatively undevel 

oped domestic capital markets. 

Therefore, developing economies arc 

particularly susceptible to capital 

flight as their economies tend to gen 

erate greater uncertainty for potential 

investors, both domestic and foreign. 

For example, in economies where in 

flation erodes the real returns of assets 

and their residents' real wealth, or 

when the domestic currency is over 

valued and significant exchange-rate 

devaluations are expected, investors 

in these economies have strong incen 

tives to seek foreign markets and cur 

rencies in order to preserve the 

purchasing power of their invest

10' As macroeconomic condi

tions within an economy become 

more unstable, the incentives to move 

wealth outside of the country in 

crease. 

Table 3 illustrates the magnitude 

of capital flight for Brazil, Mexico, Ar 

gentina, Venezuela, and South Korea. 

Brazil, Mexico and Argentina each 

had an average current account deficit 

during both the 1973-80 and 1981-88 

periods. The resulting need for for 

eign capital inflows was exacerbated 

by capital flight. For example, Table 

3 shows that although Brazil's current 

account deficit decreased as a per 

centage of GNP in each period from 

1981 through 1987, its capital flight as 

a percentage of GNP increased in 

each period. Therefore, while Brazil's 

net capital inflows decreased, capital 

Table 3 

Note: Capital Flight is calculated as follows: 

(Capital Inflows) ] (Current Account Deficit) + (Increase in Official Reserves) 1, 

where Capital Inflows = (Increase in External Debt) + (Net Foreign Direct Investment). 

This is the "World Bank" definition [hat is given in Cumby and Levich (1987). 

a: The estimate includes only 1987. 

Sources: IMF, Balance ofPayments Statistics and InternationalFinancial Statistics. 
FD!C Banking Review 

flight increased its total need for cap 

ital inflows. As Brazil has primarily 

relied upon debt-creating capital in 

flows, its total debt stock increased 

from 1981 through 1987. Venezuela 

experienced an average current ac 

count surplus from 1981 through 

1988. It also had positive capital flight 

in every period except 1987-88. Ven 

ezuela illustrates a case in which cap 

ital flight can more than offset an 

economy's current account surplus, 

resulting in an accumulation of debt. 

For example, in the 1983-84 period 

Venezuela had an average current ac 

count surplus and capital flight equal 

to 6.85 and 8.16 percent of GNP, re 

spectively. As its capital flight was 

greater than its current account sur 

plus, Venezuela also increased its 

total debt stock by over $5 billion 

from the 1981-82 period. Overall, the 

average annual current account defi 

cit for these Latin American econo 

mies was 1.52 percent of GNP over 

the 1981-88 period and their average 

annual capital flight was 3.77 percent 

of GNP. 

South Korea, which experienced a 

robust economic expansion over the 

1980s, saw capital flight increase from 

0.59 percent of GNP in 1981-82 to 

4.53 percent of GNP in 1985-86, and 

decline slightly to 3.13 percent of 

GNP in 1987-88. Even with the in 

crease in capital flight over the 1980s, 

South Korea's strong export sector 

neutralized the negative effects that 

capital flight could have potentially 

had on its need for capital inflows and 

on its ability to service and reduce its 

stock of external debt. The situation 

was much different for the Latin 

American economies cited. With an 

already heavy debt burden to carry, 

greater capital flight often meant that 

a greater share of their investment 

expenditures had to be financed with 

foreign capital funds, and investment 

projects that could not be financed 

were not undertaken. In most cases, 

the foreign capital continued to be 

mainly in the form of external debt. 

It has been argued that developing economies require inflows of foreign capital 

that derive from a fundamental relationship between the amount of national 

saving and the amount of profitable investment opportunities. Moreover, an 

economy's need for foreign capital inflows is increased by capital flight. However, 

it would be difficult to explain the depth of the debt crisis in terms of these two 

factors alone. While capital flight was a contributing factor, we can isolate some 

more specific causes for the international debt crisis; namely, a series of macro

economic events that dramatically increases the external financing requirements 

of the heavily-indebted developing economics. These will be surveyed below. 

An economy's external financing identity, given in equation (5), posits that a 

current account deficit must be financed with funds from abroad. Therefore, any 

event chat increases an economy's expenditures for imports relative to export 

revenues will increase its current account deficit, and its external financing 

requirement. With this in mind, we focus briefly on the left-hand-side of equation 

(5). The current account surplus (CA) can be broken into (i) the noninterest 

current account surplus (NICA)> which includes all trade in goods and services 

except interest payments on external debt, and (ii) interest payments on external 

debt, where interest payments enter as a negative since they are payments for the 

services rendered by capital funds from abroad (net of interest receipts on loans 

made abroad). This can be written as: 

(6) CAt = NICAi Interest Paymentsr. 

Combining equations (5) and (6), and rearranging so that we can focus on 

interest payments, we have: 

(7) Interest Paymentst = NICAt + (Debt Inflowsc + Non-Debt Inflowst 

Capital Flightc). 

Equation (7) states that an economy can finance the interest payments on its 

externaldebt with a noninterest current account surplus and/or net capital inflows 

such as loans from foreign commercial banks or multilateral agencies, foreign 

direct investment, etc.. The difference between Interest Payments and1 NICA is 

an economy's foreign financing requirement (or its current account deficit). Given 

that an economy is in need of foreign capital inflows, the identity states that the 

shortfall on its interest payment obligations must be met by net capital inflows. 

In addition, the more an economy uses debt-creating capital inflows as a funding 

source, the larger will be the basis for its interest payments in future years. 

Let us consider the balance-of-payments relationship given in equation (7) 

more carefully. Suppose that an economy is currently just able to make the full 

interest payments on its external debt, and an adverse change in any one of the 

components of equation (7), holding all of the other components constant, leaves 

some interest payments unfunded, leading to a debt-financing problem. In par 

ticular, these changes and their effects include: 

• holding net capital inflows and NICA constant, any increase in the interest 

payment obligations on external debt increases the foreign financing require 

ment above the level of capital inflows; 

• holding net capital inflows and interest payment obligations constant, the 

decrease in NICA because of improper domestic macroeconomic policies, a 

worsening terms-of-trade or a decrease in export demand will also increase the 

economy's required level of capital inflows; 

• holding interest payment obligations and NICA constant, any decrease in net 

capital inflows, such as a decrease in new credits from commercial banks, means 

that the available capital inflows fall below that which is required to make the 

full interest payments on its external debt. Similarly, an increase in capital flight 
that is not offset by capital inflows 

will leave the economy without 

sufficient funds ro make its inter 

est payments. 

Any one of these changes, holding 

everything else the same, will leave 

an economy with insufficient funds to 

fully service the interest payments on 

its external debt. While the effects of 

che individual components are im 

portant for analytical purposes, the 

balance-of-paymencs identity given 

in equation (7) imposes a consistency 

relationship upon the collective be 

havior of these components. For ex 

am pie, an economy's external 

financing requirement could increase 

from one year to che next because its 

interest payment obligations in 

creased and/or its NICA becomes 

smaller. If the economy is able to ob 

tain additional net capital inflows 

(say, from commercial bank credi 

tors), then the interest payments can 

be made and a debt-financing prob 

lem averted, albeit temporarily in this 

case. However, events combined in 

che early 1980s to increase the foreign 

financing requirements of the heav 

ily-indebted developing economies 

while reducing the capital inflows 

available co chese economies, result 

ing in their inability to fulfill their 

external debt-service obligations. 

The confluence of events that pre 

cipitated the debt crisis can be ana 

lyzed separately according to the 

division given in equation (7). Next, 

we consider the factors that increased 

interest payments on external debt. 

Table 4, column (2) shows that che 

total interest payments on external 

debt by Brazil, Mexico, Argentina and 

Venezuela increased dramatically in 

che 1981-82 period. Starting at $19.3 

billion in 1980, total interest pay 

ments on long-term external debt in 

creased to $26.7 billion in 1981 and to 

$29.8 billion in 1982. Interest pay 

ments can increase either because an 

economy is paying interest on a larger 

stock of debt or because they hold 

adjustable-race debt that is tied to a 

rising interest-rate index. To the dis 

may of developing economies and 

The Anatomv of the LDC Debt Crisis 

Table 4 

a: Total of Argentina, Brazil, Mexico and Venezuela. 

b: Annualized rate on U.S. dollar deposits. 

c: Average of Argentina, Brazil, Mexico and Venezuela. 

d: Average of developing economies in Western Hemisphere, expressed in terms of U.S. dollars. 

c: Average of industrial countries. 

Sources: IMF, International'Financial'Statistics;^'orld Bank, World Debt Tables. 

their creditors, both of these factors 

existed. In general, developing econ 

omies that relied on credits from com

mercial banks had the interest 

payments for a major portion of these 

debts pegged to a world interest rate 

such as the LIBOR rate. Under this 

arrangement, developing economies 

assumed most of the risk for world 

interest-rate increases. 

Table 4, column (1) shows that the 

cocal long-term external debt out 

standing (LDOD) for Brazil, Mexico, 

Argentina and Venezuela increased 

chroughout the 1980-1987 period. 

The stock of LDOD for these econo 

mies was 38.2 percent greater in 1982 

chan it was in 1980. In addition, col 

umn (4) shows that, in 1982, 77.5 per 

cent of the total LDOD for these 

countries had an adjustable rate. This 

ratio would exceed 80 percent in each 

year from 1983-88. Clearly, the largest 

Latin American debtors held most of 

[he interest-rate risk on their external 

debts. Therefore, when world inter 

est rates were at high levels over the 

1980-82 period, che interest obliga 

tions on che LDOD for these coun

cries were correspondingly high. 

Column (3) shows che 6-month 

LIBOR rate on U.S. dollar deposits. 

This annualized LIBOR rate peaked 

in 1981 at 16.7 percent, and it re 

mained at a relatively high level 

through 1982 at 13.6 percent. There 

fore, the increased stocks of external 

debt, the large percentage of this debt 

chat was held wich an adjustable rate 

and the high world interest rates of 

the early 1980s combined to increase 

the interest payments of heavily-in 

debted developing countries by 

1982." 

Next, we examine factors that lim 

ited che extent that any noninterest 

current account surpluses could be 

counted on to finance interest pay 

ments on external debt. Table 4, col 

umn (5) shows the total NICA 

(surplus) for the four largest Latin 

American debtors. Over the 1980-82 

period, interest payments far exDebt-service on external debt was gener 

ally paid in a "market" currency such as the 

U.S. dollar, British pound or Deutsche mark. 

Another factor that results in a greater cost for 

interest payments on external debt is the ap 

preciation of the currency in which debt is to be 

serviced relative to the debtor's currency. For 

example, the Mexican peso depreciated from 

26.2 pesos per U.S. dollar at the end of 1981 to 

96.5 pesos per U.S. dollar at the end of 1982. 

This 368 percent decrease in the value of the 

peso relative to the U.S. dollar means that the 

uost to Mexico of servicing the debt increased 

in direct proportion to the amount of debt it 

held that had to be serviced in U.S. dollars. 
FDIC Banking Review 

ceeded the NICA. In fact, the NICA 

was negative and required external 

financing in 1980 and 1981, and it was 

only marginally positive in 1982. 

While it is expected that these coun 

tries would accumulate increased ex 

ternal debts for the period in which 

interest payments are greater than the 

NICA, we also see from Table 4 that 

these countries were adding to their 

debt stocks when the NIGA was 

larger than interest payments. The 

latter can largely be explained by cap 

ital flight. 

Two macroeconomic events can 

explain most of the weakness in the 

NICA for Brazil, Mexico, Argentina 

and Venezuela in the early 1980s. 

First, the industrial economies were 

undergoing a period of stagnation as 

shown by Table 4, column (7), where 

the index of industrial production for 

the industrial economies proxies as a 

measure of economic activity in these 

economies. We see that the index lev 

els off at 91 in the 1980-81 period and 

drops to 88 in 1982. The resulting 

effect for developing economies was 

a decreased demand for goods ex 

ported from their economies by the 

industrial economies. 

The related macroeconomic phe 

nomenon that weakened the NICA 

for developing economies in the early 

1980s was a reduction in their export 

prices. Table 4, column (6) shows that 

1 A reasonable, but not perfect, measure 

for the change in real exports from developing 

economies to the industrial countries is the 

annualized percentage change in the value of 

imports to industrial countries from developing 

countries minus the annualized percentage 

change in the index of export unit values 

(prices) for the non-oil developing countries, 

with the underlying elements for both terms 

expressed in U.S. dollars. In 1979and 1980, real 

exports from developing to industrial countries 

increased at an annual rate of 17.1 and 14.5 

percent, respectively. However, this measure 

of real exports decreased by 1.4 percent in 

1981, 6.1 percent in 1982, and 3.9 percent in 

1983. 

13 Mexico was the only country whose ex 

port revenues differed from this patterYi by 

rising, albeit slightly, in 1982, after relatively 

large increases in 1980 and 1981. 

the index of export prices for Latin 

American developing economies de 

creased in every year over the 1982-88 

period. The combination of weak de 

mand and lower prices for the exports 

of developing economies over the 

1980-82 period in general meant stag 

nant, if not reduced, export revenues. 

For example, the aggregate export 

revenue for Brazil, Mexico* Argentina 

and Venezuela was $62.7 billion in 

1980, rose to $72.5 billion in 1981, fell 

to $65.4 billion in 1982, and remained 

relatively even at $66.6 billion in 

Table 5 

a: Net Flows = Disbursements Principal Repayments. 

Source: World Bank, World Debt Tables. 

1983. We can see that the decrease 

in aggregate export revenue in 1982 

coincides with the decrease in export 

prices of Latin American developing 

economies and the decrease in the 

index of industrial production for in 

dustrial economies (columns (6) and 

(7), respectively). Therefore, the 

weakness in the export sector of the 

largest debt-burdened developing 

economies, particularly in 1982, less 

ened the extent to which the NICA 

could be used to finance the increas 

ing interest payments on external 

debt. 

Lastly, we look at factors that in 

volve a reduction in the net capital 

inflows to heavily-indebted develop 

ing economies. Capital flight has al 

ready been discussed. In addition, in 

1982, commercial bank creditors 

began to curtail the amount of new 

credits that were extended to devel

oping economies and were reluctant 

to roll-over the old credits, that is, 

banks were unwilling to delay the re 

payment of principal any further. 

Table 2, column (10) shows that the 

aggregate LDOD flow to Brazil, Mex 

ico, Argentina and Venezuela de 

creased to $14.1 billion in 1982 from 

$25.2 billion in 1981, and then in 

creased to $34.6 billion in 1983. The 

inflow measure used here includes 

such items as interest payment arrears 

that are added to the principal of the 

debt outstanding, and therefore is not 

a measure of the new money that 

banks provided these countries. A 

better measure of net debt inflows is 

the "net flows" which are defined as 

the disbursements of credit minus 

principal repayments. 

Table 5 shows disbursements and 

net flows from commercial banks to 

Brazil and Mexico over the 1980-88 

period. The disbursement of new 

credits decreased dramatically over 

the 1982-83 period for both countries, 

with a corresponding drop in net 

flows. This decreased flow of new 

credits is indicative of commercial 

banks' reluctance to increase their ex 

posures to heavily-indebted develop 

ing economies as bank regulators in 

industrialized economies began to 

voice some concerns about their large 

exposures. The more-conservative 

lending approach by banks was an un 

welcome change for developing econ
The Anatomy of the LDC Debt Crisis 

omies as the latter became more hardpressed to bridge the financing gaps 

that existed between their interestpayment obligations and the re 

sources that could be extracted from 

their economies to service this debt. 

The need for foreign capital in 

flows is shown to be a characteristic of 

developing economies over time and 

across regions. Using the national in 

come accounting framework, we have 

identified this foreign financing re 

quirement as an imbalance between 

domestic investment expenditures 

and national saving, where a develop 

ing economy is typically unable to 

generate sufficient national saving to 

fund its investment projects. We have 

shown how the flight of domestic cap 

ital from these developing economies 

increased their needs for capital in 

flows. We have argued that a series of 

adverse macroeconomic factors in the 

early 1980s increased the gap be 

tween these economies' interest obli 

gations and the NICA, combined with 

the decreased flows of credits from 

commercial banks, precipitated the 

events that we now recognize as the 

international debt crisis. 

The dilemma that underlies the 

debtor problem is that the heavy 

debt-service obligations that have 

weakened many developing econo 

mies have, at the same time, increased 

their need for external capital inflows 

to provide the basis for future growth. 

The growth of a more diversified 

economy with a strong export sector 

is a key determinant of the prospect 

for debt repayment to creditor banks. 

The likelihood of repayment is en 

hanced if these heavily-indebted de 

veloping economies are able to 

maintain access, even if limited, to 

foreign capital markets and if policy 

makers in these economies make ef 

ficient use of the resources that are 

made available to them. Commercial 

bank credits have been an important 

source of external funds for these 

economies, and play a significant role 

in the debt crisis. We now turn to the 

creditor problem. 

The Creditor Problem 

The creditor problem is the threat 

to the capital of large commercial 

banks posed by the volume and un 

certain values of their loans to heav 

ily-indebted developing economies, 

and the resulting potential for insta 

bility in financial markets. Since com 

mercial banks have been the primary 

external funding source for middleincome developing economies in re 

cent history, banks amassed 

significant exposures to these debtburdened countries by the beginning 

of the debt crisis. The importance of 

the creditor problem is directly re 

lated to the extent to which these 

exposures impair a bank's capital. For 

example, if a bank holds loans to debtburdened countries that exceed, on a 

book-value basis, its buffer (i.e., capi 

tal plus loan-loss reserves), and there 

exists uncertainty in financial markets 

over the true value of these loans, 

there is also likely to be uncertainty 

over the bank's financial well-being, 

and ultimately its solvency. Such con 

cerns have the potential to become a 

source of instability in financial mar 

kets. 

The international debt crisis fol 

lowed on the heels of a period of gen 

erous lending practices by banks to 

developing economies. At the end of 

1982, the nine largest commercial 

banks in the U.S., that is, the moneycenter banks, were all heavily ex 

posed to debt-burdened developing 

economies. Money-center bank loans 

to heavily-indebted developing econ 

omies totaled approximately $64 bil 

lion, for an average exposure of 239.6 

percent of equity capital plus loanloss reserves, ranging from a mini 

mum of 153.4 percent to a maximum 

of 392.9 percent.14'15 While loans to 

heavily-indebted developing econo 

mies were concentrated primarily in 

the money-center banks, in the early 

1980s many loans had been purchased 

by regional and smaller banks in the 

U.S. At year-end 1982, money-center 

banks held 65 percent of the total U.S. 

bank exposures to these economies, 

with the bulk of the remaining $34.5 

billion being distributed among the 

16 regional banks. 

Commercial bank lending to debtburdened developing economies was 

not limited to the U.S. By year-end 

1982, non-U.S. commercial banks 

held approximately $169 billion in 

loans to heavily-indebted developing 17 1 ft 

economies. ' This is 63.2 percent 

of total commercial bank loans (i.e., 

U.S. and non-U.S.) to these econo 

mies. By the end of the 1980s, nonU.S. banks increased their exposures 

to heavily-indebted developing econ 

omies, while U.S. banks decreased 

their exposures in absolute terms. 

The exposures of the non-U.S. banks 

to these heavily-indebted developing 

economies increased to $255.5 billion 

1 This measure of loan concentration un 

derestimates the actual degree of concentration 

since reserves must be allocated for other assets 

on the balance sheet as well. An alternative 

measure which overstates the degree of expo 

sure is the ratio of loans to equity capital. For 

this measure in 1982, the average value for 

money-center banks was 275.3 percent, with a 

minimum of 184,7 percent and a maximum of 

449.9 percent. 

The heavily-indebted developing econo 

mies are those whose debt generally sold at 

below par on the secondary market over the 

1986-89 period. These countries include: Ar 

gentina, Bolivia, Brazil, Chile, Costa Rica, Ecu 

ador, Honduras, Hungary, Ivory Coasc, Mexico, 

Morocco, Nicaragua, Peru, Philippines, Po 

land, Senegal, Uruguay, Venezuela, Algeria, 

Colombia, Dominican Republic, Jamaica, Yu 

goslavia, Panama, Nigeria and 2aire. 

On the one hand, the purchase of these 

loans by regional banks spread the risk on de 

veloping country debt over a number of banks; 

however, it also spread the bad effects that 

these loans had on asset quality over a broader 

segment of the banking industry in the U.S. 

1 The group of total reporting creditor 

banks are located in Austria, Belgium, Luxem 

bourg, Canada, Denmark, France, Germany, 

Ireland, Italy, Japan, the Netherlands, Sweden, 

Switzerland, the United Kingdom, and the 

United States (including branches of U.S. 

banks in the Bahamas, the Cayman Islands, 

Panama, Hong Kong and Singapore). 

1 Although we have no data available, we 

can estimate that the individual non-U.S. bank 

exposures are significant given that these coun 

tries have banking industries that are typically 

made up of relatively few large banks. 
FD1C Banking Reveiw 

by the end of 1989. In contrast, the 

exposures of the money-center banks 

and the other U.S. (primarily regional) 

banks decreased to $46.8 billion and 

$14.1 billion, respectively. Given the 

lack of relevant bank-specific data for 

non-U.S. banks and the fact that the 

creditor problem relates primarily to 

the large banks, the analysis in the 

remainder of this section will focus on 

U.S. money-center banks. 

An important question is the excent of the largest U.S. banks' expo 

sure to developing-economy debt 

relative to capital and available loanloss reserves. Two aspects of the in 

ternational debt crisis in the 1980s are 

relevant here. First is the ability of 

U.S. banks to reduce their exposures 

to the debt-burdened developing 

economies and to build additional 

capital and reserves beneath the debts 

that remain on their balance sheets. 

Table 6 presents a simple average for 

money-center banks, excluding Con 

tinental Illinois, (hereafter known as 

the average money-center bank) of 

relevant balance sheet components 

over the 1982-89 period.20 For the 

average money-center bank, expo 

sure (total and nontrade) to debt-bur 

dened developing economies did not 

begin to decrease in absolute terms 

until 1985, while loan-loss reserves in 

creased in every year throughout the 

1982-89 period except for 1988. Eq 

uity capital increased in every year 

from 1982 through 1986, but de 

creased in 1987 and 1989 as moneycenter banks made large additions to 

their loan-loss reserves. 

The significance of a bank's expo 

sure to heavily-indebted developing 

economies is best measured relative 

to the buffer that is available to pro 

tect against the deterioration in the 

quality of these assets and still remain 

comfortably solvent. The bottom half 

The regional and smaller U.S. banks 

have, for the most part, been able co remove 

most of these debts from their balance sheets. 

Continenral Illinois is excluded from the 

group of money-center banks in the remainder 

of this section since a resolution transaction was 

made with the FDIC in 1984. 

of Table 6 shows the nontrade expo 

sure of the average money-center 

bank relative to the two extreme mea 

sures of this solvency buffer — (1J 

equity capital is the minimum buffer 

a bank would have, assuming that the 

bank does not use any loan-loss re 

serves to protect against deteriorating 

asset-quality in its nontrade exposure 

to debt-burdened developing econo 

mies, and (2) equity capital plus total 

loan-loss reserves is the maximum 

buffer, assuming that the bank uses its 

total stock of loan-loss allowances for 

its nontrade exposure. Nontrade ex 

posures are used because trade fi 

nancing by banks has traditionally not 

suffered from the same debt-service 

difficulties as has nontrade debt, and 

so trade debt would not be subject to 

the same, if any, discounts. The ratio 

of nontrade exposure to equity capital 

has fallen in every year over the 1982

1989 period, except for 1987 when the 

ratio rose to 244 percent. However, 

the average money-center bank 

shows a large provision to reserves in 

1987. Therefore, the ratio of nontrade 

exposure to the maximum buffer de 

creases in every year over the 1982-89 

period. 

Second, although the exposures of 

large U.S. banks to heavily-indebted 

developing economies have de 

creased relative to capital and re 

serves, there also has been a 

coincident deterioration in the values 

of these debts as perceived by the 

Table 6 

A. Average Money-Center Bank8 ($Millions) 

1982 $68,341 $7,590 $6,816° $2,764 $379 

1983 67,746 7,823 6,966e 3,026 427 

1984 70,115 8,066 7,194e 3,332 513 

1985 74,154 7,808 7,027e 3,529 681 

1986 75,696 7,426 6,841 3,793 874 

1987 74,198 7,109 6,620 3,119 2,138 

1988 72,199 6,627 6,262 3,675 2,049 

1989 61,803 5,698 5,307 3,305 2,536 

a: This sample excludes Continental Illinois. 

b: These exposures are loans Outstanding to developing economies whose debt is selling below 

par on the secondary market. 

c: Or net worth. 

d: This is defined as loan-loss allowances plus transfer-risk reserves. 

e: This is an estimated value using the average ratio of nontrade to total exposures during the 

1986-89 period. 
The Anatomy of the LDC Debt Crisis 

market. This reflects the inability of 

the developing economies to achieve 

growth rates that would enable them 

to fully service their debts. The aver 

age secondary market price for the 

nontrade debt owed by developing 

economies was $0.60 per dollar of 

original debt in 1986, $0.48 in 1987, 

$0.37 in 1988 and $0.33 in 1989. The 

decreasing average price of this debt 

in the secondary market illustrates a 

general market perception of its de 

creasing value. 

Objections have been raised about 

using the secondary market prices for 

developing-economy debt as a mea 

sure of the market values for these 

assets, including the relative "thin

ness" of the market. This market 

can generally be characterized as one 

with few players and volatile prices. 

The entry into the market of a major 

buyer or seller of developing-econ 

omy debt could significantly affect 

the quoted transaction price for the 

debt with no change in the net realiz

" A "chin" market means that individual 

actions are able co affect market prices. In con 

trast, a competitive market yields prices chat 

are, in general, impervious to actions by indi 

viduals. While competitive pricing is the cheo

recical objective when referring to markee 

pricing, we find few examples of this in the real 

world. While secondary market prices may not 

reflect the "true" value of loans to debt-bur 

dened developing economies, they do reflect a 

market perception of these bank assets. 

This is not a discount rate in the sense of 

an interest rate, but rather, as a fraction of value. 

The critical discount rate (denoted as a) 

can be calculated as follows: 

Solvency Buffer- a * (Nontrade Exposure) = 0, 

where a " (Nontrade Exposure) is the market 

loss on the bank's noncrade exposure to debtburdened developingeconomies, theSolvency 

Buffer is equity capital plus the portion of re 

serves that can be used for losses on its nontrade 

developing-economy loans, and a is the dis 

count rate. Therefore, the critical discount rate 

is simply the ratio of a bank's Solvency Buffer 

to its Nontrade Exposure. 

The transfer-risk reserves are reserves 

chat U.S. bank regulators require their banks to 

set aside for loans outstanding to particular dc

ve'loping economies. Only one of the moneycenter banks provisioned any reserves to this 

accGiinc, while the others charged off these 

amounts. Therefore, the impact of transferrisk reserves in this calculation is rather small. 

Table 7 

Average Money-Center Banka 

Critical Discount Rate (a= Buffer/Nontrade Debt) 

a: This sample excludes Continental Illinois. 

b: Specific Reserves are the reserves that banks are required to set aside for particular loans to 

heavily-indebted developing economies (i.e., "Allocated Transfer-Risk Reserves" on the Report 

of Condition and Income). 

c: The discount rate for each bank is a weighted average of the secondary market discounts on 

nontrade debt to the heavily-indebted developing economies, with the weights being the share 

of loans outstanding to a particular economy relative to the total stock of nontrade debt out 

standing. 

d: The secondary market prices were obtained from Salomon Brothers, Inc. 

e: This is the number of banks for which the discount rate in column (4) exceeds the cricical dis 

count rate in this column, 

able value of this debt. Therefore, the 

net realizable values of loans to heav 

ily-indebted developing economies 

may be very different from their sec 

ondary market prices. That is, these 

loans may be worth more or less if 

held to maturity than if they were sold 

immediately at secondary market 

prices. 

From a balance sheet perspective, 

if the market value of these debts 

decreases by more than a bank can 

increase its buffer, a bank's balance 

sheet is clearly weakened and the 

likelihood of insolvency is increased. 

It will be useful to define a measure 

of a bank's ability to absorb losses on 

developing-economy loans. This 

measure will be called the critical dis 

count rate, which is the maximum dis 

count on the stock of nontrade debt to 

debt-burdened developing econo 

mies that a bank is able to absorb 

22 without becoming insolvent. 

Therefore, any actual discount rate 

above the critical value would leave 

the institution insolvent and vice 

23 versa. 

Table 7 shows the critical discount 

rate for the average money-center 

bank under different assumptions 

about the solvency buffer. Columns 

(1), (2) and (3) assume that the buffer 

for loan-quality problems on develop 

ing-economy debt is equal to equity 

capital plus reserves for specific loans 

to developing economies (/.<?., trans 

fer-risk reserves) plus 90, 50 and 10 

percent of general loan-loss reserves, 

respectively. As we see in columns 

[1), (2) and (3) of Table 7, the more 

reserves that can be allocated to de 
FDIC Banking Review 

vel op ing-economy debt, the greater is 

the critical discount rate. For exam 

ple, at the end of 1989, if the average 

money-center bank was able to allo 

cate 90 percent of its loan-loss re 

serves for developing-economy debt, 

it would have been impossible for the 

average bank to become insolvent 

from this loan exposure alone since 

the critical discount rate was above 

100 percent. However, if it could use 

only 50 percent of its loan-loss re 

serves, the critical discount rate falls 

to 88.4, and it decreases to 68.9 per 

cent if it could use only 10 percent of 

its loan-loss reserves for nontrade-de

veloping-economy debt. 

Insight into the extent of bank re 

serving for losses on loans to heavilyindebted developing economies can 

be gained by computing the ratio of 

the "market" expectation of loss on 

these loans that a bank holds on its 

balance sheet to its general loan-loss 

reserve. This market expectation of 

loss is derived directly from secondary 

market prices, and is adjusted for each 

bank's specific reserves or transferrisk reserves. The ratio of this esti 

mate of loss to the general loan-loss 

reserve is the "market" expectation of 

loss on loans to heavily-indebted de 

veloping economies per dollar of loanloss reserve. For the average 

money-center bank, the ratio of its 

secondary market loss to general re 

serves is 2.47, 1.21, 1.60 and 1.29 for 

each year in the 1986-89 period. 

The reserves that banks need for 

their exposures to heavily-indebted 

developing economies depend upon 

The increasing volume of general loanloss reserves (i.e., general loan-loss reserves 

plus transfer-risk reserves) was due, almost al 

ways, to increases in the general loan-loss re 

serve component. 

Since the money-center banks were not 

required to disaggregate their nonperforming 

commercial and industrial loans between those 

to U.S. and non-U.S. addressees before 1987, 

the nonperforming U.S. commercial and indus 

trial loans for the 1983-84 period were esti 

mated using the average ratio of 

nonperforming U.S. commercial and industrial 

loans to total commercial and industrial loans 

over the 1987-89 period. 

the amounts they ultimately charge 

off their balance sheets. Clearly, the 

average money-center bank has re 

served far less than what is suggested 

by the discounts established in the 

secondary market, as these reserves 

are needed also for asset-quality prob 

lems in other areas of the bank's port 

folio as well. It must be noted, 

however, that the secondary market 

prices for the debt of heavily-in 

debted developing economies are 

"liquidation values" prevailing in a 

thin market as defined earlier. These 

liquidation values may not be an accu 

rate indicator of net realizable values. 

As the preceding discussion has 

highlighted, an important issue is the 

share of loan-loss reserves that can be 

allocated to various parts of the port 

folio, including nontrade-developing

economy debt. We see in Table 6, 

columns (4) and (5) that the average 

money-center bank made large pro 

visions to the loan-loss reserve in 1987 

and 1989 at the expense of equity 

capital. While a definitive state 

ment cannot be made about the dis 

tribution of these reserves among the 

various parts of the portfolio, it is 

known that declines in asset quality 

have occurred in money-center 

banks' portfolios outside of their loans 

to heavily-indebted developingcoun

tries, placing additional demands 

upon loan-loss reserves. The most no 

table area in recent years is in their 

portfolio of real-estate assets. For ex 

ample, the sum of the money-center 

banks' nonperforming real-estate, 

consumer, and domestic commercial 

and industrial loans (none of which 

contain developing-economy loans, 

and so will be referred to as non-de

veloping-economy nonperforming 

loans) averaged 0.81 percent of the 

sum of gross loans in the 1983-84 pe 

riod, and the average ratio increased 

to 1.71 percent in the 1987-89 pe

riod.26 

calculation can be made to derive 

a benchmark measurement for the al 

location of loan-loss reserves to a 

bank's loans to heavily-indebted de 

veloping economies by dividing the 

bank's nontrade loans to these econo 

mies by the sum of these nontrade 

loans and the non-developing-econ

omy nonperforming loans. For the av 

erage money-center bank, this 

benchmark ratio was 88.4 percent of 

loan-loss reserves in 1989, 91.1 per

centin 1988,89.3 percent in 1987, and 

92.1 percent in 1986. Therefore, the 

benchmark ratio remained in the area 

of 90 percent throughout the 1986-89 

period. This ratio represents the share 

of loan-loss reserves that a bank can 

apportion to its nontrade loans to 

heavily-indebted developing econo 

mies, given that certain assumptions 

are accepted. One assumption is that 

the asset categories in the denomina 

tor of the ratio capture, for the most 

part, all of the troubled loans that the 

bank holds on its balance sheet. If 

significant asset-quality problems 

exist in other areas of a bank's portfo 

lio, then the ratio would be lower. A 

second assumption is that the loss ex 

periences on all asset categories are 

equal. A relative increase in losses as 

a percentage of the book value for 

non-developing-economy nonper 

forming loans as compared to non

trade-developing-economy debt 

would require more reserves to be 

used in the former area, and so would 

lower the benchmark ratio. 

The discounts derived from sec 

ondary market prices on the existing 

nontrade debts owed by debt-bur 

dened developing economies to 

money-center banks increased stead 

ily during the 1986-89 period. Table 

7, column (4) shows the secondary 

market discount on nontrade debt 

(weighted by exposure) rose from 

$.299 per dollar of original debt in 

1986 to $.62 per dollar of original debt 

in 1989. It is of interest to analyze the 

effect on the average money-center 

bank of marking to market its devel 

oping-economy debt at current prices. 

In the present context, if a, the sec 

ondary market discount rate, is 

greater than ct, the critical discount 

rate, a bank would be insolvent as a 

result of this marking to market; con

12 
The Anatomy of the LDC Debt Crisis 

versely, if a < a, the bank would re 

main solvent. 

Table 7, column (1) is the scenario 

in which the bank has the largest 

buffer since it is able to allocate 90 

percent of its general loan-loss re 

serves to developing-economy debt; 

therefore, the critical discount rate (cti) 

is the largest. When this critical dis 

count rate and the secondary market 

discount rate are derived and com 

pared for each bank, there were no 

cases in which the market rate ex 

ceeded the critical rate for moneycenter banks during the 1986-89 

period. 

For a 70 percent reserve case, the 

average money-center bank would 

have had an equity capital ratio of 2.1 

percent at the end of 1989, with no 

institutions having negative equity 

capital but three banks having less 

than a two percent equity capital ratio. 

Table 7, column (2) shows another 

scenario in which a bank's buffer in 

cludes 50 percent of its reserves. 

There was one case in each year dur

ingthe 1987-89period in which oc> az. 

At the end of 1989, equity capital for 

the average money-center bank was 

1.4 percent of total assets, with four of 

the eight banks having an equity cap 

ital ratio below two percent and one 

of these banks having negative equity 

capital. 

As discussed above, the bench 

mark measure of the share of general 

loan-loss reserves that can be allo 

cated to nontrade-developing-econ

omy debt was around the 90 percent 

level during the 1986-89 period. From 

Table 7, column (1) we know that 

under this benchmark scenario, no 

money-center bank would have neg 

ative equity capital in any year during 

the 1986-89 period as a result of mark 

ing its developing-economy debt to 

secondary market liquidation values. 

In the 90 percent reserve case at the 

end of 1989, the average money-cen 

ter bank would have had a ratio of 

total equity capital to total assets of 

2.8 percent as a result of this marking 

to market, with one bank under two 

percent. 

Summary and Conclusions 

In this article, the international 

debt crisis is characterized as two in 

terrelated problems — the debtor 

problem and creditor problem. The 

debtor problem centers on the heav 

ily-indebted developing economies 

that have been weakened by the 

weight of their debt-service obliga 

tions while they continue to rely on 

inflows of foreign capital to help fi 

nance the investment projects that 

form the foundation for future eco 

nomic growth. Their needs for foreign 

capital are increased by the outflows 

of domestic capital from their econo 

mies. In addition, at the beginning of 

the 1980s these heavily-indebted de 

veloping economies faced macroeco

nomic shocks that simultaneously 

increased their interest payments and 

decreased their income from the trade 

of goods and services. When these 

events combined with a reduction in 

capital inflows, the debt crisis was at 

hand. 

The creditor problem focuses on 

the large commercial banks whose 

significant exposures to heavily-in 

debted developing economies is a po 

tential source of instability in the 

international banking system. Two 

main conclusions emerge from this 

analysis. First, given plausible as 

sumptions about the amount of loanloss reserves that a money-center 

bank could allocate to its loans to 

heavily-indebted developing econo 

mies, all money-center banks would 

have positive equity capital as a result 

of marking these loans to market 

using secondary market prices; the 

average money-center bank would 

have an equity ratio of just under 

three percent. Second, the deteriorat 

ing values on the secondary market of 

the money-center banks1 loans to 

these developing economies have 

highlighted an area of significant 

weakness on the banks' balance 

sheets. To the extent that this weak 

ness is viewed by financial markets as 

a serious threat to the money-center 

banks' financial well-being, it also 

serves as a source of financial market 

instability. This analysis is in no way 

intended to suggest that current sec 

ondary market prices are the "cor 

rect" values. These prices are 

liquidation values prevailing in a thin 

market, and the values of loans to 

heavily-indebted developing econo 

mies may be more or less than the 

prices suggested in the secondary 

market. In general, the money-center 

banks have held fewer reserves than 

the discounts implied by secondary 

market prices. 

The prospects for the future repay 

ment of debt by the heavily-indebted 

developing economies to the com 

mercial banks remain uncertain. 

However, it is certain that repayment 

will not occur without growth in their 

economies, which in turn will require 

that they have access to foreign capi 

tal markets. The strength of the bank 

ing system will be enhanced when the 

values of these "old" loans to the 

heavily-indebted developing econo 

mies are stabilized. In sum, the inter 

national debt crisis presents a 

situation in which "neithera borrower 

nor a lender be" makes sense, at least 

to the degree we have witnessed in 

this crisis. Nevertheless, the fact that 

there have been many excesses in the 

past does not preclude the possibility 

that commercial banks and develop 

ing economies can have a mutually 

beneficial relationship in the future. 
FDIG Banking Review 

REFERENCES 

Gumby, Robert and Richard M. Levich. "On the Definition and Magnitude of Recent Capital Flight," 

NBER Working Paper No. 2275, Cambtidge, MA.: National Bureau of Economic Research, June 1987. 

Dornbusch, Rudiger. "Debt Problems and the World Macro Economy," NBER Working Papet No. 2379, 

Cambridge, MA.: National Bureau of Economic Research, September 1987. 

. "Out LDC Debts," pp. 161-196, in Martin Feldstein (ed.) The United States in the World Economy, 

Chicago: University of Chicago Press, 1988. 

International Monetary Fund. Balance of Payments Statistics, Yearbook. Washington, D.C.: International 

Monetary Fund, 1989. 

. International Financial Statistics, Yearbook. Washington, D.C.: International Monetary Fund, 1990. 

Krugman, Paul R. and Maurice Obstfeld. International Economics: Theory and Policy, Glenview, IL: Scott, 

Foresman and Company, 1988. 

World Bank. World Development Report, Washington, D.C.: World Bank, 1985. 

. World Development Report, Washington, D.C.: World Bank, 1989. 

. World Debt Tables 1989-90. Washington, D.C.: World Bank, 1989. 

14 
Resolution Costs of Thrift Failures 

esolution Costs 

of Thrift Failures 

by Joseph B. Blalock, Timothy J. Curry and Peter J. Elmer* 

On August 9, 1989, the 

Resolution TrustCorporation 

(RTC) was created by the 

Financial Institutions Reform, 

Recovery, and Enforcement Act of 

1989 (FIRREA) to resolve the savings 

and loan (S&L) crisis. Prior to the 

RTC, the Federal Savings and Loan 

Insurance Corporation (FSLIC) had 

primary responsibility for resolving 

insolvent S&Ls. An analysis of the 

costs of FSLIC resolutions provides 

insight into the nature of past S&L 

insolvencies, as well as useful 

background information for assessing 

the likely costs of future resolutions. 

Previous studies of the determi 

nants of thrift failures, such as 

Kormendi et al. (1989), Barth, 

Bartholomew, and Bradley (1989), 

and Barth, Bartholomew, and Elmer 

(1989), have been limited to examin 

ing pre-resolution cost estimates be 

cause the actual resolution costs are 

not known until after an institution is 

closed and all of the assets have been 

sold. However, since a large number 

of FSLIC resolutions were completed 

in the mid-1980s, it is now possible to 

analyze many FSLIC resolutions on 

an actual cost basis. 

This paper examines the resolu 

tion costs of S&Ls resolved by FSLIC 

during the mid-1980s. The goal is to 

explain losses as a function of the 

quality of S&L assets and other fac 

tors that may have influenced the 

value of insolvent S&Ls during the 

mid-1980s. The primary finding is 

that the asset mix of an insolvent S&L 

is the primary predictor of actual res 

olution costs. The costs of resolving 

S&Ls with large amounts of high-risk 

assets and low core deposits are found 

to be significantly higher than the 

costs of resolving "traditional" S&Ls 

that primarily fund single-family 

mortgages with core deposits. Other 

factors that explain resolution costs 

are the granting of tax benefits and 

the extent to which an S&L's assets 

have below-market yields. 

Background on FSLIC 

Resolution Policies 

Modern experience with resolving 

insolvent S&Ls began approximately 

in 1980, then progressed in two 

phases: the first involved high interest 

rates during the 1980-83 period, and 

the second involved asset-quality 

problems after 1983. As the nature of 

S&L problems changed, and as 

FSLIC's cash reserves were depleted, 

FSLIC resolution policies also 

changed. 

1980-83 Period 

During the 1980-83 period the pri 

mary cause of S&L failures was high 

interest rates which raised S&L fund 

ing costs but had little effect on in 

come from long-term mortgage assets. 

This resulted in enormous operating 

losses fot a large portion of the thrift 

industry. As operating losses contin 

ued, the market value of S&Ls' net 

worth eroded and FSLIC's backlog of 

unresolved S&Ls quickly increased. 

As shown in Figure 1, the number of 

GAAP-insolvent S&Ls increased 

from 87 in 1981, to 237 in 1982, and to 

"Joseph B. Blalock and Timothy J. Curry 

are financial economists, and Peter J. Elmer a 

senior analyst, at the Resolution Trust Corpo 

ration. Timothy Curry is currently on leave 

from the Resolution Trust Corporation and is 

Visiting Professor of Finance at George Mason 

University. The authors would like to thank 

Jack Reidhill, David Home, Kenneth Thyger

son and the editorial staff of the FD/CBanking 

Revrew for helpful comments and discussion. 

The views expressed are those of the authors 

and do not necessarily represent those of the 

Resolution Trust Corpora don or the Federal 

Deposit Insurance Corporation. 

As of the end of our sample period, most 

assets had been sold from the sample of re 

solved S&Ls. For the unsold assets, we used 

the mosr recent estimates of anticipated loss. As 

described later, this estimated component of 

ihe total cost is sufficiently small that we feel 

justified in using the term "actual cost." 

zSte Kane (1989), Brumbaugh (19881 or 

White (1991) for more complete analysis of the 

forces that shaped the thrift crisis. 

15 
600 

FDIC Banking Review 

Figure 1 

FSLIG Resolutions vs. the Number of Insolvent S&Ls: 1980-1987 

Number 

Mergers 

500 470 

Liquidations 445 

40G Insolvent S&Ls 

300 

200 

1984 1985 1986 1987 

Year 

Nole: All data are from FSLIC iecorcS and Banh, Bartholomew, and BiaB\ey (1989). 

445 in 1984.3 While FSLIC resolu 

tions increased in 1981 and 1982, they 

slowed in 1983 and lagged signifi 

cantly the backlog of insolvent S&Ls 

throughout the remainder of the 

1980s. 

Although S&L failures increased 

during che 1980-83 period, they were 

relatively "clean" and reasonably in 

expensive to resolve. Because the pri 

mary problem was below-market 

yields on assets, a cash infusion from 

FSLIC was often all that was needed 

to resolve the insolvency. Most assets 

had relatively low default risk, which 

reduced uncertainty over asset qualNote that the insolvency data in Figure 1 

are measured on a book value basis. As recog 

nized by Kane (1985) and others, che number 

of insolvent thrifts On a market value basis was 

much larger than the book value basis used in 

Figure 1. The book value daia are important 

because they suggest that, even by relatively 

liberal standards, FSLIC was overwhelmed 

with insolvent S&U by 1983. 

Sinee actual resolution cost data are not 

calculated prior to 1984, the cost data used in 

Figure 2 are FSLIC estimates made prior to 

resolution. While the FSLIC estimates are gen 

erally not as accu rate as the actual cost data used 

later in this paper, the estimates nevertheless 

provide a useful basis for comparing aggregate 

costs over time. 

ity for acquirers. An early, relatively 

simple subsidy that was developed, 

which was called a yield subsidy, typ 

ically was used to enhance the yield of 

assets that had good credit quality 

(performing 1-4 family mortgages), 

but below-market; yields. In the ab 

sence of uncertainty over asset qual 

ity, acquirers were willing to purchase 

entire institutions, liquidations of in 

stitutions were rarely necessary, and 

FSLIC was not burdened with assetmanagement problems after resolu 

tion. Low default risk also helped to 

keep resolution costs relatively low, in 

the range of five to ten cents per dollar 

of assets (Figure 2). 

As FSLIC reserves declined, and 

the backlog of insolvent S&Ls 

mounted, FSLIC began experiment 

ing with assistance agreements that 

required less cash to the acquirer. 

"Yield maintenance" was developed 

to guarantee acquirers a market yield 

on nonperforming assets and other as 

sets of questionable credit quality. 

Unlike the earlier yield subsidies, 

yield maintenance was used often to 

mitigate credit-quality problems. 

Yield maintenance often was used in 

conjunction with guarantees against 

capital losses ("capital loss cover 

age"). A seties of "capital support" 

programs also-were started, often re 

quiring little cash from the acquirer. 

For example, net worth certificates 

and income capital certificates were 

created as tools for supporting an 

institution's capital while providing 

Figure Z 

FSLIC Resolution Costs as a Percent of Total Assets: 1980-1987 

oi Total Assets 

0.5 

0.1 

1980 1981 1982 1983 1984 1985 1986 1987 

Year 

Nota: All data are from FSLIC records and Thrill Financial Reports, 1980-1987. 
Resolution Coses of Thrift Failure? 

FSLIC with a share of future profits. 

FSLIC reduced its immediate cash 

requirements by backing many capi 

tal support arrangements with long

term promissory notes. Other less 

costly guarantees, such as indemnifi 

cation for legal expenses, also became 

common. 

1984-87 Period 

S&Ls were increasingly plagued 

with asset-quality problems starting 

in approximately 1984. Deregulation 

of S&L assets and liabilities in 1980 

and 1982, coupled with accessibility 

of brokered funds, enabled S&Ls to 

move away from relatively low-risk, 

low-yield, single-family mortgages (1

4s), and into higher-risk assets. As 

shown in Figure 3, S&Ls reduced 

their hold ings of assets with low credit 

risk (1 -4s and mortgage-backed secu 

rities) from 71 percent of assets in 

1981, to 55 percent in 1987. During 

the same period, the percentage of 

assets invested in higher-risk assets 

(land loans, commercial, and multi

family mortgages) increased from 17 

to 26 percent. While the new invest 

ments increased short-term yields, 

they also increased default-related 

losses and other credit-quality prob 

lems. Thus, it is not surprising that 

the percentage of S&L assets com 

prised of repossessed real estate and 

delinquent mortgages, shown in FigFigure 3 

Changes in the Credit-Risk Composition of Thrift Assets: 1981-1987 

of Assets 

1981 1982 

Year 

Note: All daTa are Irom Thrift Financial Reports, 19S1-19B7. Low credit risK Is 1-4 family mortgages plus mortgage-backed 

securiiies. High credil risk is multi-family mortgages, land loans, construction loans, non-mortgage loans, service corporalion Investments and real eslale held for investment. 

ure 4, rose continuously after 1983. 

Increasing credit problems also help 

to explain the enormous growth in the 

number of insolvent S&Ls every year 

after 1983 (Figure 1), as well as the 

fact that declining interest rates from 

1982 to 1986 failed either to reduce 

insolvencies or to revive the S&L in 

dustry. 

The shift from interest-rate to 

credit-related problems significantly 

complicated FSLIC's resolution pro 

cess. Asset-quality problems are more 

difficult to resolve than interest-rate 

spread problems owing to greater unFigure 4 

Real Estate Owned and Delinquent Mortgages 

as a Percent of Total Assets: 1980-1987 

of Total Asset; 

6 

1980 1981 1982 1983 1984 1985 1986 1987 

Year 

Note; All data are from Thrift Financial Reports, 1980-1987. 

certainty over the value of assets. If 

asset-quality problems are significant, 

it is difficult for acquirers to evaluate 

credit risk and thus difficult for the 

deposit insurer to arrange "whole 

bank" assisted acquisitions that trans 

fer all assets to the acquirer. The need 

to liquidate institutions thereby in 

creases as acquirers avoid the excep 

tionally high risks associated with 

severely distressed institutions. 

Asset-quality problems therefore efIncome capital certificates (ICCsl were 

first issued to FSLIC in September! 981. [CCs 

represented a hybrid instrument incorporating 

dements of debt and equity securities. The 

issuing association received either cash, a note, 

or some combination, from FSLIC. FSLIC typ 

ically received variable-race interest payments 

from the issuing association, if the association 

had any earnings, with payments to FSLIC 

capped at a fixed portion of the association's net 

income each year. Net Worth Certificates 

(NWCs) were authorized by the Garn-St Ger 

main Act of 1982 to provide capita! assistance 

to institutions that suffered low earnings as a 

result of home mortgage lending. NWCs dif 

fered from ICCs in that they were a form of 

"open-bank assistance" [hat did not involve 

acquisitions of insolvent S&Ls. Institutions 

with capital greater than zero, but less than or 

i:qual to three percent of assets, were author 

ized to issue NWCs to eithet FSLIC or FD1C 

in exchange for promissory notes. More de 

tailed discussion of ICCs and NWCs can be 

found in Faucctte and Kneipper (1981) and 

Mclmosh*/*/. (1983). 

17 
■ ■ 

■ 

FSLIC id deve.op 

<z.l\l<: i"\\«.[-\r\ fijTrri: uf HiilitHJlCB. 

cs i uflici=nr reserves rci rh; 

bfckloj; of -ljscs f'SLlO 

ii>*i>-\\nt-e k^reemeni: durinp rhe 

rn i.l-19S0* *ui;ght to reiulve atEcr

i|iislit\ ^re-Lilt ina wrh h: litdc uuh ai 

poitib-lt. Inititj nom ufrcn ivcrc ioJd. 

mill .ill irouUk ll ,Hi(rUi tl.1i ,i|i| ng »i 

ih.- iii^ii||j;i.in FS1 11.1 

mg. ro 'I'VL-r futnn iM;ii 

Ir^ulili'l iistcls lli'l iv,T> -j.is&ril i'i 

|||l- .1. ] .ir> i Vi\ Ai'. mi Lk.it.iii Liiv 

ii me ili£Oi"ii 'if fiinii.nt. n .milled as

iccs if ihc i"c: * vicld wa* licinw 

'ninf^^rilliil I i-> l- I Non i"li if'f

!]■? were. ^riuHi-iJ, sulIi i> future.- lix 

o. TLfci

Lim:ced ill nds al^c were 

bv be letting mrtui n iv;n-s c-f S&Th> I"ut 

rion. I n^ilv l-h: S^\ I *'m i' tI 

,rn ill liJ"U nrnl/vr .-iil^'.inl i -I 

frsnu-.i w '^ilu' •"• £ iiM r|uiokK 

Murr ili.-lr.-s^L il SSrl ' ilflLiI "C

ni.iri'-|l linn ^olvl Ll I'm *f vf fal 'CJi^. 

■Si'ii". 'ii '• L'l.nL'l hi .i kmH "I -^p [I 

||JI- Illj.tiiJ, 'M11 iii'ri.i gi rri£ril < \c&<:\\ 

:iliLiiii:iil 1'ii.v" ii ihti .P. 41^^1'ifd in 'pr I 

9SS, Fi z\\.z lonunl of ^iL^ :hj: [01lL -Iil 

ihiLJi ul :ur -iLr J■_-1■_-1_lii,■ 1.1■_■ i. Sci 

.n ih.. J.ILI1 ,tl:l nj[ loriul.:. i.'jml, 

Lj lUM liii>¥ J|n-i3l»i"' |i"'iin 

i ik. l-l^"l i^l ill rrir-i■: 3 ir nunigf -nenc, 

.i-i^hi ffls.—ji?|i poniponin^ fL^LLumci f^c 

\-,r^ Forf«mnlf :he fl S^lL pljL^ J i:i i.il 

AKJ. ll^^r.' ]-j.lt ijvi.ms tji.l. nTjsnn. n^

iu|v..J u-|[il [l;^iii|-"i l'i*^. '^ -iiorirl" jriar : 

"ti^ flip-r ir :hf Vir^P Mar? uliiIll J-.iu'

sio i nl in? MCP c;n h< E iLnd in I Ljrvir; f LSoT^ 

;nc I3if n.n: bru:iLJLUi;li, hi:J iliiv:1'11'^i1 

1 ^ftl i. 'inl"fH jr'r-r 19S7 ir< r.nt l if-.il

i-iiLi- -ifpiii'4 nsnff1cid=iE "_rr.'L hji Llj|idLil k. 

hriiin r^i'nranli crmplcrc mi*, litj 

J 4iiol.iLr rj¥sun l'oi Ti>,ii m ij rh':: lit; In 

I''-4 i. ih-i 

b ] 

|.ii.iI.Ii-ii s u.ill |-in-l"Hi r^-iljnon-. 

Th nit. r;no vrd iti rh.c fi:n qLii:. r Jl L'/S+ " ¥i ¥ 

J Ipjii. Ilio "i i|ili" nails' rhfir Ij^i 

-epcrt ••/-' Erom Dc-imt^.- L9do. and 

h. :h< rc^i of lil dju'jz;

: jtid rc^^r-^ iIjc; ^_Fl i jI.'ji-hI ," oi 'n

in /ri 

d in .irL 1 

o or n-/ir; vein Jl J'.iujI l.sIi .Tui'^ 

. I jt mjhl " >•■ i 

ov refill jcni; In ii ui In i v i-k 

III! iil^ 11 nit In nil fur n. tijiTE'1. 

'Vli. 11i-i imoji |i>.i| n.rl[i|[inlj[c ur 

p:ifurm dn 'ijiiicd JtqiiL^LEif 

ch^npci] dniiiLe '.ho lnfl^ R7 i 

On ihc unc .land, aiiec-quahcy prni

nude n almnic ini|".i.iljl. m 

WIlllOIII Ijlpi: lill.r.ilrlI:, ill ..i^li ,n il.'nr 

euiirnnln-t.- On lin cottier hsmd. die 

v ca^.T [cquircnicnci '.I [ir|in.].iBrj' 1 tin. Append Ltjmide 

Li difficiiLrcufund Liquidations in Llj^il 

nl FS],]C ! fifimly inj.]^'|u r. ^ 

jcr.BJ ^nd bunniyifg t-apadev. The 

iconic va* en icicnc lir|ii»ni nf l|n 

the rncrfi dLJCicued Lnit.nicion=. t'e., 

I 111 1^0 h'Hllll L-lL |ll KI1l.ll .1"' I 11 I.I!! I.I I' 

prublernj and Little oi no foi 

ih. In ttJiHitflc, the cash _nd 

uiinuir> rnsni. i.mlil'k (■% F1U.REA 

cnahlcd die ftl'C id dev cay ve^1 d liII r l.. 11 r r' mi nlinii III l.niiiiii'-'h 'I .in nig 

m J(Wy tsec Hd\ i in di 

The afJvenr ^1 a^wc-qu^Licv |'rnhIcm: dunni; tlie l^t-4-87 prr.uo i^ukt 

11 a.ncs|ieejally uicfuliiudy pejiod tor 

CUJDSnt pulu.} |JLIT|;'^' ^ Fnp.irrK M.ir 

^iiicu[inr.& jcHiLved from ]^b4 [■_ 

IQFi7 art Lluijoiir;:td hy die amc 

SKI '_fi i ncn r v l^cuip rcif. Ivcd hy:hc 

RTC 

:ill Lilt tori iorri[>ln ill ll"

of I'lSLIC b^3 expsnenu; 

from l^fil in 1W7 I-^iie ihcavaildilc 

djD:3j:frorn bujodu nun^ ::Lun: j t.L.it 

n,fl<-n In^c: on j ?jmi haul's winch 

icnoiTf die ci m< walin, uf ^iiinn E-..I 

h-nin|ik, i 510 niillinn c-ap.Dil Id^^ 

payment i; retunifJ u«<i $10 million 

ol I 

p nisdc [w.. -i.w^ .ir 

y^jr' a I lii fiMil .iii.ii t>rfie~ r 

^ilk i-.HiLDn rhcief-Drc lz needed Lo.d

]Ui: il. caii finite for Jlu- mliic o: 

I-'SI.[(.' luuunrLni! rc

l ujiJ: ofrcn ta n - dc be u^ed Locra. koi 

Vll iC ^C^i.imI.iI-1 Im'. f'ir m jijliiiiijiu 

n.vfjkjij^ninv <A FSLIC'i ccrnplei 

ic: and piaraniecs Sc-mo 

iii-s in ¥up;i 

with special 

c;. ^hilc filial' iii.nli-.irT.iiigi, 

mi m: fur TSLIfi ro :ha:; in tuiure 

prnt.fi SliII (jrhcn invi'Ktrl Iuhj 

ti-rm iD.ini ur itounne: c.iac arc oilfi

:ul[ rn^ah.c 

F i fclkj rlin-"t firi,i[n.^il -cpurii 

prior t-n rc^clution are nfren ol pnnr 

Ju.ilil, Ik.' mii^i ^Oiin T *ul"Ti| SoVI"1' 

failed id majnrain 9l\up:5 financial 

rcpn-i' i-nnicd'aicl.' nnm !■ ii.nl 

t.un. Thrift fi n: n-_ial J iilu •■• ere uficn 

repn.'cec.n ;irni it the inarLDiiinima: 

In^' 0 nr.ir i i.im-Ii tI. r^|".rrin^ il i|c 

Inlidu c-1 the abcvedaiaccmarni

n.ii I'"i s'jik j, v i..in Ml i1 i' Mill.I ">rr, 

fcj .jhich ctir.:plere dara arc nor aiail

jIiIl (Inured rc^nluriD-.: induce 

|1 ut.f ivi|h -f porting t-njT, in [li. ls.it 

I hr.fr t1 i.".a nci a I HcporL prunr iu rc=n

Lutiu:ii fli'"^f ii i|l rrn:^niJ fc-nl.'iir Lin 

relid.il* cost cara. anc rh.aic v-.ose 

i'"luLi..n ;txii irj\i n..r he cdl

fut UfllkT Ti-.i^in- Pur I ' 

pie. res')I utinn; thar invDl.ed N^Oi. 

].'. ^It, siiLiijrihiMlc fl '111ii, pitlOi'fr 

^tntk. or luani ftjrn F^LICi iiie u—n

.L-il hfiin-L ihc vali.c c-l these ;i

ran^ementfl ulj- nut be rcailil. 

"^■ ^l1 Aoi uiMi.nn' rco.uiiin^ nn 

Tubkl 

\i-|i|it| - .. h of 

in 

1 ."I iL"i;b":i[r; Tora] 

Acmal 

ClIM; S I 13 i:74 

Di ' 

I Ik- a.I i.l -•■Xi i 'liJiln nil ! r.^-^r-rih?-rl 11 rnr ih:l Thf nil ""if ELlcnlLDec by 

F£.T!l' Miii 
Resolution Costs of Thrift Failures 

Table 2 

Characteristics of S&Ls Resolved by FSLIC 

During the 1984:2 to 1987:4 Period 

Note: All asset classifications are calculated gross of loss reserves but net of unamortized yield 

adjustments and loans in process. The annualized cost and earnings figures in the "other" 

section are calculated as the most recent complete quarterly cost or yield data, multiplied by 

four. N/A (not available) is shown for a number of items relating co resolutions excluded from 

the sample due to data problems described in the text. 

FSLIC assistance are omitted also 

since other factors, such as regulatory 

forbearances, may account for a zero 

resolution cost. The final sample con 

tains 97 of 154 resolutions completed 

between the second quarter of 1984 

and the fourth quarter of 1987. The 

sample contains 46 liquidations and 

51 assisted acquisitions. 

The key variable, the actual cost of 

resolving an insolvent S&L, is con 

structed from FSLIC income and ex 

pense records from the resolution 

date to August 1989. The present 

value cost is calculated by discounting 

all cash flows back to the date the q 

institution was closed. The cost of 

assisted acquisitions is simply the 

present value of the cash assistance 

paid by FSLIC through the August 

1989, cutoff. FSLIC loss reserves as of 

August 1989 are used to recognize 

coses ancicipated after August 1989. 

The cost of liquidations is calculated 

as the cash FSLIC paid when the 

thrift was closed, less the present 

value of cash returned to FSLIC from 

the liquidating receivership (liquidat

ingdividends) prior to August 1989. If 

any assets remained in the receiver 

ship as of August 1989, their net 

realizable values are used as a proxy 

for the final sales proceeds. Net realiz 

able value is the present value of an 

ticipated collections (sale income, 

rents., etc.), net of disposition ex 

penses. 

Table 1 compares the resolution 

cost calculated for this study to the 

predicted (estimated) cost data used 

in previous studies. The cost of the 

sample of 97 resolutions is $7.23 bil 

lion, which is about 26 percent higher 

than the $5.74 billion cost initially 

predicted by FSLIC. The FSLIC es 

timates for liquidations are 35.3 per 

cent below the costs estimated in this 

study. The FSLIC estimates are six 

percent lower for assisted acquisi 

tions. These figures clearly indicate 

that actual resolution costs have 

tended to be considerably higher than 

the FSLIC's predicted costs. Actual 

cost data necessarily provide a much 

better basis for studying the determi 

nants of resolution costs than pre 

dicted costs. 

Table 2 provides detailed cost and 

other characteristics of the resolution 

sample along with data from resolu 

tions excluded from the sample. The 

total assets of all sample resolutions 

(gross of reserves) are $24.7 billion, of 

A 12.5 percent discount was chosen to 

approximate the discount that would be re 

quired by a thrift investor. The discount is 

estimated as an investor's weighted average 

cost of funds, equal to 0.8 multiplied by a nine 

percent cost of debt, plus 0.2 times a 25 percent 

cost of equity, which reflects a need co hold 

more equity than is typically held by a financial 

institution. 

Because several years of data are avail 

able for most resolutions, reserves for remain 

ing losses are small for assisted acquistions as 

well as liquidations. Remaining losses are less 

than ten percent of the total loss for almost all 

resolutions in the sample. 

A portion of the difference between 

FSLIC estimates and the estimates made for 

this study may be explained by the use of 

discount rates in the seven to nine percent 

range by FSLIC, which are considerably below 

the 12.5 percent rate used in this study. A 

higher discount is used in this study in an effort 

co reflect the private sector's valuation of S&L 

assets. 

19 
FDIC Banking Reviev 

which about 55 percent are from as 

sisted acquisitions and 45 percent 

from liquidations. Excluded resolu 

tions had about 80 percent as many 

assets ($19.8 billion) as resolutions in 

cluded in the sample. The average 

assisted acquisition in the sample 

($267.5 million) is slightly larger than 

the average liquidation ($240.0 mil 

lion). The average excluded resolu 

tion ($375.1 million) is considerably 

larger than either the average sample 

liquidation or the average sample as 

sisted acquisition. 

Table 2 also illustrates differences 

between S&Ls resolved as liquida 

tions and those resolved as assisted 

acquisitions. The present value cost 

of the average liquidation included in 

the sample, about 48 cents per dollar 

of assets, is over three times the 14 

cent cost of the average assisted ac 

quisition in the sample. Liquidated 

S&Ls have much higher levels of 

high-risk assets (real estate owned, 

construction loans, and land loans), 

and lower levels of low-risk assets 

(cash, mortgage-backed securities, 

and 1-4 family mortgages), than S&Ls 

resolved as assisted acquisitions. The 

delinquency, operating expense, and 

cost of funds ratios are also much 

higher for liquidations than for as 

sisted acquisitions. Finally, Table 2 

shows that the average FSLIC resolu 

tion in our sample had only 40 percent 

of its assets in 1-4 family mortgages 

and mortgage-backed securities, 

which is much less than the 55 per 

cent shown in Figure 2 for all S&Ls. 

Determinants of 

Resolution Costs 

As astartingpoint.it seems reason 

able to assume that the cost of resolv 

ing an insolvent S&L is primarily 

determined by the credit quality of 

assets. Other important factors affect 

ing cost are the yield on earning assets 

relative to the "market" yield, fran 

chise value, tax benefits granted to 

acquirers, and regional economic ef 

fects. Variables measuring these factors constitute the determinants of 

S&L resolution costs. 

Asset quality is measured by 

grouping S&L assets on the basis of 

similar credit-risk characteristics. 

Five asset classes are considered. The 

first class is real estate owned (REO). 

which includes real estate acquired 

through foreclosure as well as direct 

investments. At first blush, REO ap 

pears to have little risk of loss because 

S&Ls are generally required to 

"book" REO at "fair market value." 

However, in spite of the recom 

mended accounting treatment, expe 

rience has shown a widespread 

tendency for troubled S&Ls to incur 

unreserved losses on REO. This ten 

dency suggests that REO contains 

substantial risk of loss. 

Table 3 

Variable Definitions, Means, and Standard Deviations 

for Sample of 97 Resolutions 

Variable Definition Mean 

Standard 

Deviation 

NETLOS The present value loss for the entire institution, net of negative tangible net 

worth, existing prior to either merger or liquidation, divided by gross assets. 

NETLOS is the dependent variable in all regressions. 

0.144 0.226 

REO Real estate owned, real estate held for investment, divided by gross assets. 

LANCON Land and construction loans, net of loans in process, divided by gross assets. 

COMMORT Commercial and multifamily mortgage loans, and accrued interest receivable, 

divided by gross assets. 

NMORTS Consumer and commercial non-mortgage loans, divided by gross assets. 

OTHER Single (1-4) family mortgages, mortgage pass-through securities, equity in 

service corporations, cash and investment securities, and other tangible assets, 

net of unamortized yield adjustments, divided by gross assets. 

TRAD 

TAX 

Dummy variable taking the value of one if the institution has over 40 percent 

of gross assets in 1-4 family mortgages and core deposits to gross assets ratio 

over 60 percent, and zero otherwise. 

Dummy variable taking the value of one if the acquirer received tax benefits, 

and zero otherwise. 

0.351 

0.227 

0.480 

0.421 

YLDCOV The estimated yield on performing assets less the three-month average 

FHLMC commitment rate for the corresponding quarter. 

0.002 0.046 

Note: Gross assets are calculated gross of loss reserves but net of unarnortiicd yield adjustments and loans in process. 

za 
A second class of assets, land and 

construction loans (LANCON), also 

has substantial risk of loss due co a 

very high likelihood of default. For 

example, Table 4 shows chat land and 

construction loans have the highest 

delinquency and default rates of three 

major classes of thrift assets. The high 

natural default risk was exacerbated 

hy the face that S&Ls in the 1980s 

were often new lenders in the land 

and construction loan markets. As 

new lenders, S&Ls tended to attract 

a higher-risk clientele of borrowers 

than established lenders. These fac 

tors imply that LANCON should be 

one of the most important explana 

tory variables of S&L resolution costs. 

Two classes of assets are assumed 

to have less risk of loss than either 

REO or LANCON, but nevertheless 

substantial risk of loss. One class, 

commercial and multifamily mort 

gage loans (COMMORT), is shown in 

Table 4 to have delinquency and fore 

closure rates less than half the rates for 

LANCON, but much higher rates 

than for a relatively low-risk asset, 1 -4 

family mortgages. The other class, 

consumer and commercial non-mort 

gage loans (NMORTS), is shown in 

Table 4 but is expected to have de 

fault risk characteristics similar to 

those of COMMORT. As with 

LANCON, the natural default risk of 

COMMORT and NMORTS is exac 

erbated by the fact that S&Ls were 

often new lenders in these markets. 

A final class of assets contains 1-4 

family mortgages, mortgage-backed 

securities, and other assets with rela 

tively low credit risk (OTHER). To 

the extent that these assets contain 

credit risk, it is limited and generally 

not sufficient to cause bankruptcy. 

Thus, we expect OTHER to explain 

only a small amount of resolution 

costs. 

IZSee Kormendi er a/. (1989) or Harr.li, 

Bartholomew, and Elmer (1989) for evidence of 

the impact of tax effects on ihe cost of FSLIC's 

1988 assisted acquisitions. 

See Bartli, Bartholomew, and Bradley 

Resolution Costs of Thrift Failures 

Table 4 

Delinquency and Foreclosure Rates 

Delinquency Rate 

(60+ Days) 

Foreclosure Rate 

by Type of Loan, 1987 

1-4 Family Commercial and 

Mortgages Other Real Estate 

2.23% 9.27% 

1.34% 3.94% 

Construction 

and Land 

17.65% 

8.12% 

Note: All data ate published by the Office of Thrift Supervision for all S&Ls repotting in 1987. 

Aside from asset-quality problems, 

insolvent S&Ls often have substan 

tial assets with below-market yields 

owing to a tendency of thrift managers 

to sell high-yield (premium) assets tc 

enhance earnings. The effect of 

below-market yields is measured with 

YLDCOV, defined as the difference 

between the annualized yield on in 

terest-bearing assets in the last full 

quarter reported and the three-month 

average FHLMC commitment rate 

for 30-year mortgages during the cor 

responding quarter. If this difference 

is small (large), then asset yields are 

expected to be relatively close to (far 

from) market yields, and resolution 

costs low (high). Thus, YLDCOV 

serves as an index of the degree to 

which S&L assets are "underwater," 

and is expected to be negatively re 

lated to the resolution costs. 

Several studies have found that tax 

benefits significantly affected the 

cost of FSLIC's 1988 assisted acquisi 

tions. In general, acquirers are ex 

pected to reduce the amount of 

assistance required from FSLIC if 

they were permitted to utilize tax 

benefits from the acquired S&L. For 

example, required assistance should 

be less if an acquirer was permitted to 

"carry forward" prior tax losses of the 

insolvent S&L to shelter taxable in 

come. To capture the impact of tax 

effects, a dummy variable, TAX, is 

introduced that distinguishes resolu 

tions that granted acquirers tax bene 

fits from those that did not. TAX is 

expected to be negatively related to 

resolution costs. 

In addition to tax benefits, thrift 

acquirers were most interested in pur 

While core deposits are the primary 

component of franchise value, 

acquirers also sought attributes such 

as good market share, an established 

customer base, or an effective struc 

ture for originating loans. These attri 

butes are found most often in 

"traditional" S&Ls that emphasized 

raising funds from core deposits and 

investing in 1-4 family mortgages. 

Therefore, a dummy variable, 

TRAD, is created to measure fran 

chise value by recognizing "tradi 

tional" S&Ls. Specifically, TRAD is 

set equal to one if an S&L has signif 

icant core deposits (over 60 percent of 

assets) and 1-4 family mortgages (over 

40 percent of assets), and equals zero 

otherwise. Thus, institutions with 

TRAD equal to one may be viewed as 

relatively traditional S&Ls and ex 

pected to have lower resolution costs 

than nontraditional S&Ls, 

A final factor, regional economic 

variation, is noted here but is omitted 

from the statistical tests due to data 

limitations. The proliferation of failed 

S&Ls in the South west region is often 

cited as evidence that a large portion 

of the thrift crisis is attributable to the 

distressed Southwest regional econ 

omy. For example, approximately 20 

percent of FSLIC's resolutions dur 

ing the 1980 to 1988 period, repre 

senting almost 50 percent of all 

resolved assets, were in Texas.13 Un 

fortunately, only two of the resolu 

tions in our sample are located in 

Texas. Also, information is not avail 

able regarding the location of assets 

held by S&Ls, so institutions with 

losses from out-of-statc assets can not 

be identified. These problems sug (1989). chasing a viable, profitable franchise. gest that insufficient data are avail
FD1C Banking Review 

able to accurately test for regional 

problems. 

In summary, it is expected chat res 

olution costs are high when an S&L 

holds large amounts of high-risk as 

sets, mark-to-market losses are high, 

franchise value is small, and no tax 

benefits are granted to the acquirer. 

The importance of regional economic 

variation is not tested due to data lim 

itations. 

Results 

The determinants of S&L resolu 

tion costs are tested using ordinary 

least-squares regression analysis 

(OLS). The dependent variable, 

NETLOS, is calculated by subtract 

ing the book value negative net worth 

"hole" that existed at the time of res 

olution from the total present value 

cost of the resolution calculated in this 

study, then dividing by the book 

value of total assets. When the net 

worth "hole" is subtracted, the result 

is the loss on assets remaining in the 

S&L at the date of resolution, nee of 

any premium the acquirers may have 

paid (explicitly or implicitly) for fran 

chise value, tax benefits, or other sub 

sidies. Since reserves are added to all 

variables, the loss variable, 

NETLOS, is measured gross of re 

serves, as are all asset variables used 

to explain NETLOS.14 

The summary statistics in Table 2 

show that about 46 percent ($34.1 bil 

lion divided by $74.5 billion) of the 

total loss was booked as negative nee 

worth prior to resolution, whereas the 

remaining 54 percent is from addi 

tional losses on assets and liabilities 

that remain in the S&L at resolution. 

The use of gross balances for the 

NETLOS and asset variables eliminates con 

tamination due to inconsistent reserve policies 

among S&Ls. 

The following equation provides the best model of che cost of resolving an 

S&L based on the determinants previously discussed: 

NETLOS = 0.69REO + 0.73LANCON 4 0.47COMMORT + 0.48NMORTS 

(3.00)* (5.38)* (3.24)* (2.15)** 

0.06OTHER 1.08YLDCOV 0.09TRAD 0.13TAX. (1) 

(-0.80) (-2.36)** (-2.03)** (-3.35)* 

R2 = 0.63 

Standard error = 0.16 

F-statistic = 21.54 

The analysis omits a constant term based on the notion that an S&L should 

have no losses in excess of its net worth "hole" if its righc-hand-side variables all 

equal zero. The coefficients indicate the extent to which che cost of a resolution 

varies with the asset mix and other factors (t-statiscics are in parentheses). For 

example, the 0.69 coefficient on REO indicates chat a one percentage point 

increase in the percentage of total assets held as REO raises the cost of resolution, 

as a percent of total assets, by 0.69 percent. A single asterisk next to the REO 

c-stadstic indicates that it is significant at the 99 percent confidence level, which 

is the highest confidence level typically applied to regression coefficients. 

The remaining asset-quality variables perform largely as expected. The loss 

on the second high-risk asset class, LANCON, is only slightly higher than the 

REO variable and is significant ac the one percent level. The coefficients for the 

two medium-risk assets, COMMORT and NMORTS, are significant, about the 

same magnitude (0.47 and 0.48, respectively), and much lower than either of the 

high-risk asset coefficients, REO and LANCON. The last asset-type coefficient, 

OTHER, is not significant and very close to zero, -0.06. This suggests that low-risk 

assets may make little, if any, contribution to losses once market interest-rate 

effects are accounted for by YLDCOV. 

The coefficient for the asset-yield variable, YLDCOV, is significant at the 95 

percent level (**) and indicates that a 100 basis point rise in che yield on earning 

assets reduces resolution costs, as a percent of assets, by 1.08 percent. The 

coefficient for the traditional S&L variable, TRAD, also has the anticipated sign 

and is significant at the five percent level. The 0.09 coefficient indicates that the 

loss on assets, as a percent of assets, is about nine percent smaller in "traditional" 

S&Ls. 

The final variable, TAX, has the anticipated sign and is significant at the one 

percent level. The coefficient of-0.13 indicates that FSLIC resolution costs, as a 

percent of assets, were reduced approximately 13 percent in cases where tax 

benefits were granted to the acquirer. Thus, the analysis suggests that FSLIC 

appears to have obtained substantial value from the granting of tax benefits. While 

data were not available on the amount of tax benefits granted, the results never 

theless serve to confirm evidence from Barth, Bartholomew, and Elmer (1989) 

that FSLIC obtained considerable value from granting tax benefits for resolutions 

performed in 1988. 

The results in equation (1) are generally consistent with the primary hypoth 

eses regarding the determinants of S&L resolution costs. In particular, the results 

show chat asset quality, asset yield, franchise value and tax effects are significant 

determinants of S&L resolution costs. Assets with small amounts of credit risk 

(1-4 family mortgages, etc.) fail to explain significant amounts of losses in addition 

to the amounts explained by the remaining variables. 

The equation (1) regression was performed for several sub-samples of resolu 

tions, based on whether the resolution was a liquidation or an assisted acquisition. 

The results are shown in the first two columns of Table 5, which also shows 

22 
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B0X1 

Cash Flows ojLiquidations vs. 

Assisted Acquisitions 

Liquidations and assisted acquisi 

tions have dramatically different cash 

flows and, hence, funding characteris 

tics. In a nutshell, a liquidation re 

quires much more up-front cash than 

an assisted acquisition because a large 

initial outlay is required co pay-off in 

sured depositors. Once the insured 

depositors are satisfied, cash inflows 

are received from the sale of the 

institution's assets. In a sense, a de 

positor payoff is similar to an invest 

ment, a portion of which is paid back 

with income from the sale of assets. 

Income from asset sales occurs 

over a period of years. Investment se 

curities and performing loans with 

good documentation can be sold rela 

tively quickly. Nonperforming loans, 

real estate, loans with poor documen 

tation and other bad assets may not be 

sold for several years after the initial 

depositor payoff. Sales may take 

longer in depressed regions or if the 

asset is severely distressed. Asset sales 

also may be delayed by lawsuits or 

legal encumbrances on assets. 

Assisted acquisitions typically re 

quire much less up-front cash than 

liquidations because assets are trans 

ferred to the acquirer. The transfer of 

assets at acquisition reduces up-front 

cash by avoiding the need to wait for 

income from future asset sales. If large 

amounts of assets are transferred to 

the acquirer, then the up-front cash 

required from the insurer is small. Socalled "whole bank" acquisitions 

transfer all assets, thereby minimizing 

the need for up-front cash and elimi 

nating the need for FSLIC to dispose 

of assets later. 

The cash flow impact of alternative 

types of resolutions can be illustrated 

by imagining an insolvent S&L with 

$100 million of assets backed by a 

similar amount of insured deposits. 

Liquidation begins with a deposit 

payoff of $100 million, all of which 

FDIC Banking Review 

APPENDIX 

must be paid in cash at the start of 

resolution. The liquidation proceeds 

by generating income from asset sales 

over a period of years. An ultimate net 

loss of $40 million might result if the 

assets are sold for $70 million, and an 

additional $10 million in financing 

and administrative expenses are in 

curred. 

In contrast to a liquidation, a 

"whole bank" assisted acquisition 

might transfer assets at a value of $60 

million along with the $100 million of 

deposits. The result is a $40 million 

up-front cash payment from the in 

surer to the acquirer instead of the 

$100 million required by the liquida 

tion. In this example, both deals ulti 

mately cost the insurer $40 million. 

Limits on the availability of cash to 

fund resolutions can affect which res 

olution method is chosen. Limits may 

force the insurer to avoid liquidating 

firms that ought to be liquidated, es 

pecially if a troubled institution is 

large. It is natural to consider that 

many assisted acquisitions might be 

arranged for the same amount of cash 

required by only one large liquida 

tion. The structure of assisted acqui 

sitions also can be affected. In 

particular, assistance that replaces up

front cash payments with interest sub 

sidies and guarantees becomes an 

appealing alternative to "clean" deals 

that require only cash. Thus, limits on 

cash to fund resolutions mire the res 

olution decision when the resolution 

would strain the deposit insurer's cash 

resources. Conversely, easy access to 

funds allows the insurer to focus on 

resolving insolvent institutions at the 

lowest cost. 

BOX 2 

History o/R TC Resolution 

Transactions 

The RTC has, from its inception, 

set strict case-resolution guidelines 

that preclude the type of open-ended 

assistance agreements characteristic 

of the earlier FSLIC era. The RTC 

limits risk by avoiding guarantees 

and/or promises to cover future losses 

on sold assets, yields on nonperform 

ing assets, and other guarantees com 

mon in FSLIC agreements, 

Within the constraints of strict lim 

its on RTC guarantees, the RTC has 

nevertheless experimented exten 

sively with alternative types of resolu 

tion transactions. The RTC initially 

attempted to sell institutions as close 

to "whole banks" as possible in order 

to preserve cash and to return assets 

to the private sector as quickly as pos 

sible. The RTC attempted to provide 

flexibility by allowing bidders to sub 

mit bids for a variety of transactions, 

such as agreements to transfer only 

clean assets and liabilities, or to trans 

fer only deposits and a minimum 

amount of assets, such as branch of 

fices and computer systems. In the 

first six months the RTC also began 

experimenting with asset "put" and 

"call" options that were limited to no 

more than a six-month term. 

One problem with the initial RTC 

approach is that it resulted in substan 

tial delay due to the need for bidders 

to perform asset reviews or due dili 

gence. The time required for due dil 

igence delayed sales but generally 

failed to increase the amount of assets 

transferred to acquirers. Acquirers 

consistently showed interest in de 

posits and branches but had little in 

terest in risky assets, even after 

significant expense for due diligence. 

The RTC responded to the slug 

gish pace of resolutions in March 1990 

by offering expanded put and call op 

tions on bad and/or risky assets. The 

new program allows bidders to bid for 

only "clean banks" under a standard 

purchase-and-assumption transac 

tion. The "clean bank" transaction 

generally transfers all deposit liabili 

ties, secured borrowings, and "clean" 

assets, such as investment-grade se 

curities, performing 1-4 family mort 

gages, and consumer loans. In 

addition to the clean bank alternative, 

investors can bid on an "extended 

purchase-and-assumption transac

24 
Resolution Costs of Thrift Failures 

tion," receiving put and call options to 

purchase clean assets as well as a vari 

ety of risky assets, such as performing 

commercial loans, performing multi

family loans, nonperforming loans, 

and foreclosed real estate. These op 

tions give acquirers the right, but not 

the obligation, to purchase risky as 

sets for periods extending from 15 

days to 18 months. 

The revised program reduces the 

need for due diligence prior to an as 

sistance agreement. That is, put and 

call options enable bidders to delay 

much of their due diligence until after 

acquisition, thereby reducing the 

time required for asset reviews prior 

co acquisition. Bidders who have no 

interest in risky assets save up-front 

expense by simply leaving all ques 

tionable assets with the RTC after 

acquisition. Bidders with some inter 

est in risky assets perform more ex 

tensive asset reviews immediately 

after acquisition. 

BOX 3 

Adjustingfor Selection Bias 

Sample selection bias occurs when 

a sample deviates systematically from 

the true population due to the sample 

selection criteria. The problem of se 

lection bias applies to FSLIC resolu 

tions because FSLIC was only able to 

resolve about 30 percent of its backlog 

of insolvent S&Ls during the 1984

1987 period. Moreover, FSLIC 

stretched its limited funds by resolv 

ing only exceptionally distressed in 

solvent S&Ls as liquidations, and 

relatively "clean" insolvent S&Ls as 

assisted acquisitions. Given that 

FSLIC chose S&Ls for resolution in 

a non-random manner, the coeffi 

cients produced by the classical re 

gression model (OLS) may be biased 

estimators of the true loss coeffi 

cients. 

Sample selection bias can be dealt 

with by applying a two-stage econoSee Maddala (1983) for a more extensive 

discussion of Heckman's two-stage procedure. 

The adjustment procedure uses a soft 

ware package, LIMDEP Version 5, developed 

by William Green in August 1988. 

metric procedure first developed by Heckman (1976). 5The first stage attempts 

to identify sample selection bias by usinga probitanalysis to "explain" the sample 

selection process. In the case of FSLIC resolutions, probit is used to explain 

FSLIC's criteria for selecting insolvent S&Ls for resolution. The second stage 

then uses information from the first stage to adjust for bias in an OLS analysis of 

the determinants of S&L resolution costs. 

The first stage of the two-stage Heckman (1976) procedure begins by treating 

FSLIC's resolution choice as a binary variable. Specifically, a resolution-choice 

variable (RESOLVED) is created that equals one if an insolvent S&L was 

resolved by FSLIC, and zero otherwise. The binary variable is then "explained" 

with two variables that relate to the factors FSLIC may have considered when 

choosing an S&L for resolution. The two variables are non-interest operating 

expenses in the quarter prior to resolution (OPEXP) and the yield on thrift 

liabilities (COF) for the same quarter. The hypothesis motivating these variables 

is that FSLIC attempted to resolve S&Ls with high operating expenses and high 

funding costs regardless of whether the resolution was a liquidation or an assisted 

acquisition. This hypothesis predicts that the probability of FSLIC resolution is 

positively related to OPEXP and COF. 

The first stage of the two-stage Heckman (1976) procedure is applied to a 

sample of 475 insolvent S&Ls. The binary choice variable equals one for the 97 

resolutions in our sample, and zero for 378 insolvent S&Ls that remained unre 

solved at the end of 1987. The results of the first-stage test are shown below. 

Stage 1: Probit Results 

ResolveVNot Resolve = -6.55 + 22.84OPEXP + 275.62COF 

(-10.06)* (2.55)* (8.75)* 

Log-likelihood = -187.02 

Clii-square= 106.84 

These results confirm a significant positive relationship between high operating 

expenses, high cost of funds, and the probability of resolution by FSLIC. 

The second stage of the Heckman (1976) procedure uses a variable, LAMBDA, 

generated from the first-stage probit in an otherwise standard OLS model. 

LAMBDA captures information that helps predict the selection process of indi 

vidual observations. LAMBDA becomes small if the selectivity problem is negli 

gible, and large if it is significant. A small LAMBDA suggests that OLS 

coefficients are reliable. In essence, LAMBDA serves to correct the standard OLS 

regression for selection bias, so the OLS coefficients remain largely unchanged if 

the bias is small. 

The following are the results of the second stage of the Heckman (1976) 

procedure as applied to the simple OLS regression discussed in the text. 

Stage 2: OLS Results 

NETLOS = 0.68REO + 0.73LANCON + 0.48COMMORT + 0.47NMORTS 

(5.50)* (2.95)* (3.37)* (2.07)** 

0.02OTHER 0.07TRAD 0.89YLDCOV 0.14TAX 0.006LAMBDA 

(-0.34) (-1.81)*** (-1.98)** (-3.50)* (-0.23) 

Adjusted R2 0.46 

F-star is tic = 11.33 

It is noteworthy that the results from the second-stage OLS model are very 

similar to the results from the simple OLS model. In particular, the magnitudes 

and signs of the coefficients vary little between the two equations although some 

of the t-statistics decline slightly. The coefficient on LAMBDA, the selection bias 

variable, is very small and not significantly different from zero. The relatively 

small change in the coefficients, and the insignificant LAMBDA, suggest that the 

25 
FDIC Banking Review 

selection bias in our sample of 97 As a final note, the reader should by FSLIC in 1988. Thus, the question 

FSLIC resolutions may have had lit- bear in mind that many of the 378 ofselectionbiasremainsforanyappli

tle effect on the simple OLS results. unresolved insolvent S&Ls used in cation of the results to the current 

the probit analysis were later resolved caseload of the RTC. 

REFERENCES 

Barth, James R., Philip F, Bartholomew, and Michael G. Bradley. "The Determinants of Thrift Institution Resolution Costs.11 

Research Paper No.89-03, Office of Policy and Economic Research, Federal Home Loan Bank Board (November 1989). 

Barth, James R., Philip F. Bartholomew, and Peter J. Elmer. "The Cost of Liquidating Versus Selling Failed Thrift Institutions." 

Research Paper No. 89-02, Office of the Chief Economist, Office of Thrift Supervision (November 1989). 

Bisenius, Donald J., R. Dan Brumbaugh, Jr., and Ronald C. Rogers. "Insolvent Thrift Institutions, Agency Issues, and the 

Management Consignment Program." Research Paper No. 141, Office of Policy and Economic Research, Federal Home 

Loan Bank Board, (October 1986). 

Bovenzi, John F. and Arthur J. Murton. "Resolution Costs and Thrift Failures." FDIC Ranking Review. (Fall 1988) 1-13. 

Brumbaugh, R. Dan, Jr. Thrifts Under Siege: Restoring Order to American Banking. Cambridge, MA: Ballingcr Publishing Company, 1988. 

Faucette, Douglas and Richard K. Kneipper, "Income Capital Certificates: FSLIC Creates a Unique Savings and Loan Security." 

Journal of the Federal Home Loan Bank Board. (October 1981) 10-13. 

Heckman, James J. "The Common Structure of Statistical Models of Truncation, Sample Selection and Limited Dependent Variables 

and a Simple Estimator for Such Models." Annals of Economic ana" Social Measurement. (1976) 475-92. 

Horvitz, Paul M. "Assessing the Management Consignment Program." In Federal Reserve Bank of Chicago 

Proceedings ofa Conference on Bank Structure and'Competition, pp 337-340. Chicago: n.p., 1987. 

Kane, Edward J. The S&L Insurance Mess; How Did It Happen? Washington, D.C.: The Urban Institute Press, 1989. 

, The Gathering Crisis in Federal Deposit Insurance. Cambridge,MA: MIT Press, 1985. 

Kormendi, Roger C, Victor L. Bernard, and S. Craig Pirrong. "Crisis Resolution in the Thrift Industry: Beyond the December Deals." 

Report of the Mid-America Institute Task Force on the Thrift Crisis. {March 1989). 

Maddala, G. S. Limited Dependent and Qualitative Variables in Econometrics. Cambridge University Press, 1983. 

Mclntosh, W., A.E. Warner, and J.P. Gaines. "The Garn-St Germain Act and the Availability of Funds to the Real Estate Industry." 

Journal of the Federal Home Loan Batik Board. (May/June 1983) 16-22. 

White, Lawrence W. The S&L Debacle. New York, NY: Oxford University Press, 1991. 
Summary of Proceedings 

Summary of Proceedings 

International Conference on 

Insurance and 

Problem-Bank Resolution Policies 

by Alane K. Moysich^ 

This conference was convened 

by the FDIC on September 

26, 1990, for the purpose of 

discussing issues related to the 

operation of deposit insurance 

systems and government policies for 

intervention in problem-bank 

situations. Officials from countries 

represented at the Basle Committee 

on Bank Supervision, the Commission 

of European Communities, and 

national banking associations were 

invited to share their experiences and 

concerns regarding the provision of 

national safety nets, and to consider 

whether there is a need to coordinate 

these policies on an international 

level. 

From the U.S.'s perspective, this 

meeting was especially timely in light 

of the current debate on deposit insur 

ance reform and restructuring of the 

U.S. banking industry. International 

bankers, in particular, were asked to 

share their views on the American 

Bankers Association's proposal to 

change failure-resolution procedures 

in the U.S. Other areas of interest 

included the future of deposit insur 

ance programs and problem-bank res 

olution policies in the post-1992 

European Community and, more 

generally, how national bank regula 

tors can best maintain safe-and-sound 

financial systems in a global market 

place. 

The conference was divided into 

four panel discussions. The morning 

session, which concentrated on gov 

ernment policies for problem-bank 

resolutions, was restricted to govern 

ment officials to facilitate private dia 

logue. Banking industry representatives 

were invited to share their views during 

the afternoon session, which con 

cluded with a discussion of prospec 

tive trends in deposit insurance and 

problem-bank resolution policies. 

Panel I 

The first panel discussion cen 

tered around the role that govern 

ments should play when confronted 

with problem-bank cases. Of particu 

lar concern was how confidence in the 

banking system can be maintained 

without unduly eroding market dis 

cipline and whether there are indeed 

banks that are "too big to fail." Panel 

members were central bankers who 

have had considerable experience 

dealing with these issues. They in 

cluded: William Taylor, Director, Di 

vision of Banking Supervision and 

Regulation, Board of Governors of the 

Federal Reserve (moderator); Johann 

Wilhelm Gaddum, Member of the 

Directorate, Deutsche Bundesbank; 

Tadayo Homma, Director, Financial 

and Payment System Department, 

Bank uf Japan; Huib Muller, Execu 

tive Director, the Nederlandsche 

Bank and Chairman of the Basle 

Supervisors' Committee; and Brian 

Quinn, Executive Director, Bank of 

England. 

There was general agreement 

among the panelists that bank super 

vision and adequate capital levels are 

the first lines of defense against bank 

failures. Some panelists expressed a 

desire to see capital standards in 

creased above the current Bank for 

International Settlements' (BIS) 

guidelines which require banks to 

"Alane K. Mnysich is a financial economist 

in the FDIC's Division of Research and Statis 

tics. 

"Too big to fail" is imprecise shorthand 

for "too big to allow depositors to suffer losses." 

A situation in which a large bank fails but de 

positors are protected fnlfy is chus consistent 

with the application of a "too big to fail" policy. 

27 
FDIC Banking Review 

have equity capital, subordinated 

debt, and other reserves equivalent to 

eight percent of weighted-risk assets 

by year-end 1992. However, panelists 

also agreed that in free-market econ 

omies, bank failures can, and indeed 

should, occur. All panelists acknowl 

edged at least several recent examples 

of bank failures or, in some cases, gov 

ernment-sponsored rescues, in their 

respective countries. Most insolven 

cies or near-insolvencies were re 

solved via bailout or merger; 

liquidations cypically were limited to 

small, local depository institutions. 

While the possibility of bank fail 

ure was viewed as a necessary market 

ed iscip line tool, panel members 

stressed the need to retain flexibility 

in resolving problem-bank cases. The 

prevailing view was that decisions on 

how to handle a particular crisis in 

volve each situation's unique causes 

and effects and, therefore, cannot be 

prescribed in advance. One panelist 

noted that in his country, judgments 

regarding problem-bank resolutions 

are based on the net benefit to the 

community, not just on narrow finan 

cial calculations. Threats of contagion 

due to direct links to the failed bank, 

or to a general loss of confidence in 

institutions performing similar func 

tions, were cited as factors favoring a 

decision to provide official support. 

Panelists acknowledged that there 

may be banks that are too big to fail, 

simply because large banks often are 

important components in a nation's 

payments system and, thus, the fail 

ure of a major bank could tie up much 

of an economy's working capital. At 

the same time, however, panelists 

stressed that "too big to fail" should 

not be accepted as public policy. If 

that were the case, however, then 

those benefitting should be forced to 

pay in the form of more-demanding 

supervision or greater prudential re 

quirements. Moreover, panelists 

cited cases where government res 

cues were mounted for nonbanking 

companies that were considered too 

big to fail, as well as for small banks 

that were considered too important to 

fail. Tt was noted, however, that even 

if support is given, penalties should be 

imposed on managers, owners, and 

investors. Thus, in the words of Brian 

Quinn of the Bank of England, while 

a bank may be too big to fail, it is never 

"too big to suffer." 

Panelists firmly agreed that the 

focal point in failure-resolution deci

sions is the trade-off between main 

taining public confidence in the fi 

nancial system and preserving a 

degree of market discipline; thus, 

most regulators preferred taking 

prompt corrective action prior to a 

bank's actual insolvency. It was noted 

that overly-generous deposit insur 

ance programs give rise to the socalled moral hazard problem, or 

excessive risk-taking by insured fi 

nancial institutions. However, there 

was less agreement on the effective 

ness of market discipline in control 

ling the risk-taking activities of banks. 

One panelist's view was that today's 

markets are not fully aware of the 

competitive environment in which 

banks operate and, therefore, need to 

face the consequences of a failure in 

order to be made aware of the new 

risks. Another panelist argued that 

while market discipline should be en 

couraged, it cannot be relied on exclu 

sively due to the conflicting goal of 

maintaining financial stability. Addi 

tionally, it was noted that political 

forces sometimes may be brought to 

bear against the decision to allow de 

positors to lose money. 

Deposit insurance funds or guaran 

tee programs were seen by most panel 

members as supplemental tools to 

protect the small saver and to aid gen 

eral financial stability when a bank is 

declared insolvent. Several panelists 

noted that the U.S. federal deposit 

insurance system is far more exten 

sive than its European or Japanese 

counterparts. For example, individual 

limits on deposit insurance coverage 

in Great Britain and the Netherlands 

are rather low, while Germany's de 

posit insurance fund, which covers 

each depositor up to 30 percent of the 

bank's equity capital, does not cover 

interbank deposits and is run entirely 

by the banking industry. Hence, it 

was suggested that in Germany the 

government is not perceived to be the 

ultimate insurer of commercial bank 

deposits. 

FDIC Director C.C. Hope, jr. (far left) greets WiiJiam Taylor of the Federal Reserve (left); Huib Direct comparisons of deposit in 

MuJler, Chairman of the Basle Committee on Banking Supervision (center); and Johann Wilhelm surance coverage among various 

Gaddum of the Deutsche Bundesbank (right). Photo: Rick Bloom countries are difficult, however, due 
Summary (if Proceedings 

to differences in national banking 

structures and safety-net arrange 

ments. For example, the U.S. does not 

have any government-owned banks 

which, by definition, cannot fail, or a 

postal savings system in which the 

government explicitly guarantees 

principal and interest. Additionally, 

many countries tend to rely on failureprevention methods, including direct 

capital injections, government acqui 

sition of nonperformmg assets, na 

tionalization of troubled banks, 

provision of liquidity through central 

banks or with industry support ("life 

boats"), and government-assisted 

mergers. As a result, costs which in the 

U.S. are incurred by the FDIC are 

incurred in these countries by the 

central bank, the finance ministry, or 

a consortium of banks. 

The need to maintain flexibility in 

problem-bank resolution policies, 

particularly with respect to the 

lender-of-last-resort policies of cen 

tral banks, has been referred to as 

"constructive ambiguity" by E. Ger 

ald Corrigan, President of the Federal 

Reserve Bank of New York, who be 

lieves it is a necessary force counter 

ing the moral hazard problem 

inherent in the provision of financial 

safety nets. While panelists agreed 

that "constructive ambiguity" is an 

appropriate policy forcentral bankers, 

several expressed a desire to revisit 

the Basle Concordat, which spells 

out the responsibilities for supervi 

sion of international banks and bank 

ing groups, but does not directly 

address policies for dealing with the 

resolution of international bank fail 

ures. They noted that while it might 

not be desirable to suggest that a par 

ticular central bank will always act as 

lender of last resort, it is important to 

determine just which central bank is 

In December 1975, the central bank gov 

ernors of the Basle Committee on Bank Super 

vision approved a group of broad guidelines for 

the division of responsibilities among national 

authorities governing the supervision of foreign 

banking establishments. These guidelines; 

which were later revised in 198.1, became 

known as (he "Basle Concordat." 

Conferring during a break in the proceedings are (from left): FDIC Chairman L. William Seidman; 

ViceChairman Andrew C. Hove, Jr.; George E. French, Chief of Research's Financial Markets Section 

and Editor, FDlCEankingReview; and Arthur J. Murton, Associate Director, Division of Research and 

Statistics. Photo: Rick Bloom 

responsible for deciding whether tc 

intervene in a problem-bank situa 

tion. Several panelists suggested that 

a serious gap currently exists between 

the globalized nature of financial mar 

kets and the decentralized structure 

of central banks. Moves to bridge this 

gap during non-crisis times would 

save valuable time and help to ensure 

[hat financial stability is maintained 

in the event of an international bank 

failure. 

Panel II 

The second panel discussion fo 

cused more specifically on the role of 

deposit insurance programs. Panelists 

wete asked to comment on their own 

country's philosophy regarding the 

protection of depositots and the res 

cue of insolvent banks, as well as the 

role deposit insurance plays in main 

taining stability within their banking 

systems. This panel was moderated 

by Paul Fritts, Director of the FDIC's 

Division of Supervision. Speakers 

were drawn from countries that have 

a variety of mechanisms for dealing 

with deposit protection. They in 

cluded: Monique Dubois, Assistant 

Director, Economic Studies Section, 

Swiss National Bank; Pierre Dubois, 

Director, Belgian Banking Commis 

sion; Ronald A. McKinlay, Chairman, 

Canada Deposit Insurance Corpora

[ion; and, Robert Ophele, Represen 

tative, Banque de France. 

Of the four foreign countries repre 

sented on this panel, the government 

of Switzerland appeared to be the 

least actively involved in bank-failure 

resolution issues. Although regulation 

and supervision are the principal 

mechanisms to prevent bank failures, 

the Swiss banking industry itself plays 

an important role in maintaining a 

sound financial system by establish 

ing codes of conduct for member 

banks that supplement regulations 

imposed by Swiss banking legislation. 

One example is the joint guarantee of 

savings deposits at insolvent institu 

tions which was agreed upon in 1984 

in lieu of a legalized deposit insurance 

program. This guarantee (up tc 

30,000 Swiss francs) supplements the 

Swiss depositor preference law in 

which certain deposits receive a prior 

ity claim in the case of bankruptcy. In 

the past, most failed Swiss banks were 

taken over by other banks; however, 

since the 1984 deposit guarantee 

agreement there have been no fail 

ures and thus, the guarantee has never 

been used. 

The Association of French Banks 

(AFB) also operates a loss-sharing 
FDIG Banking Review 

CONFERENCE PROGRAM 

Morning Session 

(Government Officials Only) 

8:30 a.m. Continental Breakfast 

9:00 a.m. Opening Remarks L. William Seidman, Chairman, FDIC 

9:15 a.m. Panel I: Policy Issues Surrounding Problem-Bank Resolutions 

and Their Impact on the Stability of Financial Markets 

Moderator- William Taylor, Director, Division of Banking Supervision and 

Regulation, Board of Governors of the Federal Reserve 

Speakers Johann W. Gaddum, Member of the Directorate of the 

Deutsche Bundesbank 

Tadayo Homma, Director, Financial and Payment System 

Department, Bank of Japan 

Huib Muller, Executive Director, The Netherlands Bank 

Brian Quinn, Executive Director, The Bank of England 

10:30 a.m. Break 

10:45 a.m. Panel II: The Role of Deposit Insurance Programs in Financial 

Systems 

Moderator Paul G. Fritts, Director, Division of Supervision, FDIC 

Speakers Monique Dubois, Assistant Director, Economic Studies 

Section, Swiss National Bank 

Pierre Dubois, Director, Banking Commission, Belgium 

Ronald A. McKinlay, Chairman, Canada Deposit Insurance 

Corporation 

Robert Ophele, Representative, Banque de France 

Afternoon Session 

(Government Officials and Private Bankers) 

12:15 p.m. Luncheon Executive Dining Room 

1:30 p.m. Opening Remarks -L. William Seidman, Chairman, FDIC 

1:45 p.m. Panel III: Banking Industry Perspective on Deposit Insurance and 

Government-Sponsored Safety Nets 

Moderator C.G. ("Kelly") Holthus, President, American Bankers 

Association 

Speakers Piero Barucci, Chairman, Italian Bankers Association 

Toru Hashimoto, Deputy President, Fuji Bank, Ltd. 

Thomas S. Johnson, President, Manufacturers Hanover Trust 

Company 

G. Malcolm Williamson, Group Executive Director, Standard 

Chartered Bank 

3:00 p.m. Break 

3:15 p.m. Panel IV: Where Do We Go from Here? International Trends in 

Problem-Bank Resolution Policies 

Moderator Paul A. Volcker, Chairman, James D. Wolfensohn, Inc. 

Speakers Masahiro Akiyama, Deputy Director General, Banking Bureau, 

Japanese Ministry of Finance 

Robert Glauber, Under Secretary of Finance, U.S. Treasury 

Department 

Paolo Clarotti, Head of Division, Banks and Financial 

Establishments, Commission of European Communities 

Harry Walsh, Undersecretary, Her Majesty's Treasury 

agreement among all commercial 

banks operating in France. Deposit 

protection is limited to approximately 

$75,000 per person, with a yearly cap 

on total industry payouts. Only per 

sonal deposits held in French francs 

are insured; specifically excluded are 

foreign-currency deposits, interbank 

funds, and funds with "abnormally 

high rates of remuneration." Losses 

are shared according to each bank's 

market share, although smaller banks 

pay a larger percentage of their de 

posit base than do larger banks. This 

arrangement primarily is designed to 

protect small banks; the yearly cap 

precludes payouts of even a mediumsized bank. Additionally, the gover 

nor of the Banque de France legally 

may request that French banks partic 

ipate in assisting the rescue of a trou 

bled institution, as was the case with 

the 1987 rescue of Al Saudi Bank. 

In contrast to the industry-spon 

sored Swiss and French deposit guar 

antee programs, Belgium has a 

deposit protection fund which is man 

aged by the Rediscount and Guaran 

tee Institute, an organization which 

has close ties to the central bank. An 

nual contributions are 0.02 percent of 

covered liabilities, which are limited 

to deposits in Belgian francs, up to 

$15,000 per person. The deposit pro 

tection fund may contribute to the 

liquidation of an insolvent bank, to 

financial rehabilitation, or to the com 

plete or partial takeover of the activi 

ties of a member bank, providing that 

such interventions would be less 

costly than a payoff. However, the 

fund has no receivership capacity and 

interventions are limited to the total 

amount of the fund. These con 

straints do not appear to concern the 

Belgian public, mainly because the 

three largest banks control 76 percent 

of covered deposits and thus, accord 

ing to the Belgian representative, 

Pierre Dubois, it is perceived that 

they would not be allowed to fail. 

Of the four countries represented 

on this panel, the Canada Deposit In 

surance Corporation (CDIC) has 

powers most similar to those of the 

.10 
Summary of Proceedings 

FDIC, including the ability to acquire 

assets from member institutions and 

to act as receiver of a failed bank. 

Additionally, the CDIC is empow 

ered to borrow up to $3 billion from 

the consolidated revenue fund, if nec 

essary. Annual premiums are cur 

rently 0.1 percent of insured deposit 

liabilities. Each deposit is insured up 

to $60,000 in Canadian funds, with 

maturities not exceeding five years. 

The CDIC has handled over 20 bank 

failures since its inception in 1967 and 

strongly favors going-concern prob 

lem-bank resolutions over morecostly liquidations. Additionally, 

Chairman McKinlay noted that once 

an institution is known to be in finan 

cial difficulty, confidence is lost and 

rehabilitating the institution becomes 

nearly impossible. Therefore, the 

CDIC actively is engaged in a pro 

gram to develop standards of sound 

business and financial practices, 

whose purpose is to preclude prob 

lems from developing. Similar to most 

European countries, Canada has a 

highly concentrated banking system, 

with about ten institutions controlling 

over 75 percent of deposits. This high 

degree of concentration was cited as a 

significant contributing factor to the 

country's ability to avoid losses of the 

magnitude of the U.S. savings and 

loan crisis. 

Panel III 

This panel was designed as a forum 

for international bankers to express 

their views on deposit insurance and 

other government-sponsored safety 

nets. Issues addressed included the 

relationship between the private and 

public sectors in the provision of de 

posit insurance and decisions or ac 

tions concerning problem banks, the 

competitive effects of different de 

posit insurance systems, and the 

American Bankers Association's pro 

posal (which would mandate an auto 

matic loss for uninsured depositors) 

and other ideas to reform the U.S. 

deposit insurance system. The panel 

moderator was C.G. ("Kelly") 

Holthus, President of the American 

Bankers Association. The speakers 

included: Professor Piero Barucci, 

Chairman of the Italian Bankers Asso 

ciation; Toru Hashimoto, Deputy 

President, Fuji Bank, Ltd., Tokyo; 

Thomas S, Johnson, President, Man 

ufacturers Hanover Trust Company, 

New York; and G. Malcolm William 

son, Group Executive Director, Stan 

dard Chartered Bank, London. 

Several panelists expressed the 

view that private banks, and their 

managers., play an important role in 

maintaining public confidence in the 

safety and soundness of financial sys 

tems. How this is accomplished varies 

from country to country and several 

interesting differences were appar 

ent. For example, during Great 

Britain's "fringe" banking crisis in the 

1970s, all banks stepped in to prevent 

a genera] loss of confidence spreading 

throughout the financial system. This 

procedure was in keeping with the 

informal nature of the British banking 

system whereby a close working rela 

tionship between bankers and their 

supervisors at the Bank of England 

takes the place of many written regu 

lations. 

Japanese bank managers also take 

seriously theirresponsibility for main 

taining public confidence in the fi 

nancial system. However, in contrast 

to Great Britain where the supervi 

sory style was characterized as being 

by "hint and nod," Japanese law em 

phasizes the public nature of banks 

and supervision is very strict. Al 

though Japan has a government-spon 

sored deposit insurance system, it is 

rarely used and problem banks are 

either helped financially and manage

rially by other banks, or sold or 

merged into another bank. 

In Italy, political pressure, stem 

ming from the belief that bank crises 

should be borne by the banking sys 

tem itself, led to the creation in 1987 

of the Interbank Fund for the Protec 

tion of Deposits. Membership is vol 

untary, and member banks are legally 

bound to maintain certain balancesheet ratios. Interventions by the 

Fund must be approved by the central 

bank which is represented at its board 

meetings. In cases of liquidation, de 

posits are fully insured up to approxi 

mately $170,000 with an additional 

$675,000 covered at the rate of 75 

percent. If less-costly than paying off 

deposits, the Fund also may assist in 

transferring the failed bank's assets 

and liabilities to another institution. 

Alternatively, the Fund may provide 

support to the ailing bank itself, under 

the following conditions: (1) the insti 

tution has been placed under special 

administration by the Bank of Italy; 

(2) the financial assistance must be 

less-costly than the estimated cost of 

paying off depositors in the event of 

liquidation; and, (3) there must be 

prospects for the bank to be restored 

to sound and viable condition. 

There was general agreement 

among the foreign representatives 

that the current U.S. federal deposit 

insurance system and bank-failure 

resolution policies create a moral haz 

ard problem that is not prevalent in 

other countries. However, most pan 

elists agreed with the position that 

deposit insurance reform must extend 

beyond the federal safety net and ad 

dress structural changes in the bank 

ing industry, particularly interstate 

branching laws. Several bankers 

noted that the ability to diversify risk 

geographically would enhance the ef 

ficiency and profitability of U.S. 

banks and, therefore, strengthen their 

performance at home and improve 

their international competitiveness. 

Stronger banks would attract new 

capital and facilitate an orderly and 

efficient consolidation of the U.S. 

banking industry. 

Bankers on this panel expressed 

thoughts similar to those offered by 

government representatives during 

previous panels, with respect to the 

combined roles of market discipline 

and regulatory attentiveness in main 

taining bank safety and soundness, 

Additionally, 100 percent deposit in 

surance coverage, either for all banks 

or only for those banks deemed too 

big to fail, was viewed by panelists as 

an inappropriate government policy. 

31 
FDIC Banking Review 

In general, foreign bankers agreed 

with che American Bankers 

Association's position that more mar 

ket discipline is needed to minimize 

the potential costs of deposit insur 

ance or other financial system safety 

nets. 

During the ensuing discussion, 

some representatives expressed res 

ervations about the ABA's proposal to 

treat each failed bank in a manner that 

automatically subjects uninsured de 

positors and unsecured creditors to a 

percentage loss based on the FDIC's 

average receivership loss rate. One 

discussant suggested that this concept 

was incompatible with denouncing 

"too big to fail," since it actually guar 

antees depositors more than the stated 

insurance limit of $100,000. In addi 

tion, the proposal's intended effect 

could be subverted by politicians 

who, in some instances, might decide 

to reimburse depositors in full any 

way. In general, foreign bankers fa 

vored regulatory flexibility over 

passage of any law in their own coun 

tries that would impose fixed prob 

lem-bank resolution techniques. 

Finally, panelists were queried re 

garding the reaction of the interna 

tional financial community if the U.S. 

were to impose losses on depositors in 

a large bank. One panelist expressed 

skepticism that such an event would 

ever occur, except under the most ex 

traordinary circumstances. Others felt 

that any foreign bank doing business 

with the failed bank should be pre 

pared to accept the consequences of 

their decision. At the same time, pan 

elists noted that such a failure proba 

bly would cause foreign banks to 

re-evaluate the creditworthiness of all 

American banks. 

Panel IV 

The final panel served to summa 

rize some of the earlier discussions 

and to address future trends in deposit 

insurance and problem-bank resolu 

tion policies. In particular, panelists 

were asked to focus on what kinds of 

international coordination of safety 

nets will be needed in the future, and 

how much standardization, if any, will 

be necessary. The panel moderator 

was Paul A. Volcker, Chairman of 

James D. Wolfensohn, Inc. and for 

mer Chairman of the Board of Gover 

nors of the Federal Reserve. Speakers 

included: Masahiro Akiyama, Dep 

uty Director General, Banking Bu 

reau, Japanese Ministry of Finance; 

Paolo Clarotti, Head of Division, 

Banks and Financial Establishments, 

Commission of European Communi 

ties; RobertGlauber, Undersecretary 

of Finance, U.S. Treasury Depart 

ment; and Harry Walsh, Under Secre 

tary, Her Majesty's Treasury, Great 

Britain. 

Mr. Volcker noted that while a 

wide diversity of banking systems and 

safety-net arrangements exist, a re 

markable degree of agreement on the 

nature of the problems surrounding 

deposit insurance and bank-failure 

resolution policies was expressed by 

the various representatives. This 

common understanding, which was 

not evident in international settings as 

recently as a decade ago, was seen as 

one indication that alignment of the 

various banking systems already may 

be occurring. Although most repre 

sentatives from outside the U.S. had 

expressed satisfaction with the cur 

rent structure and operation of their 

own domestic banking systems and 

regulatory mechanisms, this panel 

speculated on how well these systems 

will perform in the long run. 

Observing that international bank 

safety and soundness begins with do 

mestic financial systems, one panelist 

noted that regulators in his country 

are closely monitoring the effect that 

interest-rate deregulation will have 

on the future stability of the domestic 

banking market. This uncertainty has 

led authorities there to focus their ef 

forts on prevention of failures, a strat 

egy preferred by a number of 

countries to contain the costs of de 

posit insurance. While this approach 

has great merit, it was recognized that 

the style of bank supervision of an 

individual country depends on a num 

ber of factors including the degree to 

which the financial industry is devel 

oped, its legal system, and even the 

social climate or national character. 

It has been noted that the U.S. 

system of federal deposit insurance is 

virtually unique in that, although stat

utorily limited in the amount of cov 

erage provided, che FDIC has 

authority to extend de facto coverage 

through its powers to arrange pur

chase-and-assumption transactions, 

financially-assisted mergers, or to pro 

vide direct assistance to banks. These 

tools, the need to handle bank insol 

vencies in the least-costly manner, 

and several well-publicized rescues of 

large banks in recent years have con 

tributed to a widespread belief in the 

U.S. that uninsured depositors will 

only suffer losses in the failure of 

small banks. This belief has raised 

competitive concerns among com 

mercial banks in the United States 

and also has led to concern that equity 

considerations may result in the 

FDIC extending de facto 100 percent 

deposit insurance coverage to all 

banks. 

Thispanelsuggested thatthereare 

really two issues raised by the "too big 

to fail" debate, only one of which can 

be dealt with through legislation. All 

panelists recognized that there are 

times when a particular bank failure 

could lead to a general loss of confi 

dence in the system. These genuine 

cases of unacceptably high systemic 

risk, which are not limited to large 

banks, are the foundation for the argu 

ment in favor of "constructive ambi 

guity," or the maintenance of 

regulatory flexibility. 

It is the other component which 

Mr. Glauber argued that the U.S. 

should try to change: that is, discrim 

ination in the treatment of uninsured 

deposits at large versus small banks 

present in the current failure-resolu 

tion procedures. While the U.S. 

should not move towards a system 

where failures are prevented, it was 

suggested that an appropriate longrun strategy might be to restructure 

the relationship between the Financial 

32 
Summary of Proceedings 

institution and its regulator. This 

would include restructuring the U.S. 

financial system to allow banks to 

adapt to new lines of business, as ad 

vocated by a number of bankers on 

the chird panel. At the same time. 

appropriate firewalls should protect 

insured deposits from the riskiest ac 

tivities and to allow supervisors to 

focus more attention on the bank it 

self, and less on the holding company 

structure. These measures, designed 

to limit the safety net, could reduce 

both the number of institutions re 

quiring resolution and the number of 

cases where a purchasc-and-assump

tion transaction is justified and, ulti 

mately, return deposit insurance to its 

historical purpose of protecting small 

depositors. 

Other ideas mentioned by panel 

ists to reduce the U.S. safety net in 

cluded limiting deposit insurance tc 

natural persons racher than compa 

nies, excluding brokered deposits 

from insurance coverage, and reduc 

ing individual coverage limits. Riskrelated deposit insurance was 

mentioned by one panelist, who felt it 

would only be marginally-effective 

given appropriate risk-related capital 

requirements and supervisory ar 

rangements that ensure enforcement 

of prudential standards. 

With respect to the convergence of 

international safety nets, the experi 

ence of the European Community 

(EC) provided a fruitful area for dis 

cussion. The majority of EC countries 

established deposit insurance pro 

grams following the Commission of 

European Communities11986 recom 

mendation, although it was noted by 

Mr. Clarotti that these programs share 

few common characteristics. With 

passage of the Second Banking Direc 

tive in December 1989, it became 

clear that deposit insurance programs 

that require branches of foreign banks 

to join the local system are incompati 

ble with the principle of home coun 

try control for banking supervision set 

forth in the Directive. 

Therefore, the Commission has 

decided that it will establish certain 

basic guidelines for harmonization of 

the individual deposit insurance pro 

grams. It is expected that these mini 

mum standards will not legislate 

uniformity among the systems, but 

rather allow the EC countries flexibil 

ity in deciding how their deposit in 

surance systems are established and 

operated. Panelists expressed the 

opinion that these different systems 

can co-exist successfully in the post

1992 environment if small depositors 

continue to use domestic banks and if 

protection is limited to individuals 

and not extended to financial institu 

tions themselves. However, further 

harmonization might be required if 

banks begin holdingforeign-currency 

deposits for small depositors or if the 

mechanics of a particular insurance 

program give rise to a competitive 

edge. 

Harmonization of deposit insur 

ance and other safety-net arrange 

ments on a world-wide basis was not 

envisioned as necessary or desirable 

in the near future. Not only was such 

an attempt thought to be politically 

unrealistic, butalso nearly impossible 

given the vast differences that cur 

rently exist in regulatory structures, 

safety-net provisions, and bankruptcy 

laws. However, as globalization of fi 

nancial markets proceeds, panelists 

felt that there most likely will be fur 

ther alignment by way of increased 

communication and cooperation 

among regulators. Familiarity with 

one another's supervisory styles was 

seen to be important for banks oper 

ating across borders and for regulators 

who will need to anticipate a given 

country's reaction in a crisis situation. 

Additionally, it was noted that the in 

surance status of deposits in foreign 

banks or branches is one area of incon 

sistency that should be clarified. 

However, the point was made that 

regardless of the pace or future degree 

of international safety-net conver 

gence, reform of the U.S. banking in 

dustry and deposit insurance system 

should proceed as soon as possible. 

Summary 

The purpose of this meeting was to 

convene policy-makers and private 

bankers from the major industrialized 

nations to share their thoughts and 

concerns regarding financial system 

safety nets in the context of a global 

marketplace. Much was learned 

about the vast differences among the 

various banking systems, but com 

mon goals also were found to exist. 

Chief among these were the desire to 

preserve the stability and integrity of 

national banking systems and to pro 

vide mechanisms that protect the 

small, unsophisticated saver. All rep 

resentatives expressed a desire to 

work together to ensure that these 

goals are met in the event of an inter 

national bank failure. 

Several speakers felt that the dis 

cussions should not be limited to the 

"too big to fail" doctrine, or even to 

failure-resolution methods in general. 

It was noted that some portion of the 

value of a bank's assets is lost when 

the institution becomes insolvent or is 

known to be in trouble. Thus, a num 

ber of regulators expressed a desire to 

continue efforts to strengthen capital 

standards, while all stressed the need 

for strong and effective supervisory 

procedures to limit the number of 

bank failures. 

One of the major themes ex 

pressed throughout the day was the 

need for bank regulators to have at 

their disposal a wide variety of mech 

anisms to deal with actual or potential 

insolvencies at financial institutions. 

Moreover, regulators need the flexi 

bility to use these measures on a caseby-case basis. It may be concluded 

from the discussions that attempts to 

have bank-failure resolution policies 

cemented into law in the United 

States would not be copied by other 

countries. 

The desire to retain a measure of 

"constructive ambiguity" in failureresolution policies was prevalent in 

discussions on "too big to fail." While 

several speakers acknowledged that 

imposing losses on depositors in the 
FDIC Banking Review 

failure of a major bank could provide 

a number of unacceptable public-pol 

icy choices for regulators and politi 

cians, none was prepared to advocate 

a "too big to fail" doctrine, and a few 

speakers expressed dismay that this 

subject has even been discussed in 

public. In general, it was felt that in 

order to encourage market discipline, 

no bank should be considered too 

large to fail; if a situation dictates that 

it is in the public interest to provide 

official support to an ailing financial 

institution, then the means should be 

available to impose penalties on its 

owners, investors, and managers. 

It was shown that several countries 

have viable deposit insurance funds or 

guarantee programs run entirely by 

the private banking sector, or in con 

junction with the central bank. For 

the most part, however, these exist in 

countries where few bank failures 

have occurred, where penalties for 

mismanagement are severe, and 

where the banking industry is concen 

trated enough for banks to be diligent 

about self-policing. Additionally, 

there was the general perception that 

the relationship between bankers and 

their regulators is much closer in 

many countries than in the U.S. and, 

in some cases, independent auditors 

play an important examination role. 

While there were some representa 

tives who expressed a desire for in 

creased coordination of international 

safety-net policies, it was generally 

felt that convergence of these policies 

is neither necessary nor desirable at 

this time. However, there were twc 

areas that conference participants 

thought required clarification in the 

near future. The first was the alloca 

tion of responsibility among interna 

tional financial regulators for 

problem-bank intervention decisions 

that may affect more than one coun 

try. This would include a clear under 

standing as to which is the lead 

authority in a given situation, who else 

may be involved, and what effects a 

decision will have on other countries. 

The second area in need of clarifica 

tion is the insurance status of deposits 

in foreign bank subsidiaries or 

branches. As a result of the current 

disparity in deposit insurance sys 

tems, some deposits may be covered 

by more than one program while oth 

ers remain uninsured. 

In summary, this conference high 

lighted the need for international fi 

nancial regulators to continue to 

communicate and to share informa 

tion with each other as banking mar 

kets continue to undergo change. 

Each country is faced with the pros 

pect of adapting national banking sys 

tems and supervisory styles to a 

globalized financial marketplace. 

Technological change and the trend 

toward multi-function financial con 

glomerates ensure that the need for 

international cooperation and coordi 

nation will become even more critical 

in the future. 

34 
Recent Developments 

Recent Developments 

Affecting Depository 

Institutions 

by Benjamin B. Christopher 

Regulatory Agency Actions 

Federal Deposit 

Insurance Corporation 

Capital Maintenance 

The FDIC issued a proposal for 

public comment to correlate the 

agency's "leverage capital require 

ments" for banks with the existing 

risk-based capital framework. The 

proposed standards would affect the 

commercial banks and savings banks 

chat the FDIC supervises, and other 

depository institutions that file appli 

cations with the FDIC. 

Under the existing leverage capital 

requirements, state nonmember 

banks must maintain "primary capi 

tal" of at least 5.5 percent of total 

assets and "total capita!" of six per 

cent. Primary capital includes com 

mon stockholders' equity, all forms of 

perpetual preferred stock, the entire 

allowance for loan and lease losses, 

and certain amounts of mandatory 

convertible debt. The new proposal 

instead would be based on a single 

narrower category of capital called 

"Tier 1" or "core" capital. FR,9/26/90, 

p. 39288. 

The FDIC adopted revisions that 

will replace the primary and total cap 

ital definitions with a Tier 1 (core) 

capital definition and establish a min 

imum three percent Tier 1 leverage 

capital ratio requirement for the most 

highly-rated banks (CAMEL ratingof 

i) that are not anticipating or experi 

encing any significant growth. All 

other state nonmember banks will 

need to meet a minimum leverage 

ratio that is at least 100 to 200 basis 

points above this minimum require 

ment. State nonmember banks with 

capital below the minimum leverage 

capital requirement will be deemed 

to be engaging in an unsafe or un 

sound practice unless they have sub 

mitted, and are in compliance with, a 

capital plan approved by the FDIC. 

In addition, the previous three per 

cent leverage test, which was based 

on primary capital and used for deter 

mining when a depository institution 

was in an unsafe or unsound condi 

tion, is replaced with a new two per 

cent "unsound condition" test based 

solely on Tier 1 capital. Effective: 

April 10, 1991. FR,3/l//9/,p. 10154. 

Purchased MortgageServicing Rights 

The FDIC adopted a final rule, to 

implement certain provisions of the 

Financial Institutions Reform, Re 

covery, and Enforcement Act of 1989 

(FIRREA), restricting the amount of 

purchased mortgage servicing rights 

(PMSRs) that FDIC-supervised 

banks and savings associations can 

use to meet capital requirements. 

Under the rule, PMSRs in excess 

of 50 percent of core capital will be 

deducted from assets and capital 

when calculating the bank's regula 

tory capital. The 50 percent limit ap 

plies also indirectly to thrifts 

supervised by the Office of Thrift Su 

pervision (OTS) since FIRREA re 

quires that agency to prescribe limits 

on PMSRs that are at least as stringent 

as those applied to FDIC-supervised 

banks. In addition, the FDIC rule di 

rectly limits PMSRs for savings asso 

ciations to no more than 100 percent 

of the thrift's "tangible capital," 

which typically consists of core capital 

minus qualifying supervisory good 

will. 

The rule permits PMSRs in excess 

of the capital limitations if those ser 

vicing rights were purchased on or 

before February 9, 1990. Also, there 

'Benjamin B. Christopher is a financial 

economist in the FDIC's Division of Research 

and Statistics. 

Referencc sources: American Banker (AB|; 

Walt Street Journal(WSj);BNA's Banking Report 

(BBR);F«*na'ifcgw/fr(FR); Commerce Clear 

ing House Inc., Electronic Legislative Search 

System (ELSS). 
FDIC Banking Review 

are exemptions from the limitations, 

under certain conditions, for PMSRs 

held by a separately capitalized mort 

gage banking subsidiary, and for a sav 

ings association in the process of 

establishing such a subsidiary. 

The final rule becomes effective 

30 days after it is published in the 

Federal Register. PR-232-90, 12m, FDIC; 

FR, 12127,p. 53137. 

Brokered Deposits 

The FDIC adopted a final rule 

pursuant to new Section 29 of the 

Federal Deposit Insurance Act (Sec 

tion 224 of FIRRE A), which prohibits 

the acceptance, renewal or rollover of 

brokered deposits by an undercapital 

ized insured depository institution 

(bank or savings association) except 

on specific application to, and waiver 

of, the prohibition by the FDIC. 

In December 1989 the FDIC 

adopted an interim rule, which pro 

vided further guidance on when an 

institution is considered undercapi 

talized, when certain deposits are con 

sidered "brokered" for purposes of 

the prohibition, and the circum 

stances under which a waiver from the 

prohibition may be granted. 

The final rule is essentially the 

same, except that it: 

a) explicitly extends the application 

of the rule to insured branches of 

foreign banks; 

b) provides further guidance on the 

meaning of "normal market area" 

in relation to the prohibition on 

paying excessive rates without a 

waiver; and 

c) explicitly provides for the oppor 

tunity to consult with an 

institution's primary federal or 

state regulatory agency before 

the FDIC acts on the waiver ap 

plication. F1L-52-90, 10119, FDIC; FR, 

9125, p. 39135. 

Liability of Commonly 

Controlled Depository 

Institutions 

The FDIC adopted a statement of 

policy that sets forth the procedures 

and guidelines the FDIC will use in 

assessing liability against commonly 

controlled depository institutions 

under Section 5(e) of the Federal De 

posit Insurance Act. The new Section, 

which was added by FIRREA, creates 

liability for commonly controlled in 

sured depository institutions for 

losses incurred or anticipated by the 

FDIC in connection with the default 

of such institution, or any assistance 

provided by the FDIC to such institu 

tion in danger of default. 

The purpose of Section 5 (e) is to 

ensure that the assets of healthy de 

pository institution subsidiaries 

within the same holding company 

structure, or of a healthy institution 

which controls a failing institution, 

will be available to the FDIC to help 

offset the cost of resolving the failed 

subsidiary. The FDIC also seeks to 

encourage the acquisition of troubled 

institutions by those capable of reha 

bilitating them and to avoid instances 

in which the assessment of liability 

against an otherwise healthy institu 

tion will cause its failure. The policy 

statement attempts to balance these 

considerations in setting forth guide 

lines and procedures that the FDIC 

will use in assessing liability and in 

granting waivers thereof. FR, 5130/90,p. 

21935. 

Agencies Encourage Lending 

to Creditworthy Borrowers 

The FDIC, the Office of the 

Comptroller of the Currency (OCC), 

the Federal Reserve Board (FRB), 

and the OTS issued a joint statement 

and guidelines to help create a climate 

in which banks and thrifts will make 

loans to creditworthy borrowers and 

work constructively with borrowers 

experiencing financial difficulties, 

consistent with sound banking prac 

tices. 

The policies encourage increased 

disclosure about the condition of fi 

nancial institutions1 loan portfolios. 

Among the numerous issues covered 

in the policy statements are: 

a) Recognition of income for certain 

nonperforming loans. The agen 

cies are considering proposed 

guidelines relative to the accrual 

of income on loans that have been 

partially charged off. 

b) Valuation of real-estate loans in 

examinations. The joint state 

ment clarifies that the supervi 

sory evaluation of real-estate 

loans is based on the ability of the 

collateral to generate cash flow 

over time, not upon its liquida 

tion value. 

c) Other issues relating to nonac

crual assets and formally restruc 

tured debt. The guidance covers 

a range of accounting issues, in 

cluding cash-basis income recog 

nition on nonperforming loans, 

treatment of multiple loans to 

one borrower, and acquisition of 

nonaccrual assets. FtL-S-91, FDIC, 

31L 

Premium Rate Increase and 

Borrowing Proposed 

The FDIC issued a proposal to in 

crease the assessment rate applicable 

to banks from 19.5 cents to 23.0 cents 

per $100 of deposits, to be effective 

July 1, 1991. The FDIC also an 

nounced its intention to borrow for 

near-term funding of the Bank Insur 

ance Fund (BIF). Discussions regard 

ing the borrowing are being held with 

the Treasury. Alternative sources of 

the funds include the Treasury, the 

Federal Reserve, the Federal Financ 

ing Bank and the banking industry. 

Chairman L. William Seidman said 

that while the combination of the pre 

mium increase and borrowings would 

be of great assistance with respect to 

current problems, the additional 

funding must be part of an appropri 

ate restructuring of the financial sys 

tem and deposit insurance. PR-29-91, 

FDIC, 2/28. 

Deposit Insurance Coverage 

The FDIC amended its deposit in 

surance regulations, largely in re 

sponse to a provision of FIRREA 

requiring uniform insurance coverage 

rules for insured banks and thrifts pre 

viously insured by the Federal Sav
Recent Developments 

ings and Loan Insurance Corporation 

(FSLIC). The FDIC's statement 

stressed that most depositors at banks 

and thrift institutions are unaffected 

by the revisions and continue to be 

covered up to the statutory insurance 

limit of $100,000. 

Among the thrift accounts in 

volved in the changes are deposits of 

so-called "457 Plan" employee bene 

fit programs made by employers for 

state or local government workers or 

employees of tax-exempt organiza 

tions. Existing FDIG rules for insured 

banks provide for coverage of a 457 

Plan's accounts up to $100,000 in the 

aggregate, while the FSLIG, in con 

trast, insured 457 Plan deposits in sav 

ings associations for up to $100,000 

per each participant. 

The Board decided to extend the 

existing rules for thrifts until January 

1992 — for both current and new par 

ticipants to maintain liquidity at the 

institutions and to give Congress time 

to consider whether to allow the 

FDIC to provide the higher coverage. 

There are approximately $4-$5 billion 

of 457 Plan deposits at savings institu 

tions. As now contemplated, begin 

ning January 29, 1992 the more 

restrictive 457 Plan rules for banks 

will apply also to thrift institutions. 

PR-8I-90,511, FDIC. 

Restrictions on Savings 

Banks* Investments 

The FDIC issued for public com 

ment a proposal that would require 

savings and loan associations (S&Ls) 

that convert to savings banks to con 

tinue operating under their existing 

restrictions on high-risk investments 

and other activities. 

An S&L that converts to a savings 

bank still would be subject to restric 

tions and notice requirements im 

posed by statute in 1989 to protect the 

Savings Association Insurance Fund 

(SAIF). Those restrictions on SAIFinsured S&Ls include a prohibition 

on junk bond investments, a ban on 

loans to affiliates engaging in certain 

high-risk activities and a limit on the 

size of loans that can be made to one 

borrower. The law also requires prior 

notice to the FDIC before establish 

ing subsidiaries or conducting a new 

activity in an existing subsidiary. 

The proposal reflects the concern 

of federal regulators about the grow 

ing number of states that have en 

acted, or are considering, legislation 

to allow the conversion of S&Ls to 

state-chartered, SAIF-insured sav 

ings banks, which could be permitted 

understate law to exercise powers and 

make high-risk investments such as 

were authorized by states in the past 

and contributed to the S&L crisis. 

The FDIC proposal does not apply 

to savings banks that have been su 

pervised by the FDIC and were not 

previously S&Ls. PR-224-90, W29, FDIC; 

FR, 12//2,p.5f!7. 

Appraisals 

The FDIC adopted a final rule 

pursuant to Title XI of FIRREA that 

requires the FDIC to adopt regula 

tions regarding the use of appraisals in 

connection with certain real-estate 

transactions by FDIC-supervised fi 

nancial institutions. The regulation 

sets minimum standards that apply to 

all appraisals performed under the 

regulation. It also sets criteria for 

transactions that will require the ser 

vices of a certified appraiser and those 

that can be done by a licensed ap 

praiser. The regulation does not apply 

to transactions with a value of $50,000 

or less. 

The appraisal standards and other 

provisions of the rule take effect on 

September 19, 1990, except for the 

specifications as to which transactions 

require the use of certified or licensed 

appraisers, which become effective 

on July 1, 1991 (or such later date as 

may be set pursuant to FIRREA). 

FIL-47-90, 8129, FDIC; FR, 8/20, p. 33879. 

Adverse Contracts 

The FDIC issued a proposal re 

garding abusive contracts in general, 

and asking for comments on ways to 

prevent depository institutions from 

entering into contracts that pose seri 

ous risks to the insurance funds. 

One abuse cited involves contracts 

for data processing and other services 

carrying inflated terms that misrepre 

sent an insured institution's financial 

condition. An insured bank or savings 

association would be prohibited from 

entering into any contract determined 

to be adverse. The agency would pro 

vide examples of terms that could in 

dicate an adverse arrangement, and 

[he appropriate federal regulatory 

agency would evaluate individual 

contracts on a case-by-case basis, giv 

ing institutions an opportunity to 

prove a contract is not adverse. 

In a related action, the FDIC is 

sued a notice of intention to propose 

a rule to prevent special problems in 

volving contracts between an insured 

institution and its parent company or 

a non-depository affiliate. Examples 

include holding companies that take 

assets from their insured subsidiaries 

without paying fair value, or that pro 

vide vital services to the subsidiary at 

excessive terms. PR-45-91, FDIC, 3/26. 

Disclosures ofBanks 

Examinedfor Community 

Reinvestment 

The FDIC issued in early March 

its monthly list of banks recently eval 

uated for compliance with the Com 

munity Reinvestment Act (CRA). A 

list covering the period July 1 through 

November 30, 1990 was issued in 

February. FIRREA requires the pub 

lic disclosure of an evaluation and rat 

ing for each bank that undergoes a 

CRA examination on or after July 1, 

1990. A copy of an individual bank's 

CRA evaluation, which includes the 

rating, is available directly from the 

bank, which is required by law to 

make the material available upon re 

quest, or from the FDIC. PR-28-9I, 

FDIC, 3/1. 

Determination of 

Economically Depressed 

Regions 

The FDIC adopted a rule defining 

"economically depressed regions" for 

purposes related to FDIC assistance 

for certain troubled thrift institutions 

37 
FDIC Banking Review 

prior to the appointment of a receiver 

or conservator. The FDIC is required 

by law to consider proposals for direct 

financial assistance by SAIF members 

whose offices are located in an "eco 

nomically depressed region" and 

which satisfy certain other specified 

criteria. 

The final rule is identical to an 

interim rule adopted by the FDIC in 

March 1990, designating eight indi 

vidual states as economically de 

pressed regions. In determining 

"economically depressed regions," 

the FDIC considered (1) the ratio of 

poor quality real-estate assets to total 

assets in the portfolios of banks, (2) 

the ratio of poor quality real-estate 

assets to total assets in the portfolios 

of thrifts, and (3) unemployment fig 

ures. The statewide percentages of 

impaired real-estate assets for banks 

and thrifts and unemployment rates 

were analyzed with reference to na 

tional levels. The eight states desig 

nated in the rale are Alaska, Arizona, 

Arkansas, Colorado, Louisiana, New 

Mexico, Oklahoma, and Texas. FIL-23, 

3122/90, FDIC;FR, Oft 7, p. 11160, 

Required Information for 

External Auditors 

The FDIC reminded depository 

institutions that, pursuant to Section 

931 of FIRREA, they are required to 

furnish certain information to their in 

dependent auditor if they have not 

already done so. The requirement ap 

plies to any independent auditor they 

have employed at any time since Au 

gust 9, 1987, and to future external 

auditors. Procedures are specified in 

the notice which institutions supply 

ing information are requested to ad 

here to in order to protect the 

confidentiality of examination reports 

or reports of supervisory activity. 

The information that each insured 

institution is required under the Sec 

tion to provide to its independent au 

ditor includes (1) its most recent 

Report of Condition, and (2) a copy of 

the most recent report of examina 

tion. In addition, if applicable, the in 

stitution must provide for the period 

covered by the audit (a) any supervi 

sory Memorandum of Understanding 

or written agreement in effect be 

tween a federal or state banking 

agency and the institution; (b) a final 

order, or description of pending ac 

tion, by a federal banking agency re 

sulting from unsafe or unsound 

banking practices, violations of laws 

or regulations, or noncompliance with 

monetary transaction recordkeeping 

and reporting requirements; (c) a final 

order, or pending action, similar to (b) 

above, by a state banking agency; and 

(d) any other civil money penalty 

against the institution or any "institu 

tion-affiliated party." FIL-37-90, 712, 

FDIC. 

Money Laundering 

FDIC-insured banks were notified 

of the Treasury Department's adop 

tion of a final rule requiring each fi 

nancial institution to keep a log of 

bank checks and drafts, cashier's 

checks, money orders and traveler's 

checks sold for cash in amounts of 

$3,000 or more. The log must contain 

specific information about the pur 

chasers), with different requirements 

for transactions involving customers 

with deposit accounts and those with 

out deposit accounts. No sale may be 

completed unless the required infor 

mation is obtained. FIL-36-90,6125,FDIC. 

The Treasury proposed amend 

ments to anti-money laundering reg 

ulations, implementing the Bank 

Secrecy Act, that relate primarily tc 

wire transfers and other funds trans 

fers between financial institutions. 

Each domestic bank involved in a 

funds transfer would be required tc 

retain certain information, the 

amount and type of which would de 

pend upon the bank's role in the 

funds transfer process. In addition, 

banks would be required to verify the 

name and address and obtain addi 

tional information on originators and 

beneficiaries of funds transfers who 

are not deposit account holders. Fi 

nancial institutions other than banks 

that transmit and receive funds would 

have similar recordkeeping require 

ments. FlL-59-90,1119, FDIC. 

Insurance Retention not 

Assured if Thrift Leaves 

FHLB System 

The FDIC advised Wauwatosa 

Savings and Loan Association, Wau 

watosa, Wisconsin, that the FDIC can 

make no assurances at this time that it 

would be able to retain its deposit 

insurance should Wauwatosa with 

draw from membership in the Federal 

Home Loan Bank System. 

The FDIC based its position on a 

determination by OTS that Wauwa 

tosa is legally bound to remain a mem 

ber of the System, and that the 

withdrawal of savings associations 

from the System would pose safery

and-soundness concerns. 

The FDIC will withhold any final 

decision on the Wauwatosa request 

for 18 months to permit the OTS to 

consider rule-making. The FDIC 

Board indicated it would entertain 

OTS's suggestion that the rule-mak 

ing process be undertaken jointly by 

the OTS, the FDIC and the Federal 

Housing Finance Board. PR-168-90, 

8129, FDIC. 

Home Mortgage Disclosure 

Submissions 

The FDIC informed institutions it 

supervises that the banks and their 

majority-owned mortgage banking 

subsidiaries subject to the Home 

Mortgage Disclosure Act (HMDA) 

and the Federal Reserve Board's Reg 

ulation C are required to submit an 

nual reports of certain residential 

real-estate lending activity. The re 

ports for calendar year 1990, in the 

form of Loan Application Registers, 

are due at appropriate FDIC Regional 

Offices, either on paper or electroni 

cally, by March 1, 1991. FIL-3-91, FDIC, 

1/23. 

Policy on Outside Legal Fees 

The FDIC's Legal Division an 

nounced a policy intended to enhance 

competition and reduce costs for legal 

services to the FDIC and the Resolu 

tion Trust Corporation (RTC). 
Recent Developments 

During 1990 the Legal Division 

paid $615 million for outside legal 

costs in helping the two agencies to 

recover an estimated $21-1 billion in 

connection with failed banks and 

thrifts. The stated amount recovered 

is cash collected and does not include 

unpaid court judgments. 

Under the policy, firms which re 

ceived more than $2.5 million in ag 

gregate fees from the FDIC and RTC 

during any previous 12-month period 

must obtain prior written approval 

from a designated FDIC official be 

fore gaining new business from the 

agencies. This policy is expected to 

promote more efficient and economi 

cal legal services while providing the 

flexibility to make more extensive 

use of certain firms where appropri 

ate. The FDIC anticipates that firms 

exceeding the cap must offer special 

expertise, reduced fees or other ben 

efits. Joint New Release, FDIC and RTC, PR 

21191;2113191. 

Division ofResolutions 

The FDIC created a Division of 

Resolutions (DOR) for the purposes 

of centralizing and enhancing the 

agency's resources for handling bank 

failures and assisting institutions that 

are in danger of failing. DOR will be 

responsible for planning for and han 

dling bank failures, encompassing 

such activities as assembling data 

aboutanticipated failures, conducting 

meetings with potential acquirers, co 

ordinating with other agencies, and 

overseeing other aspects of resolu 

tions. The Division also will develop 

the FDIC's overall resolution policies 

and financing strategies. 

Other responsibilities of DOR will 

include the administration of resolu 

tion agreements, the design and nego 

tiation of asset service agreements, 

interim managementofFDIC-owned 

"bridge banks," and the management 

and sale of capital instruments ac 

quired from assisted banks. PR-40-91, 

FDIC, 3119. 

Study ofRisk-Based Deposit 

Insurance 

The system of flat-rate deposit in 

surance premiums has been criticized 

because it provides an inducement for 

a bank or thrift to increase its portfolio 

risk without incurring any additional 

insurance premium expense. It is ar 

gued that flat-rate premiums subsi 

dize "high-risk,!) poorly managed 

institutions at the expense of the wellrun institutions. Section 22O(b)(l) of 

F1RREA requires the FDIC to study 

the establishment of premium assess 

ment categories related to types of 

risk to the insurance funds and report 

its recommendations to Congress by 

January 1, 1991. The FDIC issued its 

report as required. 

The report discusses primarily two 

approaches to risk-based premiums: 

(1) adjusted capital, and (2) reinsur 

ance. It is recognized that there are 

many proposals for pricing deposit in 

surance that merit consideration, and 

this report is not intended to preclude 

any of those options. 

The adjusted capital approach to 

risk-based premiums would use a de 

pository institution's capital-to-asset 

ratio, adjusted for some performance 

measure(s), as the basis for deposit 

insurance premiums. 

The reinsurance approach is an in 

tegrated system of public and private 

insurance that is intended to deter 

mine a market price for each bank's 

deposit insurance. The FDIC would 

purchase coverage, for a small per 

centage of its risk that a covered de 

pository institution will fail, from 

qualified private reinsurers. The 

FDIC would base the premium it as 

sesses the covered institution on the 

risk-based price set by the reinsurer in 

a competitive bidding process. The 

reinsurance approach is designed ex 

plicitly for large (as defined) banks 

and thrifts. 

The report does not recommend 

any specific approach to risk-based 

premiums. It does recommend that 

the FDIC be given the authority to 

levy such premiums. It states that the 

implementation of a risk-based pre 

mium system must be coordinated 

with other reforms to the deposit in 

surance system, and options should 

be evaluated in the context of the 

proposals made in the Treasury's re 

port on the deposit insurance system. 

A Study of the Desirability and Feasibility of a 

Risk-Based Deposit Insurance Premium System, 

FDIC, December 1990,86 pp. 

New Publications 

Chairman Seidman announced in 

April 1990 that the agencies are devel 

oping an early-warning system to as 

sist in identifying possible difficulties 

in commercial and residential real-es 

tate markets. It appears that very high 

rates of growth are often followed by 

economic downturns — though some 

times with a considerable lag — thus 

analysis is being focused on markets 

having abnormally high rates of 

growth. In connection with the proj 

ect, Real Estate Market Indicators, and 

Real Estate Lending Patterns and 

Trends, are being released by the 

FDIC's Division of Research and Sta 

tistics. 

Resolution Trust Corporation 

RTC Performance Report 

The RTC held 183 institutions in 

conservatorship, with assets totaling 

$91.8 billion, at the end of January. 

Reflecting uncertainties regarding 

legislation to provide additional fund 

ing for the RTC, the pace of resolu 

tions slowed in January compared tn 

most of 1990. 

Also under the RTC's jurisdiction 

on January 31 were 362 receiverships, 

resulting from the resolution of 

thrifts, with $63 billion in assets. 

The 10 institutions resolved in Jan 

uary brought the total number of res

olutions to 362 from the 

establishment of the RTC in August 

1989 through January 31,1991. These 

institutions held $114 billion in assets 

at the time of resolution. 

Sales and principal collections 

since inception have totaled $137 bil

lion, net of putbacks, and subject to 

additional returns under unexpired 

39 
PDIC Banking Review 

putback provisions of resolution 

transactions. The $137 billion repre 

sented 47 percent of the total assets of 

the 545 institutions when they were 

taken over by the RTC. Collections in 

asset categories include $64 billion in 

securities, $51 billion in mortgages, 

$13 billion in nonmortgage loans, $4 

billion in real estate, and $5 billion in 

Other assets. RTCReview, RTC, January 1991. 

Accelerated Resolution 

Program 

The RTC will undertake a pilot 

program designed to accelerate the 

marketing and sale of troubled sav 

ings associations before they are de 

clared insolvent and placed into 

conservatorship. Chairman L. Wil 

liam Seidman said that "experience 

shows that the longer an institution 

sits in conservatorship, the more 

likely it is that its value will diminish. 

We want to act before that happens 

... Under our Accelerated Resolution 

Program (ARP), the institution will be 

marketed by the RTC, the OTS, and 

its management. When a buyer is 

identified, the thrift will be closed by 

the OTS, placed with the RTC, and 

immediately reopened in the hands of 

the waiting buyer. By preserving the 

franchise value of the institution, it 

will be more attractive to investors, 

and this wil I lower the ultimate cost of 

its resolution." 

The ARP was scheduled, as of the 

date of this release, to begin in several 

weeks pending funding approval and 

policy review by the Oversight Board. 

Institutions that will be offered under 

the ARP are those that the OTS has 

determined are in danger of failing 

and whose financial condition would 

cause them to be placed into RTC 

conservatorship within one year. The 

institutions also should have an ac 

ceptable management structure, sta 

ble operations, and franchise value. 

The pilot program, which will in 

volve approximately ten institutions, 

will be reviewed and evaluated after a 

period of about three months. News Re 

lease, RTC, 7/'10190. 

Retention of Thrift Branches 

Acquired by Banks in 

Emergency Acquisitions 

The RTC adopted a rule permit 

ting retention and operation by in 

sured banks of branches of failed or 

failing thrifts acquired pursuant to the 

emergency acquisition provisions of 

Section 13(k) of the Federal Deposit 

Insurance Act. The purpose of the 

rule is to permit insured banks to re 

tain and operate such branches de 

spite provisions of state law that 

would limit their ability to do so. The 

RTC believes that such state laws 

present a serious impediment to the 

emergency acquisitions of troubled 

thrifts by banks, and increase the cost 

of resolution of these thrifts. Effective 

June 1, 1990. FR, 6/1/90,p. 22323. 

Branching Rule Upheld in 

Appeals Court 

The U.S. Court of Appeals for the 

Eighth Circuit, reversing a district 

court decision, ruled that the RTC has 

the authority, under the Federal De 

posit Insurance Act as amended by 

FIRREA, to pre-empt state laws for 

bidding the sale of former thrift 

branches for conversion to branches of 

commercial banks. 

The case arose when the RTC pro 

posed to sell the failed Independence 

Federal Savings Bank of Batesville, 

Arkansas, to Worthern Bank Trust 

Co., Little Rock, with former Inde 

pendence branches to be converted 

into Worthern branches. 

In a similar case in Colorado, the 

U.S. Court of Appeals for the Tenth 

Circuit upheld the RTC in allowing 

banks that acquire failed savings insti 

tutions to operate the acquired offices 

as branches of the acquiring bank, 

notwithstanding any provision of state 

\aw.AB,7/6/90,p.2;7/23,p.9;/0/10,p.4;BBR, 

9110, p. 398; 2118191, p. 309. 

Affordable Housing 

Disposition Program 

The RTC is adopting an Afford 

able Housing Program to implement 

provisions of FIRREA which, among 

other things, require the establish 

ment of a ninety-day marketing pe 

riod for the disposition of eligible res 

idential properties for which the RTC 

has title in its corporate capacity or as 

a receiver. The program is to provide 

homeownership and rental housing 

opportunities for moderate-income, 

lower-income, and very low-income 

families and individuals. The final 

rule is effective August 21, 1990. FR. 

8131190, p. 35564. 

Regional Public Service 

Centers 

The RTC has opened Public Ser 

vice Centers in its four regional offices 

to provide services in each region that 

are similar to the services offered by 

the RTC Reading Room in Washing 

ton, D.C. The centers provide regionspecific, and other publicly available 

information about the RTC, which 

the public can request by telephone, 

mail, or on a walk-in basis. Staff is also 

available to help in solving problems 

that the public has experienced in 

dealing with the RTC. News Re/ease, RTC, 

3/19/9/. 

Federal Reserve Board 

Capital Adequacy Guidelines 

The FRB approved final capital 

leverage guidelines and transitional 

capital standards for state member 

banks and bank holding companies, 

effective September 10, 1990. The 

final guidelines are essentially the 

same as the proposals the FRB issued 

for public comment late last year. 

Bank holding companies and state 

member banks must maintain Tier 1 

capital equal to a minimum of three 

percent of assets. The transitional 

standards permit institutions to com 

ply with existing capital-to-asset ra 

tios until the end of the year, or to 

conform to a risk-based standard to 

become effective January 1, 1991. 

The existing minimum capital ade 

quacy ratios are 5.5 percent primary 

capital, and six percent total capital, to 

total assets. 

For leverage purposes, Tier 1 cap 

ital for state member banks includes 

common equity, minority interests in 

40 
Recent Developments 

equity accounts of consolidated sub 

sidiaries, and qualifying noncumula

tive perpetual preferred stock, less 

goodwill. It excludes other intangi 

bles and investments in subsidiaries 

as determined by the FRB on a caseby-case basis. For bank holding com 

panies, Tier 1 capital consists of 

common equity, minority interests in 

equity accounts of consolidated sub 

sidiaries, and qualifying perpetual 

preferred stock, the latter limited to 

25 percent of Tier 1 capital. PressRekase, 

FRB, 812190; FR, SI10, p. 32828; BBR, 8/13, p. 

250. 

Bank Holding Companies: 

Bank and Nonbank 

Subsidiaries' Transactions 

Interlocks of Officials. The FRB is 

considering allowing director inter 

locks between the nonbank subsidiar 

ies of bank holding companies and 

their bank and thrift affiliates as long 

as the majority of the board of direc 

tors of the securities underwriting 

company would not be composed of 

directors of the affiliated depository 

institutions. The current restrictions 

already allow interlocks between the 

boards of a bank holding company 

and its "Section 20 subsidiary." 

With respect to officer and em 

ployee interlocks, the complete pro 

hibition could be replaced with a 

requirement that the Section 20 sub 

sidiary not be managed or controlled 

by its affiliated banks or thrifts and 

that there not be a substantial identity 

of personnel between the entities. 

Comment also is being sought on 

whether certain specific interlocks 

should be prohibited (for example, 

whether an officer or director of a 

bank or thrift should not be permitted 

to serve as chief executive officer or 

chief financial officer of an affiliated 

securities underwriting company). 

Cross-Marketing. Under the FRB's 

present policy a bank or thrift affiliate 

is prohibited from acting as agent for, 

or engaging in marketing activities on 

behalf of, the Section 20 company. 

The FRB requested comment on 

modifying these restrictions by plac 

ing substantial reliance on disclosure 

requirements that apply to the activi 

ties of Section 20 companies, together 

with provisions of the Glass-Steagall 

Act prohibiting a bank from engaging 

directly in underwriting and dealing 

in securities. Comment is sought par 

ticularly on marketing activities that 

should be limited in order to avoid 

potential conflicts of interest. 

Purchase}Sales of Financial Assets. 

With respect to a bank or thrift's pur 

chase of financial assets from, or sale 

of such assets to its affiliated securi 

ties underwriting company, such 

transactions are currently prohibited, 

except in the case of U.S. Treasury 

securities, or direct obligations of the 

Canadian federal government, that 

are not subject to repurchase or re 

verse repurchase agreements be 

tween the underwriting subsidiary 

and its bank or thrift affiliates. Com 

ment is sought on extending the ex 

emption to those U.S. Government 

agency securities, and U.S. Govern 

ment-sponsored agency securities, for 

which there is a market with a breadth 

and liquidity comparable to that for 

U.S. Treasuries. Press Release, FRB, 713190. 

International Banking 

Operations 

The FRB proposed a number of 

revisions to Regulation K (Interna 

tional Banking Operations) pursuant 

to a requirement of the International 

Banking Act that the FRB review its 

regulations at least every five years to 

ensure that the purposes of the Edge 

Act are currently being served. 

Since 1979, Regulation K has ex 

plicitly authorized foreign subsidiar 

ies of both U.S. banks and bank 

holding companies to underwrite and 

deal in debt and equity securities out 

side the U.S. Among its proposals, the 

FRB would raise the underwriting 

limit on a consolidated basis (parent 

firm and foreign subsidiaries), that is 

applicable to equity securities to the 

lesser of $60 million or 25 percent of 

the investor's Tier 1 capital. The limit 

could exceed $60 million on a caseby-case basis for strongly capitalized 

institutions. The limit on equity secu 

rities of any one issuer held in trading 

or dealing accounts would be raised 

from $15 million to the lesser of $30 

million or ten percent of the investor's 

Tier 1 capital. 

Currently, Regulation K permits 

U.S. banking organizations to under 

write credit life, accident, and health 

insurance abroad. In addition, the 

FRB has granted approval on a caseby-case basis for a number of U.S. 

banking organizations to engage in in 

surance underwriting activities in a 

number of countries. The FRB now 

proposes to add underwriting of life 

insurance and similar types of insur 

ance for which the risks are actuarially 

predictable to the list of permissible 

activities in Regulation K. The gen 

eral authority to engage in life insur 

ance underwriting would be limited 

to subsidiaries of bank holding com 

panies. Press Release, FRB, 811/90. 

Notice of Changes in Senior 

Officials 

The FRB proposed interim 

amendments, pending the adoption 

of final amendments to its Regulation 

Y to implement the provisions of 

F1RREA that require bank holding 

companies and state member banks 

that have recently undergone a 

change in control, or have less than 

minimum required capital or are oth 

erwise in troubled condition, to file a 

notice with the FRB prior to adding a 

member of the board of directors, or 

employing an individual as a senior 

executive officer. This prior notice 

requirement also applies to state 

member banks that have been char 

tered within two years before the pro 

posed management change. The 

FRB may disapprove any proposed 

board member or senior executive of 

ficer whose service is not considered 

to be in the best interests of the de 

positors of the bank or the public. The 

provisions of FIRRE covered in this 

release apply to insured banks, thrift 

institutions, and credit unions. 

lease, FRB, 2114)90, 

41 
FDIC Banking Review 

Appraisal Standards for 

Federally Related 

Transactions 

The FRB adopted amendments to 

its Regulations and Y to implement 

provisions of FIRREA regarding realestate appraisal standards. The 

amendments identified which trans 

actions require an appraiser, set forth 

minimum standards for performing 

appraisals., and distinguish those ap 

praisals requiring the services of a 

state-certified appraiser from those 

requiring a state-licensed appraiser. 

The appraisal standards were effec 

tive August 9, 1990, and the certifica 

tion and licensing requirements 

become effective July 1, 1991. The 

FRB set a threshold level of $100,000 

for real-estate transactions for which 

appraisals must be obtained. Press Re

lease, FRB, 6128190. 

Following the FRB*s publication 

of its rule, concerns were raised about 

whether $100,000 is an appropriate 

level. The federal financial institution 

regulatory agencies other than the 

FRB have adopted a threshold level 

of $50,000. The FRB is now seeking 

comments on whether it should con 

form in its regulatiop to the level 

adopted by the other agencies. The 

FRB also is inviting comments, with 

respect to reducing the threshold 

level from $100,000 to $50,000, con 

cerning the effects on (a) the increase 

in the cost of obtaining appraisals, (b) 

the availability of licensed or certified 

appraisers, and (c) the history of losses 

in this range of transactions resulting 

from inadequate appraisals. FR, 

11126190,p. 49057. 

Banks' Dividend Payments 

The FRB amended its Regulation 

H to clarify the circumstances under 

which state member banks may pay 

dividends and will bring the calcula 

tion of dividend-pay ing capacity more 

closely into line with current regula 

tory reporting standards and generally 

accepted accounting principles 

R, 1/8/91,p.627; 12/26/<>0,p.52982. 

The rule is consistent with a regu 

lation issued by the OCC for national 

banks. 

Investment Brokerage 

Activities 

Under the FRB's interpretive rule 

a bank holding company may not en 

gage in the "sale or distribution" of 

shares of investment companies ad 

vised by the bank holdingcompany or 

one of its nonbank subsidiaries. The 

FRB proposed to modify this rule to 

clarify that a BHG and its nonbank 

subsidiaries may broker shares, solely 

as agent for the account of customers, 

of both open- and closed-end invest 

ment companies that are advised by 

the BHC or any of its bank or nonbank 

Subsidiaries. Press Release, FRB, 6119/90. 

Required Notices under 

Change in Bank Control Act 

The FRB is amending its Regula 

tion Y to remove the current regula 

tory requirement that a person that 

has already received regulatory clear 

ance to acquire ten percent or more of 

the voting shares of a state member 

bank or bank holding company file 

additional notices under the Change 

in Bank Control Act for subsequent 

acquisitions resulting in ownership of 

between ten and 25 percent of the 

shares of the bank or bank holding 

company. This amendment is in 

tended to reduce the regulatory bur 

den without impairing the FRB's 

ability to properly evaluate acquisi 

tions under the CIBC Act. The 

amendment is effective November 9, 

1990. FR, 11/16/90, p. 47843. 

Court Rejects "Source of 

Strength " Policy 

federal appeals court in New Or 

leans ruled that the FRB does not 

have the power to force bank holding 

companies to give assistance to their 

financially troubled subsidiaries. An 

FRB policy, made explicit in regula 

tions in 1984and 1987, required bank 

holding companies to use their assets 

to assist their banking units "during 

periods of financial stress or adver 

sity." The court said the FRB does 

not have the "authority to regulate the 

day-to-day soundness of the subsid 

iary banks," and that the holding 

company's refusal in this case to trans 

fer assets did not constitute an "un 

safe and unsound practice." 

The case involved MGorp, a Dal 

las-based bank holding company, 

concerning actions taken by the FRB 

in the fall of 1988 and in 1989. WSJ, 

5/16/90, p. A2. 

J.P. Morgan Allowed to 

Underwrite Stocks 

The FRB gave approval for J.P. 

Morgan Co. to underwrite and deal 

in stocks through a subsidiary. It is the 

first time since passage of the GlassSteagall Act in 1933 that a banking 

firm has had these powers. 

J.P. Morgan and several other 

BHCs are already engaging in under 

writing and dealing in corporate debt 

securities, having been granted that 

authority by the FRB in January 1989. 

Morgan's newly acquired securi 

ties powers are subject to certain re 

strictions. Not more than ten percent 

of the securities subsidiary's revenues 

may be derived from the underwriting 

of corporate equities, corporate debt, 

commercial paper, securities backed 

by mortgages and consumer debt, and 

municipal bonds. At least 90 percent 

of the subsidiary's revenues must 

come from the underwriting of fed 

eral debt. WSJ, 9/20/90, p. CI; BBR, 10//, p. 

519. 

The FRB granted approval for 

Bankers Trust New York Corp., Ca 

nadian Imperial Bank of Commerce, 

and The Royal Bank of Canada to 

underwrite and deal in equity securi 

ties. The activities will be conducted 

through separate subsidiaries. BBR, 

1/21191,p. 101. 

Court Upholds BHCs' 

Securities Underwriting 

An FRB decision in 1989 permit 

ting five banking companies to en 

gage in securities underwriting 

activities through subsidiaries was up 

held by the U.S. Court of Appeals for 

D.C. In January 1989 the FRB 

42 
Recent Developments 

granted approval for Bankers Trust 

New York Corp., Chase Manhattan 

Corp., Citicorp, J.P. Morgan & Co., 

and Security Pacific Corp. to under 

write and deal in corporate debt, and 

to sell common stock within a year. At 

the time of the decision, FRB officials 

said reviews would begin to ensure 

that the institutions have sufficient 

capital, internal controls and expertise 

before being permitted to begin the 

underwriting activities, and that 

BHCs entering this business must 

have capital that is "substantially 

above" required minimums. In its ap 

proval the FRB specified several re 

strictions on transactions between the 

parent firms, subsidiary banks, and 

the securities and other nonbank sub 

sidiaries. AB, 41U190, p. 1; also see this Review, 

Spring/Summer, 1989, p. 32. 

Banks Can Offer 

Reduced-Rate Credit 

Cards to Affiliates' 

Customers 

The FRB amended its Regulation 

Y to allow banks owned by bank hold 

ing companies to offer a price reduc 

tion on credit cards issued to their 

customers if the customer also obtains 

a traditional banking product from 

any of the credit card bank's affiliates. 

The amendment is effective Decem 

ber 18, 1990. 

Section 106 of the Bank Holding 

Company Act Amendments of 1970 

generally prohibits banks from offer 

ing reduced consideration forcreditor 

other services if that reduction is con 

ditioned on a requirement that the 

customer also obtain some additional 

service from the bank or a holding 

company affiliate of the bank. The 

Section allows the FRB to permit ex 

ceptions that are not contrary to the 

Section's purposes. 

The FRB granted approval for 

Norwest Corporation, Minneapolis, 

and NCNB Corporation, Charlotte, 

North Carolina, to offer reduced-rate 

credit cards to customers of their affil 

iate banks. The grants of exemptions 

were based upon the FRB's analysis 

of the competitiveness of the relevant 

credit card markets. In its approvals 

the FRB retained the right to termi 

nate the exemptions if it was found 

that the arrangements resulted in 

anticompetitive practices. FR, 11/15/90, 

p. 47741; Press Release, FRB, 11/8; 6122. 

Home-Equity Lines of Credit 

The FRB amended its Regulation 

Z, Truth in Lending, relating to 

home-equity loans. The final rule be 

came effective on September 19, 

1990, but compliance is not manda 

tory until October 1, 1991. 

The amendments provide that a 

creditor may stop advancing funds, or 

reduce the credit limit on a home-eq 

uity line of credit, when the interestrate cap is reached, provided that the 

creditor's right to do so was specified 

in the initial agreement. 

It is required that all repayment 

phase disclosures be given to custom 

ers when they receive the application 

for the line of credit. Press Release, FRB, 

9/14190; FR, 11/28, p. 49391. 

Securities Activities 

Permissible for BHCs 

The FRB proposed to amend its 

Regulation Y to add to the regulatory 

list of nonbanking activities generally 

permissible for bank holding compa 

nies certain financial advisory activi 

ties and the provision of full-service 

securities brokerage services. This 

combination of activities is currently 

permitted on a case-by-case basis, the 

FRB having determined that, subject 

to certain restrictions, these activities 

are so closely related to banking as to 

be a proper incident thereto for pur 

poses of the BHC Act. 

The FRB requested comments 

also on whether it is appropriate to 

permit BHCs to provide these discre 

tionary investment services to retail 

customers as well as institutional cus 

tomers. FR, 9/5190, p. 36282; Press Release, 

FRB, 8/30. 

NCNB Permitted to Manage 

RTC Assets 

The FRB granted approval for the 

$69.2 billion NCNB Corp., Charlotte, 

North Carolina, to engage in asset 

management, servicing, and collec 

tion activities for the RTC and the 

FDIC. The services will be provided 

through a Dallas, Texas subsidiary. 

The OCC recently allowed na 

tional banks to manage failed-thrift 

assets for the RTC. 

NCNB will not own the assets 

being managed or serviced under this 

authority, but it is not precluded from 

acquiring institutions whose assets 

have been managed by the subsidiary. 

NCNB agreed to establish proce 

dures to preserve the confidentiality 

of information gained in the manage 

ment process. 

While it has previously granted 

similar asset-management authority, 

the FRB said NCNB will try to make 

those services available to a wider 

range of potential customers. BBR, 

117/9/,p. 9. 

FRB Stops Citicorp 

Delaware Unit's Insurance 

Underwriting 

The FRB ruled that the powers 

granted for state-chartered banks to 

sell and underwrite insurance nation 

wide under a recently enacted Dela 

ware law are in conflict with the BHC 

Act. The FRB ordered a subsidiary of 

Citibank to stop insurance underwrit 

ing, because the insurance unit would 

in effect operate under the state's law 

as a separate nonbank corporate en 

tity. 

The FRB's decision apparently 

does not prevent banks from engag 

ing in such insurance activities in 

other states that permit banks to do so. 

In November 1989, a federal appeals 

court upheld the FRB's contention 

that the latter does not have regula 

tory authority over state-chartered 

bank subsidiaries of bank holding 

companies (see this Review, Fall, 

1989, p. 40). AB, 9/11/90, p. 1; 9/24, p. 18. 

43 
FDIC Banking Revicv 

Approvalfor Foreign BHC 

Control of First Boston 

Corp. 

The FRB permitted CS Holding, 

owner of Credit Suisse, Switzerland's 

third largest bank, to put $300 million 

in equity into The First Boston orga 

nization, increasing the Swiss firm's 

interest in First Boston's parent, CS 

First Boston Inc., to about 60 percent 

from 44.5 percent. Reportedly, it is 

the first time in recent history that a 

foreign firm or a bank has taken a 

majority ownership in a major U.S. 

investment bank. First Boston and CS 

First Boston will be subject to restric 

tions in making acquisitions, mer 

chant-banking, and bridge loans. WSJ, 

iilNIPO.p.Ci. 

Swiss BHC Can Offer 

Non-Financial Futures 

Advice 

The FRB granted approval for 

Swiss Bank Corp., Basle, Switzerland 

to offer investment advice on non-Fi

nancial futures and options through a 

joint venture with a Chicago-based 

limited partnership. The 

partnership's advice-giving activities 

will be limited to SBC-related organi 

zations. The $123.3 billion-asset 

Swiss BHC has several branches and 

agencies in the U.S. 

The FRB previously has permitted 

BHCs to provide investment advice 

to large investors on futures and op 

tions related to bank-eligible securi 

ties, and on certain stock and bond 

indices. 

Concerns were reiterated by the 

FRB about potential advetse aspects 

of joint ventures between BHCs and 

firms involved in securities activities 

not approved for BHCs, such as the 

erosion of the separation of banking 

and commerce, and possibilities of 

conflict of interest. The applicant 

made certain commitments to main 

tain a separation. BBR, WI9t,p. 8. 

Management Interlocks with 

Securities Subsidiary 

Permitted 

The FRB gave approval for a secu 

rities subsidiary of the $2.6 billionasset First Eastern Corp., 

Wilkes-Barre, Pennsylvania, to pro 

vide certain financial advisory and pri 

vate placement services, and in 

addition, allowed the subsidiary to 

have three of seven directors in com 

mon with the parent firm's subsidiary 

banks. The FRB had previously ruled 

that private placement activities con 

ducted directly by a bank do not con 

stitute underwriting or dealing in 

securities. It said also that concerns 

about common control of a bank and 

a securities affiliate "are less signifi 

cant where, as here, the securities af 

filiate is engaged in agency activities 

and where no substantial capital is at 

risk." BBR, 7130190, p. 179. 

Approval for BHC to Acquire 

Community Development 

Organization 

The FRB permitted Luxemburg 

Bancshares, Inc., Luxemburg, Wis 

consin to acquire a small corporation 

which plans to acquire and re-develop 

the only medical clinic in Luxem 

burg, which has a population of about 

1,000. BBRJ1/26190, p. 850. 

Automated Clearing House 

Services 

An action by the FRB will enable 

Visa U.S.A. to offer its automated 

clearing house services nationwide. 

Visa U.S.A. has been offering ACH 

services in some regions since 1987, 

thus providing an alternative to the 

Federal Reserve as a supplier of these 

services. Visa's system, however, has 

faced a difficulty in that only financial 

institutions with accounts at the Fed 

eral Reserve Bank of San Francisco 

could settle Visa-processed clearing 

house transactions directly on their 

reserve accounts. In late October, the 

FRB took action that will allow finan 

cial institutions maintaining accounts 

in any of the 12 Federal Reserve dis 

tricts to settle the Visa transactions 

directly on those accounts. All, fi///i>o, 

p.l. 

Payments System Risk 

Reduction 

As part of its payments system risk 

reduction program, the FRB re 

quested comments on a proposed pol 

icy that would prohibit bankers' 

banks and Edge corporations from in 

curring funds or book-en try overdrafts 

on Fedwire. The Federal Reserve 

Banks would assess a penalty fee 

when these or other institutions with 

imposed zero caps incur inadvertent 

daylight or overnight overdrafts on 

Fedwire. FR,5/3/i90,p.2i086 

Expedited Funds Availability 

Pursuant to provisions of the Expe 

dited Funds Availability Act, the FRB 

proposed an amendment to its Regu 

lation CC to require paying banks to 

provide same-day settlement for 

checks presented by 8 a.m. local time 

at specified locations. The proposal 

would eliminate presentment fees for 

these checks and thereby facilitate 

their collection. FR, 2/6/9/, p. 4743. 

Office of the Comptroller of the 

Currency 

Minimum Capital Ratios 

The OCC amended its capital reg 

ulation to establish a new minimum 

leverage ratio of three percent Tier 1 

capital-to-total assets for the highestrated banks, with an additional cush 

ion of 100-200 basis points for all other 

banks. Existing definitions of primary 

and secondary capital were replaced 

with Tier 1 and Tier 2 capital. 

As amended, the definition of cap 

ital is consistent with capital used in 

the OCC's risk-based capital guide 

lines. These guidelines were pub 

lished in January, 1989. FR, 9121/90, p. 

38191. 

Banks' Payment ofDividends 

The OCC revised and clarified its 

rules, effective December 13,1990, tc 

make the calculation of the dividendpaying capacity of national banks con 

sistent with regulatory reporting and 

GAAP with respect to the treatment 
Recent Developments 

of the allowance for loan and lease 

losses. 

National banks will not be allowed 

co include provision for loan losses as 

a part of income when calculating div 

idend-paying capacity. Also, banks 

must use only capital surplus repre 

senting earnings in the dividend-ca 

pacity calculation. An earnings test 

limits dividend payments to net re 

tained profits for the current period 

plus the previous two calendar years. 

The effective date for applying the 

earnings test is January 1, 1991. A 

bank may pay dividends on preferred 

stock if the payment exceeds net un 

divided profits only after the approval 

of the OCC. FR, 12/13/90, p. 51269; AB, 

12/14,p. 2;BBR, 12/24,p. 10/6, 

Banks May Manage Assets 

forRTC 

The OCC issued an opinion clari 

fying that national banks may provide 

asset-management services to the 

RTC. An official said that contracts 

for providing the service would be 

considered on an individual case 

basis. Among the requirements is that 

an applicant must have strong capital, 

and sufficient trained personnel for 

conducting the activity. Banks would 

need to protect against a conflict of 

interest between the asset-manage 

ment function, which should be per 

formed through a subsidiary, and the 

institution as lender to a purchaser of 

the assets. Also, banks were cautioned 

chat asset-managers might be ex 

posed to liability under the Com 

prehensive Environmental Response, 

Compensation, and Liability Act. ABA 

Bankers Weekly, 11/6190, p. 6;AB, 11/26, p. 8. 

Loan Sales in Farmer Mac 

Program 

The OCC issued a guidance on 

national banks' participation as loan 

sellers in the Federal Agricultural 

Mortgage Corporation (Farmer Mac) 

program. Banks are provided an ex 

planation of the regulatory account 

ing, capital, and legal lending limit 

treatments for three ways a national 

bank might sell loans into the pro 

gram, and important supervisory re 

strictions that apply. RankingC'trcular248, 

10124/90, OCC. 

Securities Brokerage 

Permitted on Bank's 

Premises 

In an interpretive letter, the OCC 

permitted an unaffiliated securities 

broker to conduce business on a na 

tional bank's premises in return for a 

percentage of the gross commissions 

received by the broker. 

Almost all of the securities broker 

age activities would be conducted by 

nonbank employees, and signs would 

give customers clear notice that the 

bank and brokerage are separate. 

The decision follows other OCC 

decisions which have allowed lease 

terms under which the banks receive 

a percentage of the tenant's gross in 

come from business conducted on the 

premises, and have required a similar 

Separation. ABA Bankers Weekly, 1/8/91,p. 7. 

Investment in Commodities 

Contracts 

The OCC granted approval for 

Chase Manhattan Bank co pool in 

vestor money and invest it in com 

modities contracts, on foreign 

currencies, precious metals and finan 

cial futures. 

Commodities funds are used as a 

source of profits and also as a hedge 

for other investments. Chase will be 

the first bank to offer commodities 

pools domestically, but previously has 

invested in several funds offshore. /«

terpntive Letter 541t 3191 tOGC;AB, 3119,p. 1. 

Banks' Selling of Insurance 

Upheld 

The U.S. District Court for the 

District of Columbia upheld a 1986 

decision of the OCC giving approval 

for an insurance-agency subsidiary of 

a national bank located in a small town 

to solicit and sell insurance to custom 

ers anywhere in the country (National 

Association of Life Underwriters v. Rob 

ert L. Clarke and United States National 

Bank of Oregon). 

The National Bank Act allows na 

tional banks located in towns having 

a population of less than 5,000 to act 

as a general insurance agent. The 

issue in chis case was whether the 

activities so permitted are restricted 

in each case to the small town, and the 

Court found no such restriction. The 

Court said that "claims for relief 

should be addressed to Congress; this 

court is the wrong forum." The insur 

ance industry was expected to appeal 

the decision. ABA Rankers Weekly, 5/15/90,p. 

4,AB,5/9,p. I. 

Banks' Power to Sell Debt 

Cancellation Contracts 

Upheld 

The U.S. Supreme Court declined 

to review an appeals court ruling (Tay 

lor v. First National Bank of Eastern 

Arkansas, 11/13/90), thereby uphold 

ing a lower court's decision that a na 

tional bank may sell debt cancellation 

contracts. The circuit court found that 

[he activity does not constitute the 

"business of insurance" under the 

McCarran-FergUvSon Act and there 

fore is not subject to state regulation. 

The OCC, though not a named 

party in the case, argued that the con 

tracts are among national banks' inci 

dental powers under the National 

Bank Act. BBR, n/19/90,p. 824. 

Branching Ruling Upheld 

A federal appeals court upheld an 

OCC ruling allowing national banks 

in Missouri to branch outside their 

home county, even though state-char

cered banks in the state are not per 

mitted out-of-county branching 

(Independent Bankers Association of America v. 

OCC, 10/29/90). 

State-chartered thrifts in Missouri 

are allowed to branch statewide. The 

OCC, concluding that thrifts in the 

state, as a practical matter, were con 

ducting a banking business, acted 

under a provision of the McFadden 

Act which permits national banks to 

branch anywhere that state banks can 

branch. 

The case arose from an application 

in 1987 by First National Bank & 

Trust Co. of Columbia, Missouri co 

establish two branches outside its 

45 
FDfC Ranking Review 

home county. BBR, 11112190, p. 790; ABA 

Hankers Weekly, !W3,p.4. 

Examination Schedule 

Changes 

The OCC proposed revising its 

schedule of examinations to eliminate 

die current requirement for at least 

two examinations per year of every 

national bank. It would allow the 

agency to schedule examinations as it 

deems necessary. ABA Bankers Weekly, 

8121190, p. 4. 

Agricultural Lending 

Practices Study 

Tn response to the agricultural re 

cession in the early 1980s, banks made 

major changes in their lending pro 

cesses, this report notes, including 

tightening their underwriting stan 

dards, and improving credit analyses 

and credit administration procedures. 

The results of a recent survey, how 

ever, raise "serious concerns." 

The OCC analyzed the practices 

used by 47 national banks, represent 

ing a statistical sample of all commu 

nity banks in the Midwestern District 

that have 25 percent or more of their 

loans in agricultural loans. 

It was found that many lack the 

underwriting standards necessary to 

thoroughly assess and control accept 

able risks for the loan portfolio. Some 

of the weaknesses in these respects 

are similar to the deficiencies that 

caused large loan losses experienced 

by agricultural community banks in 

the late 1970s and early 1980s, the 

study says. 

"Pronounced weaknesses" are 

common in the analysis of customer 

profitability, repayment capacity and 

efficiency- Most banks do not prop 

erly evaluate those performance indi 

cators, and the banks that do 

frequently lack the internal standards 

for proper use of the information. 

Also, improvements are needed in the 

methods used to assess the reliability 

of cash flow and accrual income infor 

mation. It was found that banks too 

frequently depend on income tax re 

turns; this information tends to be in 

adequate for these purposes and can 

distort analysis of a borrower's finan 

cial position and progress. 

Several weaknesses were identi 

fied in loan administration. Thirteen 

percent of the banks lacked written 

policies for agricultural loans, and 

many do not have guidelines for man 

aging Concentrations Of Credit. Agricul 

tural Loan Underwriting Study, OCC, April 1990. 

Office of Thrift Supervision 

Policy on Dividends, Other 

Capital Distributions 

The OTS announced a new rule 

under which well-capitalized and 

well-managed savings associations 

will find it easier to pay dividends or 

make other capital distributions. 

while troubled institutions will have 

limits on their capital distributions. 

The same standards will apply to 

all types of capital distributions, in 

cluding dividends, stock repurchases 

and cash-out mergers. Associations 

that meet their fully phased-in capital 

requirements established under 

FIRREA and require only normal 

OTS supervision can distribute up to 

100 percent of net income earned to 

date during the calendar year plus 50 

percent of their capital surplus (the 

amount of capital over their fully 

phased-in capital requirement) with 

out OTS prior approval. Institutions 

that meet current capital require 

ments can distribute, without prior 

OTS permission, from 25 to 75 per 

cent of their current earnings, de 

pending upon the extent they are 

meeting their fully phased-in capital 

requirements. Institutions that fail to 

meet current capital requirements are 

prohibited from making any capital 

distribution without prior written ap 

proval from OTS. NEWS, OTS, 6125/90. 

Interest-Rate Risk 

Component of Capital 

The OTS issued a description of 

proposed methodologies for calculat 

ing an interest-rate risk component to 

ensure that savings associations main 

tain levels of capital con >ensurate 

with the degree of interest-rate risk to 

which they are exposed. Minimum 

risk-based capital requirements were 

announced by the OTS in November 

1989. 

The proposal would require a sav 

ings association to hold capital against 

interest-rate exposure in an amount 

equal to 50 percent of the estimated 

decline in the market value of its port 

folio equity that would result from an 

immediate 200 basis point increase or 

decrease in interest rates. Portfolio 

equity is defined as the aggregate net 

market value of assets, liabilities, and 

off-balance-sheet items. FR, 12131190,p. 

53529;3115191,p. UII5. 

Loans to One Borrower 

The OTS adopted a regulation 

that permits savings institutions that 

meet their fully phased-in capital re 

quirements, and are not of supervi 

sory concern, a transition period until 

December 31, 1991 before they must 

comply with a general 15 percent 

loans-to-one-borrower limit. That 

limit resulted from passage of 

FJRREA. About 1,100 savings insti 

tutions qualified for the transition rule 

as of mid-1990. Through 1990, 

healthy thrifts can grant new loans of 

up to 60 percent of their unimpaired 

capital and unimpaired surplus to one 

borrower for development of domes 

tic residential housing. The transition 

limit drops to 30 percent after Decem 

ber 31, 1990, and 15 percent begin

ningjanuary 1, 1992. 

Generally, new commercial loans 

must conform to the permanent 15 

percent limit, but qualifying thrifts 

can use the higher transition limits to 

continue funding loans that were 

made before enactment of FIRREA 

in August 1989. Such preexisting 

loans can be for either residential or 

nonresidential projects. AH loans 

made under the transition rule must 

be secured by first liens on real prop 

erty, and meet other specified criteria. 

Thrifts that do not qualify under 

the transition rule must continue to 

fully conform to the national bank 

lending limits imposed by FIRREA 

and embodied in a March 1990 OTS 
Recent Developments 

regulation. Generally, the limit is 15 

percent of a thrift institution's unim 

paired capital and unimpaired sur 

plus, or $500,000, whichever is higher. 

Before FIRREA, thrifts could lend up 

to 100 percent of their regulatory cap 

ital to one borrower. NEWS, OTS, 7/2/90 

Notification of Changes in 

Senior Officials 

The OTS is requiring insured sav 

ings associations and thrift holding 

companies to notify the agency prior 

to adding or replacing a director or 

senior executive officer, if the institu 

tion has been chartered less than two 

years in the case of an insured institu 

tion, has undergone a change in con 

trol within the preceding two years, is 

not in compliance with its minimum 

capital requirement or is otherwise in 

"troubled condition," as determined 

from the institution's most recent Re 

port of Condition or examination. 

The notice must be received by the 

OTS District Office at least 30 days 

before the effective date of the addi 

tion, hiring or promotion. 

The action was taken pursuant to a 

provision of FIRREA which requires 

certain depository institutions or their 

holding companies to provide such 

notifications to their regulatory agen 

cies. The agency may, in certain cir 

cumstances, disapprove the proposed 

changes in officials. Thrift Bulletin 45, OTS, 

4/25190. 

Securities-Selling in 

Deposit-Taking Offices 

The OTS proposed a regulation 

that would prohibit a savings institu 

tion from selling its own debt securi 

ties or those of its corporate affiliates 

on premises where it also accepts in 

sured deposits from the public. The 

selling of equity securities would 

have to comply with several safe 

guards, including a requirement that 

buyers be informed that such securi 

ties are not federally insured. 

Like the current rules, the pro 

posed regulation would prohibit a sav 

ings association from paying any 

commissions to employees who sell 

equity securities, and such securities 

sales could not be made by tellers at 

teller counters. Selling areas for eq 

uity securities would have to be phys 

ically segregated from areas where 

tellers take deposits. The specified 

safeguards notwithstanding, com 

ments were solicited also on whether 

the selling ban should be extended to 

include equity as well as debt securi 

ties. 

The proposed regulation does not 

affect the current rule under which a 

savings association, with OTS ap 

proval, can lease segregated and 

clearly identified parts of its facilities 

to the association's service corpora 

tion to use in selling various securities 

directly or through a joint venture 

with an affiliated discount brokerage 

firm. NEWS, OTS, 513190. 

Appraisals 

The OTS adopted a final rule, sim 

ilar to regulations being issued by 

other federal financial institutions 

regulatory agencies, implementing 

Title XI of FIRREA. Among its pro 

visions the regulation identifies 

which ttansactions require an ap 

praiser, sets forth minimum standards 

for performing appraisals, and dis 

tinguishes those appraisals requiring 

the services of a state-certified ap 

praiser from those requiring a state-li 

censed appraiser. Effective August 

23, \990.FR, 8/23/90, p. 34533. 

Thrift Conversions Directly 

to Banks Permitted 

The OTS issued a legal opinion 

stating that direct conversion of thrifts 

into national banks is permitted by 

the Home Owners Loan Act as 

amended in 1989 by FIRREA. Here 

tofore these conversions were allowed 

to be done only through indirect, 

three-step procedures. While the 

OTS action should facilitate the con 

versions, industry officials said it 

would be much easier at present for 

the relatively new and small thrifts to 

convert. Institutions would be subject 

to taxation on accumulated loan-loss 

reserves should they become banks. 

ABA BanimWedrfy, 11120/90,p.3.;BBR, 1///9, 

p. 816. 

New Approach to 

Supervisory Conversions 

In an order in which Shadow Lawn 

Savings Bank, SLA, Long Branch, 

New Jersey, converted from mutual 

to stock form, and subsequently was 

purchased by Rochester Community 

Savings Bank, Rochester, New York, 

the OTS signaled a new approach to 

resolving the problems of basically 

healthy but significantly undercapi 

talized mutual institutions. 

The method is designed to give 

OTS a truer picture of a troubled 

institution's financial condition by 

sliminatinggoodwill from the calcula 

tion of whether an institution quali 

fies for supervisory conversion. In 

effect, faltering mutual institutions 

now can attract capital sooner, before 

they become hopelessly insolvent. 

Under the old system, weak mutual 

thrifts seeking capital from acquirers 

had to wait before being eligible for 

supervisory conversion until they 

were insolvent accotding to GAAP, 

which permits a thrift to record assets 

at cost and defines goodwill as an 

asset. By the time institutions were 

GAAP- insolvent, they often held lit 

tle or no value for potential acquirers. 

The new approach also is in line 

with FIRREA, which limits and ulti 

mately phases ou t good will as an asset 

in the calculation of tegulatory capital. 

NEWS, OTS, 3/28/90. 

Courts Rule on Goodwill 

Writedown Agreement, 

Forbearance 

A U.S. claims court judge ruled 

that a requirement of FIRREA that 

supervisory goodwill be removed 

from thrifts' capital accounts by 1994 

violates a preexisting contract allow 

ing the writedown of goodwill over a 

35-year period. Winstar Corp., a Min 

nesota company, brought the case on 

behalf of a subsidiary, United Federal 

Savings and Loan Association, which 

was taken over by regulators last May. 

47 
FDIC Banking Review 

It is thought that the government 

will appeal if the court awards money 

damages. If the decision is upheld, 

the government could be exposed to 

hundreds of lawsuits and billions of 

dollars in claims. 

The judge said the thrift owners 

relied on memoranda from the Fed 

eral Home Loan Bank Board which 

promised a long amortization period, 

and that they had presented "undis 

puted evidence" that a contract did 

exist. He rejected the government's 

position that the memoranda "merely 

wcte representations of then-existing 

regulatory policy." He said that while 

Congress remains free to change the 

regulatory treatment of supervisory 

goodwill, "the government may be 

compelled to pay for the results of its 

actions, especially when in so doing 

the government actually is paying be 

cause it received a benefit." AB, 8/9/90, 

p. I. 

A U.S. district court judge in Geor 

gia ordered the OTS to comply with a 

1987 forbearance agreement, and is 

sued a preliminary injunction against 

efforts by the agency to force an insol 

vent thrift to agree to its merger and 

sale by the OTS (Guaranty Financial 

Services, Inc. v. OTS, 8/10/90). The 

court also blocked the agency's at 

tempt to not honor an agreement al 

lowing the thrift to amortize 

supervisory goodwill over 25 years. 

ERR, 8121190, p. 346. 

The U.S. Court of Appeals for the 

Sixth Circuit ruled that a forbearance 

agreement in 1988 between Franklin 

Federal Savings Bank and the Fed 

eral Home Loan Bank Board is not 

binding upon OTS (Franklin FSB v, 

OTS, 3/12/91). The court held that 

F1RREA abrogates such agreements. 

BBR, 3/18/91, p. 520. 

Disclosure of Reports of 

Condition 

The OTS will make available to 

the public all information, except for 

three categories, it collects in the 

Thrift Financial Report from the sav 

ings associations it supervises. Data 

proprietary to the regulatory process 

will not be released, the OTS said, 

because to do so would increase the 

incentive for inaccurate reporting of 

this information. This category in 

cludes classified assets, specific valu 

ation allowances, fair value of assets 

repossessed, and loans 30-89 days 

overdue but still accruing interest. 

Restrictions are placed on disclo 

sure of maturity/re pricing/rate infor 

mation used to measure interest-rate 

risk. Collecting of this information is 

currently being expanded and en 

hanced, and meanwhile, if fully dis 

closed the data could be mislead ing to 

the public. Upon completion of the 

enhancement program, expected to 

occur in early 1991, the disclosure will 

be expanded. Finally, data reported 

monthly, except balances fur end-of

quarter months, will not be disclosed 

at this time. These data are subject to 

such a large degree of variability as to 

be potentially misleading for analysis 

purposes on a month-by-month basis. 

FR, 8/7/90, p. 32168. 

Thrifts' Release of Customer 

Records 

The OTS removed a rule issued by 

the Federal Home Loan Bank Board, 

effective December 15,1989, that au 

thorized federally chartered savings 

associations to disclose, unless the 

customer objected in writing, 

customers' names and addresses to 

any party. The agency plans to pro 

pose a new regulation. FR, 8111/89, p. 

33859; 8/24/90, p. 34698. 

Forming Mutual Holding 

Companies 

The OTS proposed a regulation 

describing the procedure and criteria 

for forming a federal mutual holding 

company, as authorized under the 

Competitive Equality Banking Act of 

1987. 

The proposed regulation is similar 

in many respects to those already in 

effect for a federally chartered savings 

association to convert from mutual to 

the stock form of organization. In this 

case a savings association would be 

permitted to operate within a holding 

company structure while retaining 

the advantages of mutual ownership. 

FR,/// It'll.p. I!'26; Regulatory Update, National 

Council tij Savings Institutions, 1/26. 

Court Protects Regulators' 

Decision-Making Process 

A U.S. court of appeals in Rich 

mond, Virginia, vacating a lower-court 

contempt citation against M. Danny 

Wall, former Director of the OTS, 

ruled that government officials do not 

have to explain the mental process by 

which they reach decisions. The case 

arose from the government takeover 

of Franklin Savings Association, Ot 

tawa, Kansas, in 1990. The appeals 

court cited a long history of court de 

cisions, dating from a 1941 Supreme 

Court ruling, that have held that, ab 

sent "extraordinary circumstances," a 

government decision-maker will not 

be compelled to testify about his 

mental processes in reaching a deci 

sion, "including the manner and ex 

tent of his study of the record and his 

consultations with subordinates. 

NEWS, OTS, 1/11/91. 

Federal Financial Institutions 

Examination Council 

Policy Statement on 

Practices Relating to 

Securities 

The five member agencies pro 

posed to revise the FFIEC's policy on 

selection of securities dealers and on 

unsuitable investment practices. The 

proposal addresses the selection of se 

curities dealers, requires depository 

institutions to establish prudent poli 

cies and sttategies for securities trans 

actions, defines securities-trading or 

sales practices that are viewed by the 

agencies as being unsuitable when 

conducted in an investment portfolio, 

indicates characteristics of loans held 

for sale or trading, and denotes certain 

types of securities with volatile price 

or other high-risk characteristics that 

are generally not suitable investments 

for depositor institutions. 

It is required that managements of 

depository institutions have sufficient 

knowledge about the securities firms, 

48 
Recent Developments 

and personnel with whom they are 

doing business in order to conduct 

safe-and-sound securities transac 

tions. Boards of Directors should ap 

prove the securities portfolio policy 

and review management's strategies 

and activities on at least a quarterly 

basis for consistency with portfolio 

policy. 

Boards of Directors would be re 

quired to document approval of the 

overall portfolio policy, and manage 

ment would have to document its 

strategies for significant portfolios. 

Securities holdings that do not 

meet the supervisory reporting cri 

teria for either investment or trading 

portfolios would be reported as held 

for sale. The latter must be reported 

at the lower of cost or market value. 

Several criteria are added to the regu 

lation for determining whether secu 

rities that are held for investment are. 

in reality, held for sale or trading. 

Certain specific unsuitable invest 

ment practices are identified in the 

additions to the regulation. Also 

added are certain securities whose ac 

quisition would receive increased reg

ulatory attention and may be 

considered unsuitable. FR, 113/91,p. 263. 

State Licensing of 

Real-Estate Appraisers 

The FFIEC issued advisories on 

state criteria for licensing of real-es 

tate appraisers. 

As authorized by Title XI of 

FIRREA, the FFIEC earlier released 

guidelines for state certification and 

licensing of real-estate appraisers (see 

this Review, Fall 1990, p. 45). 

The advisories state that accept 

able standards should continue to in 

clude meaningful but not overly 

restrictive education, experience and 

testing requirements. This may in 

clude permitting either the education 

or experience requirements to be met 

after passing a licensing test. 

All persons should be required to 

pass a meaningful written test before 

they are licensed to perform apprais 

als for federally related real-estate 

transactions. The Appraisal Subcom 

mittee believes that standards issued 

by the Appraiser Qualification Board 

(AQB) of the Appraisal Foundation 

represent a useful guide to the states 

in establishing examination require 

ments. 

An experience requirement of 

2,000 hours is a reasonable standard to 

ensure that licensed individuals have 

sufficient practical experience. A 

state, consistent with Title XI, might 

well recognize real-estate-related ex 

perience such as that of a real-estate 

lending officer or a real-estate broker 

as being acceptable for some or all of 

the experience requirement, if such 

experience has included the actual 

performance or professional review of 

real-estate appraisals. 

The education requirement of the 

AQB for the "residential real property 

appraiser" is 75 classroom hours in 

certain specific subjects. The Sub 

committee believes that 75 hours is a 

reasonable minimum educational re 

quirement for licensed appraisers, es 

pecially in light of the potential for 

transitional provisions permitting it to 

be satisfied for a period of up to two 

years after obtaining a license. Consis 

tent with the AQB criteria, the educa 

tional requirement should be fulfilled 

in actual classroom time rather than 

through home study and correspon 

dence courses. FFIEC Press Release, 

11/28190; Advisory, Appraisal Subcommittee of 

FFIEC, 90-1, SIS; 90-2,11/28. 

Return of Loans to Accrual 

Status 

The FFIEC requested comments 

on a proposal by the four federal bank 

and thrift supervisory agencies for an 

accounting change, applicable to the 

institutions which they supervise, for 

returning a partially charged off loan 

that has been on nonaccrual status to 

accrual status, without first recovering 

the partial charge-off or becoming 

fully current in accordance with the 

contractual loan terms. Among the is 

sues for comment are whether the 

proposal is consistent with GAAP and 

whether it should apply only to cer 

tain loans on a selective basis. Press 

Release, FFIEC, 3/14191 . 

Treatment ofAsset Sales 

with Recourse 

The FFIEC requested comments 

on asset sales with recourse, in partic 

ular on how "recourse arrangement" 

should be defined and how the sales 

should be reported. 

Traditionally, recourse has re 

ferred to the seller's retention of some 

credit risk in asset sales, but increas 

ingly sellers are extending loss cover 

age to other types of risk, such as 

interest-rate risk, prepayment risk, 

foreign-exchange risk, and liquidity 

or marketability risks. 

Comments were requested also on 

how the amount of capital required to 

support recourse arrangements 

should be determined, and how re 

course arrangements should be 

treated for lending limit purposes. 

FIL-41-90, FFIEC, 7/6; BBR, 7/2/90, p. 4. 

Home Mortgage Disclosure 

Act Reports 

The FFIEC approved a new for 

mat for the Home Mortgage Disclo 

sure Act (HMDA) required 

statements for individual lenders and 

for the aggregate HMDA reports for 

each Metropolitan Statistical Area in 

the United States. The Council also 

approved the public release of edited 

raw data for the loan and application 

registers that lenders are required to 

prepare beginning with the data for 

1990. 

The Council's actions are in re 

sponse to amendments to HMDA 

contained in FIRREA. Among other 

requirements, the amendments ex 

panded the coverage of HMDA to 

include lenders that are not affiliated 

with depository institutions or their 

holding companies, required the re 

porting of data on the disposition of all 

applications for home-purchase and 

home-improvement loans, and re 

quired the reporting of data on the 

race or national origin, gender and in 

come of loan applicants and borrow 

ers. Press Release, FFIEC, 7/2/90. 

49 
FDIC Banking Review 

National Credit Union 

Administration 

Approval Requiredfor 

Change in CU Officers, 

Directors 

The NCUA issued rule changes to 

implement a section of FIRREA 

which requites that an insured credit 

union that has been chartered less 

than two years or is in troubled condi 

tion to notify NCUA at least 30 days 

prior to the addition of any individual 

to the board of directors or a commit 

tee or the employment of any individ 

ual as a senior executive officer. 

NCUA may disapprove any change 

that it determines not to be in the best 

interests of the members of the credit 

union or the public. A process for ap 

pealing an adverse NCUA decision is 

included in the rule. Effective No 

vember 26, 1990. FR, 10l26l90,p. 43084. 

Member Business Loans 

The NCUA proposed additional 

requirements on credit unions in 

volved with business lending. 

One of the changes being proposed 

would limit credit unions to financing 

no more than 80 percent of the value 

of the security for a loan. Another 

would lower the maximum member 

business loan to any one borrower 

from 20 percent of reserves to ten 

percent. 

Federally insured credit unions 

held less than $800 million in com 

mercial loans in mid-1986, when the 

NCUA began collecting data on such 

lending; however, four years later the 

total had grown by 78 percent to $1.4 

billion. About 7 percent of federally 

insured credit unions (895) are cur 

rently engaged in some form of busi 

ness lending to their members. For 

these institutions, business loans rep 

resent an average of 3.7 percent of 

assets. It is noted that in the five larg 

est failures of member credit unions 

in each region during 1990, commer 

cial lending was a factor in 16 of the 

30 cases. FR, 1124/91, p. 2123. 

CU Investments 

The NCUA proposed to prohibit, 

with respect to federal credit unions, 

certain investments that expose the 

institutions to an inordinate degree of 

interest-rate risk, including cerrtiin 

mortgage derivative products, such as 

Stripped Mortgage-Backed Securities 

(SMBSs)and residual interests inCol

lateralized Mortgage Obligations 

(CMOs) or Real Estate Mortgage In 

vestment Conduits (REMICs). 

(NCUA has previously determined 

that SMBSs are unsuitable invest 

ments for the vast majority of credit 

unions.) Federal CUs holding any of 

these high-risk investments would be 

required to dispose of the investment 

within one year unless a longer period 

is approved by NCUA in writing. FR, 

3121191, p. 11944. 

Approvalfor CU 

AssetlLiability Acquisitions 

The NCUA proposed to require 

any credit union whose accounts are 

insured by the National Credit Union 

Share Insurance Fund (NCCSIF) to 

have the NCUA's approval before ac 

quiring loans or othet investment as 

sets or assuming or receiving any 

assignment of shares or liabilities of 

any credit union not insured by 

NCUSIF, of any other depository in 

stitution, of any successor in interest 

to either such institution, or of any 

NCUSIF-insured credit union not in 

liquidation. Certain asset acquisitions 

would not be subject to the approval 

process. FR, 11/26/90, p. 49059. 

Restriction on Sale of 

Uninsured Shares 

The NCUA proposed that feder 

ally insured state-chartered credit 

unions, as a condition of federal share 

insurance, be prohibited from offer 

ing uninsured shares. The ban would 

not apply to shares that are uninsured 

solely because the amount is in excess 

of the maximum insurance coverage. 

The NCUA said that as many as 

thirteen states may authorize statechartered credit unions to offer "unin 

sured membership shares." These 

shares are at risk to the member and 

are intended to serve as a form of 

capital for the credit union. It was 

noted further that while the agency is 

aware of only four federally insured 

state-chartered credit unions that 

presently offer this type of account, 

additional credit unions recently have 

indicated that they are considering of 

fering uninsured membership shares. 

Proposed Rules trnd Regulations, NCUA, 5110/90. 

State Legislation and 

Regulation 

Banks' Insurance Powers 

De/aware: A new law extends the 

power to underwrite and sell insur 

ance nationwide to about 40 moneycenter and regional banks that have 

opened state-chartered affiliates in 

Delaware since enactment in 1981 of 

an economic development law. Many 

of the banks chartered in the state 

years ago already had the insurance 

power. 

The insurance operations must be 

conducted through separate divisions 

or subsidiaries. Asssets, liabilities and 

records of the insurance units must be 

kept separate from those of the bank. 

Investment in such insurance opera 

tions is limited to 25 percent of the 

bank's total capital, surplus and undi 

vided profits. 

A companion law places restric 

tions on banks' marketing of insur 

ance in Delaware. Selling ro Delaware 

residents is limited to direct mail, gen 

erally to credit card customers. WSJ, 

5/3!190,p. AI6.AB, 5131,p. 2. 

Illinois: New legislation allows a 

state bank to own and opetate a sub 

sidiary for selling insurance pursuant 

to the state's insurance statutes. 

Banks are nor allowed to establish an 

insurance agency — they must con 

duct this business through acquisition 

of an existing insurance agency, or sell 

through an agency, that has existed for 

at least a year. The insurance 

subsidiary's employees must be li 

censed as insurance producers. A 

number of consumer safeguards are 

provided, including that employees of 

the insurance subsidiary are prohib

50 
Recent Developments 

ited from both making loans on behalf 

of the bank and soliciting or transact 

ing the sale of insurance to the same 

bank customer. Illinois Banker, 9190, p. 19. 

North Dakota: The state Banking 

Board authorized state-chartered 

banks to sell annuities, subject to the 

state's securities laws and subject also 

to the same restrictions and disclo 

sures that are required by theOCC for 

national banks. Customers must be 

informed that the annuity is a product 

of an insurance company, nor of the 

bank, and that it is not federally in 

sured. Northwestern Financial Review, 7/14190. 

p. 43. 

Virginia: State-chartered banks, 

thrifts, and credit unions could sell, 

but not underwrite, insurance 

throughout the state under a bill 

signed by the governor. 

Many banks in the state already 

may legally sell insurance. These in 

clude four major banks having this 

authority under grandfather provis 

ions of the Garn-St Germain Act of 

1982 and state laws. About 50-60 

banks can sell insurance products 

under a state law that permits this 

activity in towns having a population 

of 5,000 or less. Approximately 20 na 

tional banks have this power under a 

similar provision in federal banking 

law. If approved by the Governor, the 

legislation would become effective on 

July I, 1991. BBR, i(28(9i,p. 144. 

Washington: State bank regulators 

are now permitting banks having an 

office in a town with a population of 

5,000 or less to sell insurance through 

out the state. It is no longer required 

that, to have this power, a bank's head 

office be SO located. The State Bank Regula 

tor, 111 I WO, p. 7. 

Savings Institution Charters 

and Conversions 

Alabama: New legislation permits 

state- and federally chartered S&Ls 

and savings banks to convert to statechartered banks with the approval of 

the Superintendent of Banks. ELSS, 

2(12191. 

Florida: Mercantile Bank, a $90

million institution with offices in St. 

Petersburg and Tierra Verde, con 

verted from a federal savings bank to 

a commercial bank, under provisions 

of FIRREA. Officials said it was the 

first such conversion involving an in 

dependent thrift in the Southeast. 

Southern Hanker. Jit/yfAngusff90'.p. 28. 

Illinois: A new law provides for the 

chartering of savings banks by the 

state. With the new charter a savings 

bank is not subject to certain business 

and supervisory restrictions applica 

ble to savings associations, and does 

not need to meet the QTL test in 

FIRREA in order to maintain its tax 

bad debt reserve. Illinois Danker, 8190. p. 4: 

BBR. 8(20, p. 296. 

Louisiana: Federal and state-char 

tered S&Ls are permitted under a 

new law to convert to a state savings 

bank charter. A moratorium on these 

charters will be in effect until Sep 

tember 1991. Vie State Bank Regulator. 

1119190, p. 6. 

New Jersey: Recently enacted legis 

lation permits state-chartered S&Ls 

that meet federal minimum capital 

requirements to convert to state sav 

ings banks. About 40 of 86 state S&Ls 

would qualify under the six percent 

capital requirement, and the same 

number would qualify under another 

provision of the law specifying three 

to six percent minimum capital for a 

state S&L to convert for the purpose 

of merging with a state savings bank 

which meets the higher requirement. 

Approximately 20 states now per 

mit state-chartered S&Ls to convert 

to state savings bank charters. BBR. 

3/4(91.p.4H;AB.3H.p.2. 

North Carolina: Under new legisla 

tion the State Banking Commission 

may approve the conversion of S&Ls 

to state-chartered banks. The law re 

quires that such a conversion be ex 

pected to result in improved services 

to the public, and that the thrift be in 

sound condition. A mutual savings as 

sociation must first convert to a stock 

association in order to apply for con 

version to a bank. BBR, 816/90,p. 229. 

Closed Institution's 

Depositors to Receive 

Payments 

RJtodeIslana'/The Depositors Eco 

nomic Protection Corp. was created 

under a recently enacted law to liqui 

date the assets of institutions closed 

earlier whose deposits were not feder 

ally insured. On January 1 the Gover 

nor closed 45 credit unions and banks 

whose deposit accounts were insured 

by the failed Rhode Island Share and 

Depository Indemnity Corp. As of 

late January, 14 of these institutions, 

not having obtained federal deposit 

insurance, remained closed. About 

350,000 accounts remained frozen, 

with $1.3 billion in deposits. 

Depositors will be paid their de 

posits in full up to $100,000 over a 

specified period of time. Repayment 

of each additional $100,000 incre 

ment up to $500,000 will be reduced 

by 10 percent, and the amount over 

$500,000 will be 50 percent repaid. 

The payments will be financed in part 

by a $150 million bond issue, and by 

the sale of the failed institutions' as 

sets, 

Regulators are said to be taking 

steps to bring more credit unions in 

other states under federal deposit in 

surance. Twenty states permit the use 

of private insurance by some statechartered credit unions. An estimated 

$17 to $20 billion is held in these 

privately insured accounts, represent 

ing eight to ten percent of all credit 

union deposits. VSJ.?llli9l,p.A4; 1129.p. 

C27: 112, p. A3: BBR. 1/28, p. 143; 2118. p. .305; 

AB, 1122, p. I. 

Intrastate Banking 

Alabama: A statutory amendment 

permits a bank that is a subsidiary or 

an affiliate of a holding company to 

accept deposits and payments on ob 

ligations as agent for other banks in 

the state that are subsidiaries or affil 

iates of the same BHC. Effective 

3/29/90- EI.SS. 2112/91. 

Illinois: The Governor signed leg 

islation, effective August 15, 1990, 

that allows a state or national bank in 

51 
FDJC Banking Review 

Illinois to establish ten full-service 

branches in its home county, an addi 

tional five in each contiguous county, 

and five in any non-contiguous 

county, but located not more than ten 

miles from the bank's main office. 

Under prior law, banks in Illinois were 

allowed a total of only five full-service 

branches. 

The amendments reduce homeoffice protection in counties having a 

population of 250,000 or more, where 

branching will be prohibited within 

200 yards from another bank's head 

office. Illinois Banker, 10190, p. 8. 

Mississippi: A new law permitting 

the operation of multibank holding 

companies in the state was scheduled 

to go into effect on July 1,1990. BHCs 

are prohibited from acquiring any 

shares of any Mississippi bank that 

has not operated for at least five years, 

with some exceptions, one of which is 

the acquisition of shares of a bank the 

total of which before the acquisition 

were more-than-fifty percent owned 

by the acquiring company. BBR, 4/9/90, 

p. 613. 

Nebraska: New legislation allows 

banks in the state to acquire the 

branches of failed or undercapitalized 

S&Ls. An official said that under the 

law such a branch could be transferred 

before an undercapitalized S&L is ac 

tually declared insolvent. ABA Banters 

Weekly, 5/22/90, p. 6. 

Oklahoma: A branching law 

amendment restricts state-chartered 

thrifts to the same branching rights as 

state banks to avoid the type of 

challenge to the state's branching 

laws that occurred in Mississippi and 

elsewhere. While banks in Missis 

sippi did not have statewide branch 

ing authority, the Comptroller of the 

Currency ruled under the McFadden 

Act that national banks in the state 

could branch statewide, on the 

grounds that thrifts, which could 

branch statewide, were operating es 

sentially as banks. Oklahoma Banker, 8/90, 

p.P. 

Banks are permitted under new 

legislation to acquire savings banks 

and S&Ls and operate them as 

branches anywhere in the state. The 

State Bank Regulator, 9/9/90, p. 7. 

Tennessee: New legislation permits 

state banks and savings institutions to 

establish and maintain branches any 

where in the State. Vie State Bank Regulator, 

11/9/90, p. 6; ELSS, 2/12/9L 

Wisconsin: The Governor signed 

legislation that makes permanent the 

changes made last year in the state's 

law that permits banks to open 

branches without geographic restric 

tions, establish joint branch banks, 

offer each other's customers financial 

services, and operate courier services. 

BBR, 3/26/90, p. 530. 

Interstate Banking 

Connecticut: A new law permits na 

tionwide reciprocal banking, effective 

January, 1992. Out-of-state institu 

tions cannot enter through de novo of 

fices until February 1, 1992. Under 

prior law only banks in New England 

were allowed entry into the state. BBR, 

3/19/90, p. 481. 

Delaware: The state's nationwide 

interstate banking law for commercial 

and savings banks became effective 

on June 30,1990. Out-of-state holding 

companies can acquire Delaware 

banks that have been in existence at 

least five years, if the target institution 

has not elected to remove itself from 

being open to acquisition. Banking Legis 

lation ana1 Policy, Federal Reserve Bank of Phila 

delphia, April-June, 1990, p. 6. 

Kansas: A regional, reciprocal in 

terstate banking law was enacted. Ef 

fective July 1, 1992, bank holding 

companies based in Arkansas, Colo 

rado, Iowa, Missouri, Nebraska, and 

Oklahoma are allowed to acquire 

Kansas banks or BHCs if the home 

state of the acquirer has a similar law. 

BBR, 3125/91, p. 556. 

Massachusetts: The Governor 

signed a law on July 6 that permits 

banking firms outside New England 

to purchase Massachusetts banks or 

open offices in the state, effective 60 

days after the signing. Previously, fi 

nancial institutions outside the region 

were prohibited from taking deposits, 

acquiring banks, or opening branches 

in Massachusetts. The state's banks 

are allowed to "opt out" of the inter 

state provision until July 1, 1992. 

Banks and bank holding companies, 

both out-of-state and intrastate, are 

limited by a 15 percent cap on the 

amount of the total deposits in the 

state they can control through acqui 

sition. 

A "net new benefits" test must be 

met by out-of-state institutions seek 

ing to enter the state. The benefits 

test involves capital investment, job 

creation, services to the public, and 

commitments to maintain and open 

branch offices. BBR, 7/16/90, p. 94. 

New Hampshire: new law extends 

to the entire U.S. the state's recipro 

cal, interstate banking law that pre 

viously had been restricted to the 

states of New England under a law 

enacted in 1987. The new law was 

effective immediately. It also in 

creased to 20 percent, from 15 per 

cent, the maximum amount of 

deposits in the state that any one bank 

can control through the purchase of 

another bank. This restriction can be 

waived if the Banking Commissioner 

determines that a bank is experienc 

ing difficulties that could lead to fed 

eral intervention. BBR, 4/30/90,p. 727. 

North Dakota: A new law permits 

nationwide, interstate banking on a 

reciprocal basis, effectivejuly 1,1991. 

Among the specified restrictions, an 

out-of-state institution cannot acquire 

a North Dakota bank without its con 

sent, and the institution must agree to 

make the same percentage of com 

mercial loans in North Dakota that it 

does systemwide. BBR, 4/1/91,p. 602. 

Pennsylvania: New legislation, ef 

fective December 18, 1990, provides 

for reciprocal interstate operations for 

savings banks. ELSS, 2/12/91. 

Tennessee: Under new legislation, 

banks and bank holding companies in 

any state may enter Tennessee 

through purchase or opening a bank. 

Reciprocity is required. The law be

52 
Recent Developments 

came effective January 1, 1991. BBR, 

3126/90, p. 530. 

Savings institutions are given sim 

ilar authority to banks for interstate 

banking. Effective 3/8/90. ELSS, 

2112191. 

Utah: decision of Utah regulators 

to allow BankAmerica Corp. to oper 

ate a Salt Lake City office as a full-ser 

vice branch of its Arizona-chartered 

bank is seen as a precedent that could 

result in further interstate branching 

by state-chartered banks. The Utah 

office was acquired by BankAmerica 

as part of its $81-million purchase of 

Western Savings and Loan 

Association's assets and liabilities 

from the RTG in May 1990. Follow 

ing its acquisition of Western, 

BankAmerica converted it into a 

state-chartered commercial bank. 

Having obtained full banking privi 

leges in Utah, Bank of America Ari 

zona could open more branches in the 

state, AB, 7H2190, p. i. 

Wyoming:T\\e. legislature approved 

a measure that requires all bank 

branches operating in the state to be 

licensed annually. The bill was 

prompted by the possibility of inter 

state banking and the regulators' de 

sire to establish control over such 

branches. Out-of-state banks with 

branches in the state are required to 

designate one office as a principal 

place of business for the location of 

banking records. If enacted, the legis 

lation would be effective July 1,1991. 

BBR, 2125191,p. 350. 

Sale of Securities Restricted 

in Branches 

California: Without written regu 

latory permission, depository institu 

tions are prohibited under a new law 

from selling certain uninsured securi 

ties issued by the bank or its affiliates 

in a branch that accepts deposits from 

the public. Sales of uninsured securi 

ties in the deposit-taking area of the 

branch must have the customer's 

written statement of understanding 

that the security may not be federally 

insured. California Banker, 11 {12/90, p. 3. 

Lenders* Liability Is Limited 

Colorado: Bankers are protected 

under a new law against claims by 

third parties that they or their prop 

erty is being hurt by polluted property 

that the bank owns through foreclo 

sure. The legislation limits thirdparty liability for lenders who comply 

with certain conditions to the cost of 

cleaning up contaminants or pollu 

tion. It states that "no lender-owner 

. . . shall ... be liable for any thirdparty liability arising from contamina 

tion." AB, 4/26/90,p. 4. 

States Will Conduct Joint 

Examinations 

Arizona and Utah agreed to con 

duct joint examinations of state-char 

tered commercial banks with 

multistate branches. Reportedly it is 

the first such multistate agreement of 

its kind for commercial banks, though 

there have been similar agreements 

between states for thrift institutions. 

The agreement covers coordination 

of examinations, division of regula 

tory authority, information sharing, 

and fees. 

The action by the states follows 

the purchase of Arizona's Western 

LSavings and Loan Association by 

BankAmerica Corp., and its conver 

sion into state-chartered Bank of 

America Arizona, with authority to op 

erate Western's single Salt Lake City 

office as a branch. AB, 9/4/90,p. 2. 

State Regulators Will 

Coordinate Foreign Bank 

Supervision 

With respect to international 

banks operating in their states, regu 

lators in New York, California, Flor 

ida, Illinois, Georgia, Michigan, and 

Washington will share such informa 

tion as financial condition, examina 

tion rating, business practices, 

compliance record, and the bank's re 

lationships with its home-country su 

pervisor and its parent company. The 

Conference ofState Bank Supervisors 

said the agreement will simplify com 

pliance and ensure uniform, thorough 

regulation. 

Foreign banks hold almost $700 

billion in assets in the U.S., or 23 per 

cent of all U.S. banking assets, and 94 

percent of foreign bank-controlled as 

sets are under state regulation. 

State banking departments in sev 

eral states also are working on an 

agreement to exchange information 

about domestic banks with interstate 

Operations. NEWS RELEASE, Conference of 

Slate Bank Supervisors, 1/18/90. 

Bank and Thrift Performance 

Banks' Earnings Continue 

Depressed by Loan Losses 

Commercial banks in the U.S. 

earned a total of $1.4 billion in the 

fourth quarter of 1990, declining from 

$3.7 billion in the third quarter de 

spite the fact that net interest margins 

widened. For the full year, banks' 

earnings were $16.6 billion, up by $1 

billion from 1989. 

High levels of troubled assets and 

provision for loan losses continued to 

heavily impact earnings. Commercial 

banks reserved $11 billion in the 

fourth quarter for domestic credit 

losses, compared to the previous high 

of $7.8 billion in the third quarter of 

1990. For the full year, total provision 

for losses on domestic and foreign op 

erations were $31.7 billion, $670 mil 

lion more than in 1989. 

In the Northeast Region, 38 per 

cent of all banks had negative earn 

ings in the fourth quarter. 

Nationwide, troubled assets were 

2.9 percent of all bank assets at the 

end of 1990, up from 2.3 percent in 

1989. 

The FDIC's list of "problem" 

banks totaled l,012at the end of 1990, 

down by 97 institutions from 1989, 

and well below the record number of 

1,575 in 1987. Assets of "problem" 

banks, however, were above the total 

of any previous year, reaching $409 

billion at year-end 1990. FDICQuarterly 

Banking Profile, Fourth Quarter, 1990. 
PDIC Banking Review 

Thrift Industry's Reduced 

Losses Reflect Ongoing 

Cleanup 

Thrift institutions in the private 

sector reported losses of $965 million 

in the fourth quarter of 1990, up from 

the $774 million loss in che third quar 

ter, bucwell under che $3.1 billion loss 

in the last quarter of 1989. OTS Di 

rector Timothy Ryan said "the year

to-year reduction in losses reflects the 

continuing profitability of the health 

ier thrifts and the ongoing cleanup of 

che industry through the transfer of 

insolvent and near-insolvent thrifts to 

che Resolution Trust Corporation." 

As of December 31, a total of 2,342 

chrifcs remained in the private sector, 

down 255 from year-end 1989. OTS 

divides these institutions into four 

groups: (I) well-capitalized and prof 

itable institutions (1,069), (II) thrifts 

expected to meet capital require 

ments (710), (III) troubled institu 

tions with poor earnings and low 

capital (369), and (IV) thrifts expected 

co be transferred to the RTC (194). 

Group I and II institutions, represent 

ing in numbers over three-fourths of 

the private-sector industry, and about 

60 percent of the assets, together had 

earnings in the fourth quarter of $645 

million, compared to $704 million in 

the final quarter of 1989. 

Texas, with 13 of the most trou 

bled thrifts at year-end 1990, is now 

outranked in that respect by Florida 

(21), California (20), and New Jersey 

(15). NEWS, OTS, 3/14191. 

Banks Overtaking Thrifts as 

Mortgage Investors 

If present trends continue, com 

mercial banks will pass S&Ls in the 

second quarter of 1991 in total invest 

ment in mortgages/mortgage securi 

ties. In the six months ending 

September 30, 1990, banks increased 

their holdings by 11 percent, to $527.4 

billion, while S&Ls' holdings de 

clined by six percent co $645.2 billion. 

A year and a half ago, banks topped 

S&Ls in the monthly production of 

home loans for the first time. 

While some of che largest banks 

sell most of their originacions, and 

then earn fees servicing the loans, al 

most all banks hold at least a portion 

of their new loans. Banks have be 

come large buyers, because of attrac 

tive yields, of securities backed by 

mortgages, and collateralized mort 

gage obligations. The advantages to 

banks of mortgage-related invest 

ments in part reflect current business 

conditions and may diminish over the 

coming months. 

Thrifts still have a much higher 

investment in mortgage-related assecs relative to their total assets than 

banks have — 55 percent as compared 

co 16 percent. AB, 1125191,p.!. 

Recent Articles and Studies 

Treasury Study on Deposit 

Insurance, Agency 

Restructuring, and Banking 

Reforms 

The Treasury Deparcment sub 

mitted its report on the federal de 

posit insurance system co Congress, as 

required by FIRREA. In its letter of 

transmittal, the Treasury said its goal 

"has been to develop practical propos 

als to reform and strengthen the fed 

eral deposit insurance system; 

modernize our financial system to 

make banks safer and more competi 

tive, both domestically and interna 

tionally; and streamline the bank 

regulatory structure." 

Among the report's conclusions is 

chat deposit insurance has been ex 

tended well beyond its original pur 

posed). It proposes that in the short 

term deposit insurance coverage be 

limited to $100,000 per institution for 

individual accounts and $100,000 per 

institution in retirement accounts. In 

the long term the goal is limited cov 

erage per depositor across all deposi 

tory institutions. 

Additional proposals to reduce the 

scope of deposit insurance include 

elimination of pass-chrough coverage 

for deposits held by professionally 

managed pension plans for Bank In 

vestment Contracts. Also eliminated 

would be the coverage of brokered 

deposits, and coverage of nondeposit 

creditors. 

The FDIC would not protect un 

insured deposits unless it is cheaper to 

do so. If the Treasury and Federal 

Reserve jointly determine that sys 

temic risk exists, they would have the 

flexibility to fully protect uninsured 

depositors. These and certain other 

proposed new policies to limit cover 

age of uninsured depositors would be 

phased in after a three-year delayed 

effective date. 

Well-capitalized banks would be 

authorized to have financial affiliates, 

including securities, mutual funds 

and insurance affiliates. Financial 

companies would be permitted to 

own well-capitalized banks, and com 

mercial firms could own financial 

holding companies. These ownership 

structures would be subject to fund 

ing and disclosure firewalls and other 

specified safeguards. 

The manner in which insurance is 

sold has generally been regulated at 

the state level. The report states that 

unless greater federal regulation of in 

surance is sought, the federal govern 

ment should generally defer to the 

states in the manner in which banks 

are permitted to sell insurance prod 

ucts of either affiliated or unaffiliated 

companies. National banks should be 

permitted to sell insurance products 

in states that permit such activities for 

their own banks. 

Direct equity investment in real 

estateand othercommercial ventures, 

which is already prohibited for na 

tional banks, would be prohibited for 

state banks as well. Federally insured 

state-chartered banks would gener 

ally be prohibited from engaging in 

activities not permitted for national 

banks, unless the state bank is fully 

capitalized and the FDIC finds that 

the activities do not create a substan 

tial risk of loss to the insurance fund. 

Nationwide banking would be al 

lowed for holding companies in three 

years. National banks would be per 

mitted to branch interstate im

54 
Recent Developments 

mediately wherever interstate 

branching is permitted, but there 

would be no preemption of intrastate 

branching restrictions. Interstate 

banking for state banks would be au 

thorized, but not required for all 

states. 

With respect to regulatory restruc 

turing, the Federal Reserve would 

regulate all state banking organiza 

tions. Anew Federal Banking Agency 

under the Treasury Department 

would regulate all national banking 

organizations and all thrifts. All super 

visory and regulatory functions as a 

primary regulator would be trans 

ferred from the FDIC. Modernizing the 

Financial System: Recommendations for Safer, 

More Competitive Banks, U.S. Department of the 

Treasury, February 1991. 

GAO Study on Deposit 

Insurance 

The General Accounting Office is 

sued a report, which was required by 

FIRREA, on reform of the deposit 

insurance system. 

One of the report's conclusions is 

chat coo often the enforcement pro 

cess against unsound banking prac 

tices has been too slow, and the delay 

has caused failure-resolution costs to 

be higher. It proposes speeding up 

the problem-detecting and supervi 

sory-enforcement process through a 

required, more clearly defined, 

"tripwire" approach. Starting at the 

earliest stage when certain problems 

can first be identified, for example, 

increasing interest-rate risk, or unusu 

ally rapid growth, regulators would 

have to initiate corrective action. This 

approach would be carried through to 

defined signals of more serious prob 

lems, including asset deterioration, 

declines in capital below required lev 

els, and serious impairment of capital. 

The report favors chc use of a riskbased deposit assessment system. 

After the BIF is recapitalized, and 

when industry capital adequacy is at 

tained, the risk-based assessments 

could be reduced for well-capitalized 

banks. 

New powers would be granted 

only on a case-by-case basis to wellmanaged and well-capitalized institu 

tions. 

The FDIC should not be required 

to use the least-cost method for re 

solving failure cases, at least not until 

the industry condition is improved. In 

any case, the report says, it is neces 

sary that the federal regulators have 

the flexibility to take any needed 

steps to preserve industry stability. 

The FRB, in consultation with the 

FDIC, should be given the authority 

to determine when an institution is 

"too big to fail." 

One alternative for fully protecting 

depositors having accounts exceeding 

the limit of insurance would be to give 

them a choice of having their excess 

deposits insured by paying for such 

insurance explicitly or implicitly 

through a reduced yield. Deposit Insurance 

A Strategy For Reform, (/.S. General Accounting 

Office, March, J991. 

Other Studies on Deposit 

Insurance Reform 

The proposals for deposit insur 

ance reform contained in this article 

("Insurance Reform Can Stop 'Beat

the-Bank1 Syndrome," by Robert T. 

Parry) are based on several assump 

tions: a) prevention of destabilizing 

runs is the primary rationale of deposit 

insurance; b) market discipline is the 

most effective means of controlling 

risk-taking by financial institutions; 

and c) equity and subordinated 

debtholders are the most likely 

sources of market discipline. The 

most important of his proposals, the 

writer states, is for prompt resolution 

of failure cases, and abandonment of 

"forbearance." This rule would be 

applied to all institutions, regardless 

of size. The success of this would de 

pend upon having a risk-adjusted 

minimum capital. An institution fall 

ing below this minimum would be 

closed or reorganized. If combined 

with "progressive discipline," an in 

stitution approaching the minimum 

would be subject to increasingly strin 

gent regulatory limits on their behav 

ior. 

Debtholder discipline would not 

be needed, nor would the deposit in 

surance fund, if the prompt closure 

rule were operating properly. How 

ever, regulators can and do make mis 

takes regarding asset valuation. 

There is a need to augment bookvalue measures of capital with market 

valuation wherever possible. Regard 

ing the valuation of loans, the writer 

cites two principles to make use of: a) 

the book value of a loan overstates its 

market value whenever the interest 

rate on a comparable new loan rises 

above the older loan's contractual 

value, and b) classified loans are not 

worth what their book values imply 

they are worth, 

The final element of the reform 

proposals is to limit deposit insurance 

to $100,000, "preferably on a per-ca

pita basis, if a practical way can be 

found to do this." AB, 4/19190, p. 23. 

The writer {Back From the Brink, 

1990, Peter J. Wallison) presents a 

plan for privatizing deposit insurance 

and strengthening the nation's banks 

and savings institutions. Banks and 

healthy thrifts would form Deposit 

Guarantee Associations (DGAs) 

which, after a period of transition, 

would guarantee all interest-bearing 

and certain other liabilities of selected 

other institutions that are not mem 

bers of the same DGA. Participation 

in a DGA would be mandatory for 

individual banks or banking firms 

having assets of $1 billion or more. 

Supervision of the DGAs could be by 

the FDIC, the study says. 

A stop-loss provision — such as is 

commonly found in the insurance in 

dustry — would limit an individual 

institution's liability, in this case to 20 

percent of the institution's capital in 

excess of its "base" level of three per 

cent. Losses of a DGA beyond the 

specified limitation would be borne 

by other DGAs. While the BIF and 

SAIF would provide a back-up guar 

antee on insurance up to $100,000 for 

DGA members, in effect the Funds 

55 
FDIC Banking Review 

would not have to provide resources 

until the committed capital of all 

DGA members had been exhausted. 

DGA banks would pay the BIF or 

SAIF only a nominal premium. The 

DGAs would charge members a riskbased premium, which would be set 

by a formula in a guarantee contract 

between the DGA and the institution, 

and which would be subject to reset 

ting at frequent intervals. An individ 

ual institution's premium would be 

set by a DGA in competition with 

other DGAs; thus the premium would 

be market-established. Most sound 

institutions would, the author be 

lieves, pay a premium for insurance 

well below the amount they now pay. 

The only such institutions not realiz 

ing a saving would be chose with large 

foreign deposits on which assess 

ments are not paid. 

The professional staffs of the guar 

antee DGAs would monitor and limit 

the risks assumed by the institutions 

for which they are responsible. If an 

institution could not obtain insurance 

by the end of a designated time period 

it would be sold, reorganized, or liqui 

dated by its last guarantor. Also by Peter J. 

Waltison: "Privatize Deposit Insurance," WSJ, 

Sll6(90,p.A14. 

Banks' Selling ofInsurance 

The GAO conducted a study of 

banks selling insurance, specifically 

sales of insurance underwritten by un

affiliated insurance companies, with 

all risk of loss due to policyholder 

claims borne by the insurance compa 

nies. The study focused on the poten

tial effects on consumers, other 

insurance sellers, and bank safety and 

soundness. 

At present most banks can sell 

credit insurance, and state-chartered 

banks in a majority of the states are 

permitted to sell most forms of insur 

ance. In towns of less than 5,000 in 

population, bank holding companies, 

national banks, and some state banks 

can sell all types of insurance. A bank 

holding company with assets less than 

$50 million can sell some type of in 

surance. 

There may be advantages, the 

GAO report says, to consumers from 

banks selling insurance with respect 

to increased convenience and a saving 

of time in purchasing insurance. 

Consumers' insurance costs might be 

reduced if banks could lower costs 

through joint marketing of bank and 

insurance products. The study did 

not, however, attempt to estimate the 

extent of any savings, or whether such 

savings would lower insurance premi 

ums. 

With respect to coercive tie-ins, 

banking law forbids practices where 

the customer is forced to purchase an 

additional product to receive credit. 

While credit insurance is relatively 

susceptible to tie-ins, previous Fed 

eral Reserve studies have found favor 

able consumer perceptions, which did 

not indicate widespread abuse by 

banks. These studies concluded that 

while instances of abuse may occur, 

coercive tie-ins are not widespread in 

bank sales of insurance. Additional 

measures to protect consumers could 

include disclosing that insurance pur 

chases are voluntary, and requiring 

that insurance marketing be sepa 

rated from the credit-approval pro 

cess. Such a separation, however, 

might reduce or eliminate the cost 

savings that would otherwise flow 

from joint marketing of banking and 

insurance products. 

Banks have potential competitive 

advantages over other insurance sell 

ers, for example, through joint mar 

keting of bank and insurance 

products, and their access to bank cus 

tomers and customer information, and 

shared overhead costs. However, 

these advantages are not unique to 

banks, and any large insurance seller 

has an advantage over small agents. 

Although expanded bank sales of 

insurance underwritten by unaffilia

ted insurance companies would not 

endanger bank safety and soundness, 

it is suggested that additional mea 

sures may be necessary to ensure that 

consumers do not become confused 

about whether insurance products 

sold by a bank are backed by federal 

deposit insurance. Bank Powers Issues 

Related to Banks Selling Insurance, U.S. General 

Accounting Office, 9/90,38 pp. 

Activities ofBHC Securities 

Subsidiaries 

This study develops information 

on the activities of bank holding 

companies' subsidiaries authorized 

by the FRB under Section 20 of the 

Glass-Steagall Act. That Section per 

mits FR member banks to be affili 

ated with firms which are engaged, 

but not principally engaged, in activi 

ties that are generally forbidden to the 

banks themselves. 

In 1987, the FRB began approving 

applications submitted by BHCs to 

allow their wholly-owned nonbank 

subsidiaries to underwrite and deal in 

certain bank-ineligible securities, 

specifically, municipal revenue 

bonds, mortgage-related securities 

and commercial paper. The FRB 

placed a limit of five percent of a 

subsidiary's gross revenues on the 

revenues that could be generated 

from the bank-ineligible activities. 

The FRB also required certain "fire 

walls" designed to insulate insured 

bank affiliates from the risks associ 

ated with Section 20 activities. In Sep 

tember 1989 the revenue limit was 

raised to ten percent. Approvals were 

granted in early 1989 that involved 

underwriting and dealing in corporate 

debt and equity securities, the latter 

subject to a one-year moratorium. In 

order for firms to begin these activi 

ties they had to meet some additional 

requirements. These involved mana 

gerial and operational structures suffi 

cient to ensure compliance with the 

"firewalls," and a capital plan. 

The GAO's report finds that in the 

third quarter of 1989 the 13 Section 20 

firms which were in operation under 

wrote about $69 billion in "bank-inel 

igible" securities, including 

mortgage-backed securities, munici 

pal bonds, commercial paper, and 

consumer-related receivables. Com 

mercial paper represented about 98 

percent of that amount, increasing by 

56 
Recent Developments 

more than 500 percent from a year 

earlier. Activities involving the other 

securities also showed large percent 

age gains. Section 20 firms in the sec 

ond quarter of 1989 had total capital 

of about $1.8 billion, or approximately 

4 percent of the capital of all securities 

firms then registered with the Securi 

ties and Exchange Commission. 

The report states that "although 

there are risks associated with Section 

20 company underwriting and dealing 

in bank-ineligible securities, these ac 

tivities also provide bank holding 

companies with opportunities to di 

versify their activities and thus limit 

their risks from any single activity ... 

it is still too early to tell whether Sec 

tion 20 firms' activities and placing 

these activities in a nonbank subsid 

iary have actually affected the risk 

levels within their holding compa 

nies." Bank Powers; Activities aj Securities Sub 

sidiaries ofBank Holding Companies, U.S. Genera/ 

ArcauntingOffice, March, 1990. 

Nonbank Activities ofBHCs 

This article ("The Nonbank Activ 

ities of Bank Holding Companies," J. 

Nellie Liang and Donald T. Savage) 

finds that at year-end 1988, 284 bank 

holding companies held net nonbank 

assets totaling $164.0 billion. Assets 

devoted to nonbank activities in 

creased 11.7 percent in 1988, and rep 

resented 6.9 percent of the firms1 con 

solidated bank and nonbank assets at 

the year-end. 

Ownership of nonbank assets is 

highly concentrated. The top five 

firms (in terms of net nonbank assets) 

held 57.2 percent of the total held by 

reporting firms in 1988, and the lead 

ing ten held 73.4 percent. For those 

firms, nonbank assets represented 

17.8 percent of total assets of the hold 

ing companies. Three organizations 

had over 20 percent of their total as 

sets in net nonbank assets. 

Traditional banking activities, 

such as commercial finance, mortgage 

banking, consumer finance, and leas 

ing, accounted for 56 percent of aggre 

gate nonbank assets in 1988. 

Securities brokerage, growing by 

more than 50 percent in asset volume 

in 1988, accounted for 15.4 percent. 

The evidence suggests that nonbank subsidiaries generally are more 

profitable than bank subsidiaries, but 

nonbank profits have moved in paral 

lel with bank profits over the 1986-88 

period. Various measures appear to 

indicate that nonbank subsidiaries, 

while better capitalized, are riskier 

than bank subsidiaries. Thus the 

growth in the relative share of nonbank activities could have important 

implications for the safety and sound 

ness of banking organizations. Federal 

Reserve Bulletin, May, 1990, pp. 280-292. 

U.S. Justice Department 

Reports on S&L 

Investigations 

The U.S. Justice Department, in a 

report compiled as of July 22, 1990, 

stated that 328 persons have been 

charge with crimes in connection with 

an estimated 243 S&Ls that have 

been "victimized" since October 1, 

1988. In addition, there have been 

convictions of 213 persons, resulting 

in prison terms totaling415 years, plus 

nearly $1 million in fines, and restitu 

tions ordered amounting to $56.6 mil 

lion. 

The number of failed financial in 

stitutions under investigation by the 

FBI grew by 31 percent to 530 in 

February, from 404 at year-end 1989, 

according to the report. Texas leads in 

FBI investigations of failed financial 

institutions, with 198, followed by 

California (41), Louisiana (36), and 

Oklahoma (32). In the Northeast, 

New York was the leader, with nine. 

AB, 8120190,p.9. 

57