314

The Meeting of the Advisory Committee on Community Banking

of the

Federal Deposit Insurance Corporation

Held in the Board Room

Federal Deposit Insurance Corporation Building

Washington, D.C.

Open to Public Observation

April 2, 2015 - 9:00 A.M.

The meeting of the FDIC Advisory Committee on Community Banking ("Committee")

was called to order by Martin J. Gruenberg, Chairman, Federal Deposit Insurance Corporation

("FDIC") Board of Directors.

The members of the Committee present at the meeting were: Cynthia L. Blankenship,

Vice Chairman and Chief Operating Officer, Bank of the West, Grapevine, Texas; Pedro A.

Bryant, President and Chief Executive Officer ("CEO"), Metro Bank, Louisville, Kentucky;

Roger Busse, President and CEO, Pacific Continental Bank, Eugene, Oregon; Leonel Castillo,

President and CEO, American Bank of Commerce, Provo, Utah; Christopher Emmons, President

and CEO, Gorham Savings Bank, Gorham, Maine; Jack Hartings, President and CEO, The

People Bank Corp., Coldwater, Ohio; Jane Haskin, President and CEO, First Bethany Bancorp.,

Inc., Bethany, Oklahoma; Mark Hesser, President, Pinnacle Bank, Lincoln, Nebraska; James

Lundy, CEO, Western Alliance Bank, Phoenix, Arizona; Arvind Menon, President and CEO,

Meadows Bank, Las Vegas, Nevada; Mary Ann Scully, Chairman, President and CEO, Howard

Bank, Ellicott City, Maryland; David Seleski, President and CEO, Stonegate Bank,. Fort

Lauderdale, Florida; Gwen Thompson, President and CEO, Clover Community Bank, Clover,

South Carolina; John Tolomer, President and CEO, The Westchester Bank, Yonkers, New York;

and Derek Williams, President and CEO, First Peoples Bank, Pine Mountain, Georgia.

Members of the FDIC Board of Directors present at the meeting were: Martin J.

Gruenberg, Chairman, Thomas M. Hoenig, Vice Chairman, and Jeremiah O. Norton, Director

(Appointive).

Corporation staff who attended the meeting included: Willa M. Allen, Ruth R. Amberg,

Steven O. App, Valerie Best, Luke H. Brown, Richard A. Brown, Kitty Chaney, Carolyn D.

Curran, Christine M. Davis, Robert C. Drozdowski, Doreen R. Eberley, Bret D. Edwards, Diane

Ellis, Lekeshia Frasure, George E. French, Kyle L. Hadley, Christopher L. Hencke, William H.

Henley, Jr., Matthew 1. Kepniss, Alan W. Levy, J. Mark Love, Christopher Lucas, Brendan R.

Mazur, Roberta K. McInerney, Stacy T. Meisel, Jonathan N. Miller, Mark S. Moylan,

April 2, 2015
315

Christopher J. Newbury, Thomas E. Nixon, Jessica Nye, Elizabeth Ortiz, Richard J. Osterman,

Mark E. Pearce, Sylvia H. Plunkett, Marlene M. Roberts, Floyd Robinson, Claude A. Rollin,

Barbara A. Ryan, Munsell W. St. Clair, Martin P. Thompson, James C. Watkins, Cottrell L.

Webster, Mindy West, and Charles Yi.

William A. Rowe, III, Deputy to the Chief of Staff and Liaison to the FDIC, Office of the

Comptroller of the Currency ("OCC") was also present at the meeting.

Chairman Gruenberg welcomed the Committee, including seven new members, and

observed that the Committee was a great resource for the FDIC. He provided an overview of the

day's agenda. First, there would be an update on recent developments in the FDIC's community

bank initiative, then a second panel would discuss the FDIC's efforts to reduce regulatory burden

pursuant to the interagency process required by the Economic Growth and Regulatory Paperwork

Reduction Act. A third panel of particular interest to community banks, Chairman Gruenberg

said, would discuss the operation of the FDIC's Professional Liability Program and its oversight

by the FDIC Board of Directors. The fourth and fifth panels would discuss cybersecurity and the

retail payment system. Finally, he said there would be a discussion of recent supervisory

guidance on topics such as brokered deposits, interest rate risk ("IRR") and the qualified

mortgage rule promulgated by the Consumer Financial Protection Bureau ("CFPB"). Chairman

Gruenberg introduced Chief of Staff Barbara Ryan who moderated the day's proceedings.

Ms. Ryan introduced the panelists for "Update on Community Bank Initiatives," Doreen

Eberley, Director, Division of Risk Management Supervision ("RMS"), Mark Pearce, Director,

Division of Depositor and Consumer Protection ("DCP"), and Diane Ellis, Director, Division of

Insurance and Research ("DIR"). Ms. Eberley said that RMS was reviewing its pre-examination

information request program to make sure it is as efficient as possible. She noted that RMS and

DCP had reworked the pre-examination request letter process in 2013, but that RMS was still

receiving some feedback that bankers were unable to determine how examiners used some of the

information that had been requested; she recognized that, if one cannot tell how information is

being used, it may feel unnecessary to gather it. Ms. Eberley reported that she had established

two working groups - one a management group of field supervisors and another one at the staff

level- to review the whole process for improvements. She said she established the working

groups about one month earlier and would keep the Committee updated on the review's progress.

Regarding the FDIC's technical assistance program, Ms. Eberley reported that RMS was

working on two new videos on cybersecurity; one is a basic introduction to cybersecurity and the

other focuses on vendor management. She indicated that RMS is also updating previously

released videos on IRR and corporate governance. Finally, Ms. Eberley said that the FDIC had

developed three new vignettes in the previously released Cyber Challenge series. The three

vignettes present common cyber issues that institutions face, she said, and provide challenge

questions that allow a bank's management or board to consider how they would respond. Ms.

Eberley noted that the series provides a reference guide that directs bankers to answers and

guidance in the Federal Financial Institution Examination Council's ("FFIEC") information

technology ("IT") Handbooks. Finally, Ms. Eberley described a survey that is being developed

for users of technical assistance videos to obtain feedback on the video content, the range of

topics, the utility of the videos and how the videos are being used.

April 2, 2015
316

Mr. Pearce said DCP shared the goal for the technical assistance videos to be helpful and

tailored to community bank needs. He added that, if there are regulatory changes that

community banks need to respond to, the FDIC wanted its videos to be updated to help banks

manage those responses. Mr. Pearce noted the CFPB was considering changes to its definitions

of what qualifies as a rural institution which may be beneficial to community banks and that the

changes would be discussed later in the meeting. Mr. Pearce reported that DCP had released a

new technical assistance video concerning loan originator compensation; he observed that the

underlying rule prohibits a loan originator in the mortgage from receiving compensation that is

based on the terms of the transaction or a proxy for those terms. He said that the video describes

the technical elements of the rule such as the definitions of loan originator, compensation, and

proxy, but also discusses exceptions to the rule (such as a de minimis exception), that may be

particularly beneficial to community banks. Mr. Pearce described a second new video on

mortgage servicing for small mortgage servicers. He said the video focuses on the definition of a

small servicer and the exceptions to the requirements applicable if one is a small servicer.

Ms. Ellis described four research papers pursuant to the Community Bank Research

Initiative that the FDIC hopes to complete in 2015. The first paper will focus on small closely

held banks; it will identify the characteristics and performance of this group of institutions and

explore some of their strategic opportunities as well as challenges such as management

succession, and recruiting and retaining qualified employees. Ms. Ellis described the second

paper as focusing on the cost functions and economies of scale among community banks. She

said the current paper would update work done in 2012 and take a more statistical approach to

the problem of distinguishing between fixed and variable costs, and regulatory and nonregulatory costs of community banks. The third paper will focus on mutual ownership of

community banks. She said the study will parallel to some extent the FDIC study prepared in

2014 concerning minority depository institutions, it will highlight structural changes among

mutual institutions, and will look at their geographic distribution, financial performance and

balance sheet characteristics. The fourth paper will consider the structural profitability of

community banks with a focus on those banks that consistently outperform and underperform the

averages. Ms. Ellis indicated the study will review where such banks are located, their lines of

business, what things they specialize in, and the areas of the income statement where they

outperform or underperform. She said a goal of the study would be to identify some of the

competitive challenges and unique opportunities these banks face.

Member Seleski complimented the research projects; he said that the profitability

information would be useful, but was concerned that the data available would not be detailed

enough to make the most useful distinctions; for example, the data may not be able to answer

what comprises non-interest income. Ms. Ellis agreed that the Call Report data was sometimes

insufficiently detailed to answer some questions, but noted that researchers were coordinating

with bank supervisory staff to get insights into some of the data. Member Hesser noted that the

Committee was not suggesting that the Call Report be expanded. In response to a comment from

Member Blankenship about family owned institutions, Ms. Ellis said the Call Report does not

provide data about family ownership, but reported that case managers and field supervisors were

helping gather data by answering a standard set of questions concerning ownership type.

Chairman Gruenberg noted that family owned institutions make up a distinctive and substantial

April 2, 2015
317

segment of community banks so that it would be worthwhile to develop a better understanding of

them and their particular issues. Member Blankenship applauded the work on family owned

community banks and suggested that an important inquiry would be about their plans for the

future; she said that this sector of community banking might be particularly at risk from

management succession and regulatory burden issues. Member Bryant thought that the research

projects would be extremely helpful for smaller banks as they conduct strategic and succession

planning. Member Williams agreed that research into cost, function, economies of scale, and

structural profitability would all help the smallest of the small banks, a segment that has not

received sufficient attention despite its cumulative size.

Member Williams also reported that he had heard industry feedback that the preexamination preparation for safety and soundness examinations was much improved and that

examinations were proceeding more efficiently as a result. Member Busse agreed and reported

that his bank's recent safety and soundness and compliance examinations had gone smoothly.

Ms. Eberley said she appreciated the feedback. Chairman Gruenberg later said that he

appreciated the exam process feedback, noting that Ms. Eberley and RMS put enormous effort

into ensuring that the exam process across the country consistently followed the FDIC's

priorities. He added that the FDIC welcomes all types of feedback and tries to respond

positively to it. Member Hartings complimented the technical assistance videos on loan

originators, ability to repay, and qualified mortgages.

In response to a question from Member Tolomer, Ms. Eberley clarified that the FDIC's

research was focused on closely held banks and was not limited to family owned institutions.

Member Castillo suggested that the FDIC's research could explore if specific new regulations

had caused banks to experience structural changes in revenue sources and/or changed behaviors

over the last five to seven years. He expected that extensive regulatory change has impacted

banks' operations, but was interested what the data might reveal. Ms. Ellis agreed and said a key

issue would be how cost functions have changed over time. She described what the FDIC found

concerning various economies of scale (or the lack of them) in 2011, but said that the FDIC

would like to expand on that study and find if there was a trend over the years. Member

Blankenship emphasized the usefulness of research into the various sub sectors of community

banks which are often lumped into a single category. She expressed the beliefthat the FDIC's

examination process would be improved after it gains greater knowledge about such subsectors

because it would help examiners recognize that some differences among community banks are

due to their different structures and strategic plans. In response to a question from Member

Bryant about the definition of community banks for the FDIC's research purposes, Ms. Ellis

noted it is not a strictly size-based threshold, but is based on a bank's business model and its

geographic dispersal among other characteristics. She observed that 94 percent of community

banks have below $10 billion in assets, but that some larger institutions are also considered

community banks under the FDIC's research definition.

Ms. Ryan introduced the speakers for the panel titled "Update on the FDIC's Regulatory

Review under the Economic Growth and Regulatory Paperwork Reduction Act ("EGRPRA"),

Roberta McInerney, Deputy General Counsel, Legal Division, Ruth Amberg, Assistant General

Counsel, Legal Division, and James Watkins, Senior Deputy Director, RMS. Ms. McInerney

noted that the EGRPRA review process was discussed in the previous meeting and provided an

April 2, 2015
318

overview ofthe process. She said the EGRPRA review requires the FDIC, the acc and the

Federal Reserve to review their regulations at least once every ten years by publishing their rules

in categories and requesting public comment to identify rules that are outdated or unnecessary.

Ms. McInerney reported that the agencies divided their regulations into 12 categories that would

be published in four Federal Register notices before the end of2016. She noted that the first

three categories of regulations were published in 2014 (applications and reporting; powers and

activities; and international operations) and that the agencies received 40 comments that were

being reviewed. The second notice, which included the categories of banking operations, capital

and the Community Reinvestment Act "CRA"), was still open for comment, and the agencies

encouraged the public to provide input. She said the agencies were holding six outreach sessions

around the country to seek direct input from bankers, consumer and community group

representatives, and other interested parties.

Ms. McInerney provided an overview of some of the comments the agencies had received

and responses to them. In response to public comment, the agencies decided to include recently

issued regulations in the EGRPRA review. In addition, she said the agencies would also

welcome comments on regulations issued by the CFPB and the Financial Crimes Enforcement

Network ("FinCEN"). Although the EGRPRA agencies would not be able to take direct action

on such regulations, Ms. McInerney explained that the agencies would share them with the

appropriate regulators and expected to find such comments helpful as they conducted the

EGRPRA review and their bank supervisory activities. She noted that Chairman Gruenberg

supported reducing burden as soon as the agencies could without waiting until the end of the

EGRPRA process. Consistent with that direction, she reported that, in response to feedback

about confusion in the de novo bank process, the FDIC reviewed its existing policies and issued

new Questions and Answer documents to address that process. Similarly, in response to

feedback about the Call Report's burden, especially on community banks, Ms. McInerney

reported that the FFIEC was exploring ways to streamline the Call Report. She noted that, in

response to public comments, the FDIC revised its policy on the use of limited liability

companies to significantly reduce the number of applications necessary. Finally, Ms. McInerney

said that some commenters expressed concern about the cumulative regulatory burden facing

community banks overall. She explained that whenever the FDIC is required to impose

regulatory requirements, it carefully considers the burden with a special focus on community

banks. Ms. McInerney encouraged bankers to participate in the EGRPRA review process.

Mr. Watkins discussed five recurring themes being raised in the EGRPRA process. The

first was Call Reports. Bankers, he indicated, expressed the desire to streamline the Call Report

or eliminate certain schedules. Mr. Watkins said that the agencies are reaching out to better

understand the processes banks follow to prepare their Call Reports and regulatory filings. The

agencies are also evaluating training and technical assistance initiatives to help bankers prepare

Call Reports. Examination frequency is a second theme being raised in the EGRPRA process.

Mr. Watkins said some commenters recommended changing the frequency of examinations

established in statute by raising the exception threshold for small institutions from $500 million

to $1 billion or more, and increasing the examination interval to 24 months. Mr. Watkins said

that some commenters suggested a longer examination cycle could be supplemented by targeted

periodic reviews; that greater scheduling flexibility could be exercised; and that regulators could

use more electronic measures to obtain and share information.

April 2, 2015
319

A third burden reduction theme Mr. Watkins discussed was appraisal thresholds. He

reported that some banks commented that the appraisal regulation requirement to obtain an

outside or certified appraisal on loans of $250,000 or more is out of date and should be raised to

a higher level to account for changes in the economy and real estate costs. The fourth theme was

the burden related to Bank Secrecy Act ("BSA") requirements. Mr. Watkins said commenters

recommended raising the threshold for currency transaction reporting from $10,000 to $20,000

or higher, raising the recordkeeping threshold for the purchase of monetary instruments from

$3,000 to $10,000, and also allowing more exemptions for certain customers. The fifth theme

related to communications. Mr. Watkins said bankers asked the FDIC to continue to promote

open and regular lines of communication, in particular to ensure that supervisory expectations

meant for large banks are not imposed on community banks. He observed that the FDIC was

reaching out to its examination staff as well as banks to avoid that outcome. Mr. Watkins also

noted that the FDIC was issuing technical assistance videos to promote useful information on

regulatory issues and changes for bank directors, officers, and employees; it also maintains a

regulatory calendar so that bankers can see the landscape for new requirements. Mr. Watkins

echoed the intention that the FDIC would reduce burden as the opportunity arose rather than

waiting for the end of the EGRPRA process.

Member Castillo inquired about the process for considering changes to appraisal

thresholds, BSA requirements and the Call Report. Mr. Watkins indicated that the process

depended on the source ofthe regulatory requirement. If the FDIC issued the requirement, it

could take action regarding it, but if the recommended change required modifying a statute, the

FDIC would work with other agencies to make recommendations to Congress. If a requirement

is established by another agency, such as BSA requirements established by FinCEN, the FDIC

would share its insights and feedback from bankers with the other agency. He added that the

FDIC's input would be helpful to the other agency's deliberations about its requirements.

Member Lundy said that poor appraisals contributed to the previous financial crisis and that one

good outcome of that crisis was the improvement in appraisal standards. He indicated that since

the banking industry had embraced the value of good appraisals, their recommendations about

raising thresholds should be taken seriously.

Member Hartings suggested that the FDIC consider statistically analyzing institutions

that became troubled or failed over the last ten years for insights on best employing FDIC

examination resources. Mr. Watkins said that he believed there is real value in comprehensive,

periodic examinations to ensure a bank that is rated as a CAMELS "2" remains, in fact, a 2-rated

bank and is not drifting, taking on new risks, or expanding into areas where it does not have

expertise. He said identifying issues early and providing timely feedback to the bank is critical

to ensuring a healthy banking environment. Mr. Watkins added that every failed bank and its

supervisory history are examined by the FDIC Board. Member Blankenship asked ifthe FDIC

had considered reducing the frequency of examinations based on comprehensive audits that

banks employ; she noted that her bank hires third-party firms to do loan reviews as well as BSA

and compliance reviews. Mr. Watkins said that third-party reviewers' work can sometimes fall

short of what is needed and there is benefit to periodic examinations conducted by examiners

who have been extensively trained by the FDIC for that purpose. Mr. Watkins said the FDIC

does consider a bank's audits and their quality and then adjusts how deep and extensive the

April 2, 2015
320

FDIC examination needs to be based on that evaluation. Member Scully inquired whether the

FDIC had reviewed data about banks that were rated "1" or "2" and then dropped precipitously

for insights into how the FDIC could best focus its resources. Mr. Watkins responded that the

FDIC engages in extensive off-site analysis of bank data and looks, for example, at balance sheet

growth, changes to management or a business plan, elevated levels of past due or problem loans,

concentrations, and IRR. When the FDIC identifies heightened risk, he explained, it may prompt

a telephone call to the bank or an on-site visit.

Member Menon inquired if it is possible for the FDIC to rely on more visitations rather

than full scope examinations, especially for higher rated banks. Mr. Watkins said that some

earlier attempts to streamline examinations had not always been successful; he observed that it is

important to identify bank problems at an early stage to avoid big losses and indicated that

streamlined examinations might miss some areas that warrant closer examination. Member

Williams suggested that there might be a tradeoff between Call Reports and examination cycles;

if banks continue rigorous quarterly reporting, then it might warrant a longer examination cycle,

or, ifbanks stay on the same examination cycle, the FDIC could consider alternate quarter

limited scope Call Reports. Mr. Watkins said the FDIC welcomed suggestions on streamlining

Call Reports or specific examples of where bankers thought the FDIC was spending more time

than was necessary. Member Williams said that the Independent Community Bankers of

America had proposed that "1" and "2" rated banks that fit a certain risk profile could engage in

full Call Reporting in the June and December quarters, but have a more limited Call Report in

March and September.

Member Bryant recommended a paper titled "The Future of Community Banking" which,

he said, studied banks from 2006 to 2014 that had gone from highly rated to poorly rated, but had

resumed a higher rating; he said that his bank's board of directors found it useful for "lessons

learned" in the recent crisis. Member Blankenship suggested that, if the FDIC engaged in

additional off-site statistical analysis of banks, it could exercise more flexibility in customizing

the examination cycle for banks which were not experiencing changes that increased risk and

were engaging third-party analyses of their businesses. Mr. Watkins observed that FDIC

examinations are risk focused; examiners directed their review function to areas where they had

identified higher levels of risk. He welcomed thoughts on improving risk focusing. Member

Lundy made reference to the previously discussed improvements in pre-examination preparation

and suggested that the FDIC make similar improvements in targeted and non-full scope

examinations. He also suggested that the FDIC could communicate what its expectations were

when banks experienced various risk increasing situations such as new business lines, rapid

growth, or an economic decline.

Member Seleski indicated that bankers generally welcomed input from examiners that

looked at the bigger picture and asked broader questions concerning their banks' risks. He

contrasted such a consultative approach with a "gotcha" approach where examiners focus on

small regulatory infractions that would not affect the institution's well-being. Member Seleski

said that, after his bank had made acquisitions, the FDIC conducted a visitation that looked at

integration issues from a high level and said that his bank found the visitation very helpful. He

contrasted that with a five hour meeting discussing $20,000 loans in a $2.2 billion institution.

Member Hesser provided an example of how examination burden can be reduced. He said that

April 2, 2015
321

his bank has multiple charters and said that examiners coordinated targeted examinations of

capital markets so that there was only one examination rather than four similar ones.

Member Busse agreed that pre-examination scope discussions had been helpful in

focusing examinations and said that it dovetailed into the idea of a focused risk assessment of the

institution. He also noted that when a bank has an area of specialization, the FDIC can send in

an examiner to concentrate on that specific area; he said that such examinations became very

focused, meaningful and consultative and he encouraged the FDIC to continue that approach.

Member Scully acknowledged that the FDIC could face criticism if it moved away from a "one

size fits all" approach to examination, but recommended that, if the FDIC took a somewhat

differentiated approach, it would be beneficial. Member Hartings said community bankers are

passionate about examination burden because an examination requires two weeks of the time of

the bank's highest level staff, and during that time, other bank priorities are suspended. He

added that a 12 month examination cycle actually provided only 8 months to focus on his

business since he had to respond to pre-examination requests and final examination results did

not occur immediately; thus, it was important whether the examination cycle was 12 or 18

months. Member Menon observed that community banks have limited staff and time to devote

to examinations and recommended that the FDIC try to accomplish more work off-site.

Member Williams suggested that banks would appreciate more feedback about the

subsequent use ofBSA required reports; at present, he said, the work appeared thankless and for

no clear benefit. Member Blankenship commended the FDIC for considering moving toward a

more risk based examination approach and acknowledged that the FDIC's approach had not been

static. She observed that new technology was creating a sea change in community banks'

business models and that, similarly, the FDIC might consider changing the model in which they

conduct examinations. Mr. Watkins said that the Committee members' feedback was very

helpful. He suggested that a future Committee meeting could further discuss FDIC's off-site

reviews and how they interact with examinations.

The Committee stood in recess at 10:21 a.m. and reconvened at 10:50 a.m. that same day.

Richard Osterman, Deputy General Counsel, Legal Division, Floyd Robinson, Assistant

General Counsel, Legal Division, and Bret Edwards, Director, Division of Resolutions and

Receiverships ("DRR") presented the panel titled, "The FDIC's Professional Liability Program"

("PLP"). Mr. Osterman provided context for the PLP, noting that the FDIC acts in two

capacities. In its corporate capacity, he explained, the FDIC supervises state nonmember banks

and insures financial institutions; in its receivership capacity, it acts as receiver for failed banks

and thrifts to liquidate assets and pay claims. Mr. Osterman noted the FDIC's PLP arises from

its receivership capacity. In the most recent financial crisis, he said, over 510 banks failed, with

a peak of 157 failures in 2010, 18 failures in 2014, and 4 so far in 2015; by comparison, 2,300

institutions failed in the crisis of the late 1980's to early 1990's.

Mr. Robinson explained that the FDIC has litigation authority for its civil actions, in

other words, it is not required to consult with any other federal agency before bringing a civil

claim. He also observed that the receiver succeeds to all rights and powers of the failed

institution and its shareholders, depositors and officers, and also owns all derivative claims. Mr.

April 2, 2015
322

Robinson said that statutes oflimitations apply to these claims, the FDIC has three years to bring

a tort claim and six years to bring a breach of contract claim; those time periods begin to run

from the date the bank fails, he noted, provided that the claims had not lapsed under applicable

state law before the failure. Tort claims, he said, are claims for negligence, gross negligence,

breach of fiduciary duty, legal, accounting, or appraisal malpractice. Breach of contract claims

are claims the FDIC pursues when attempting to recover against a fidelity bond; in this crisis

they also included closing protection letter claims in mortgage fraud cases. Mr. Robinson said

that the FDIC also pursued Residential Mortgage Backed Securities ("RMBS") claims for the

first time in the most recent crisis.

Mr. Osterman discussed a variety of safeguards to ensure that the FDIC pursues

meritorious, cost-effective claims. First, the FDIC Board of Directors issued a policy statement

in 1992 that makes clear that FDIC lawsuits against bank directors and officers are instituted

only after thorough FDIC investigation. He explained that the DRR and the Legal Division

jointly investigate if there are valid claims and that these investigations typically take about 18

months. A decision to pursue a case, Mr. Osterman said, is subject to a multi-level review

including senior DRR and Legal Division officers, and then must be approved by the FDIC

Board. Mr. Osterman said that, before a case is filed, the FDIC attempts to contact potential

defendants to explore settlement. The FDIC is actively involved in the management ofPLP

litigation, he explained, using approximately 50 in-house attorneys to oversee outside counsel.

Moreover, cases are subject to ongoing review by FDIC attorneys who are always available to

discuss cases. The public may access information about the PLP on the FDIC's website.

Mr. Robinson discussed how the FDIC determines if a case is meritorious. He explained

that the FDIC looks at the applicable state law, good corporate governance policies, the

execution of those policies, and how boards of directors responded to criticism (from regulators,

and accountants and consultants hired by the bank). Mr. Robinson said the FDIC considers the

duties of directors and officers and whether they were breached. These duties include: fiduciary

duties of care and loyalty; a duty to supervise core bank functions; a duty to review information

about the bank's operations and performance; and a duty to take prompt action to remedy

weaknesses and respond to supervisory criticisms. Mr. Robinson said that the FDIC's website

and technical assistance videos provide information outlining directors' and officers' duties. He

noted that the standard of care is established by state law and discussed the ability of the FDIC to

pursue simple negligence claims. Mr. Robinson discussed the Business Judgment Rule, which

provides limited deference to directors' and officers' decisions if they were made: on an

informed basis; in the best interests of the bank; in good faith; and free of conflicts of interest;.

Mr. Osterman discussed how the FDIC determines if a case is cost-effective to pursue,

noting that recoveries come primarily from available insurance and personal assets. He observed

that, early in the recent crisis, insurance policies had virtually no exclusions with respect to

potential claims by the FDIC, but that more policies had such exclusions as the crisis developed.

Mr. Osterman said that the FDIC issued a 2013 Financial Institution Letter to alert bankers to

this changed situation. Regarding personal assets, he said that the FDIC's claims are often for

much more than a defendant can pay so the FDIC may settle a claim based on an ability to pay

(after receiving a required defendant's financial statement). Mr. Osterman then discussed

various charts that had been provided to the Committee. One chart showed peaks in the number

April 2, 2015
323

of cases that occurred approximately three years after the peaks of failures in the last two crises.

He observed that the FDIC currently has about 100 professional liability cases filed, of which

about 60 are director and officer cases.

Mr. Edwards observed that the PLP is cost effective, between 1986 and 2014 its

recoveries were just over $8.6 billion compared to its expenses of just over $2.1 billion. He

noted that the period for recoveries lags the period for expenses by several years and that large

recoveries in any given year can skew the statistics so that it is best to look at recoveries and

expenses over an entire bank failure cycle. Mr. Edwards stated that the expenses that he spoke

of included outside counsel, outside investigation costs, in-house counsel and investigation costs

and accounting expenses. Mr. Osterman observed that most recovered funds are returned to the

Deposit Insurance Fund which, in turn, lowers the cost of deposit insurance for well-run banks.

He also described actions the FDIC takes in its corporate capacity, including enforcement

actions, referrals to the Department of Justice, awards of criminal restitution to the FDIC and

actions by the Inspector General that are coordinated with the Department of Justice.

Member Seleski said that his bank, which has acquired several banks, including failed

institutions, found that banks whose boards were composed of people who had served on more

than one bank board were generally better run. He expressed concern that the potential liability

of being a bank board member might discourage qualified people from serving in that role.

Member Seleski then provided the hypothetical example of a retiring bank president who is

wealthy and questioned whether such a person would be willing to risk being a board member

for $500 or $1,000 per month. He asked if the FDIC had ever inquired among bank board

members whether they would be willing to join another bank board. Mr. Osterman said the

FDIC shared the concern about a potential chilling effect, but he observed that: 1) most banks do

not fail so that there are no lawsuits; 2) in most failed banks, the FDIC does not bring lawsuits;

and 3) if a bank director does their job, there is nothing for them to worry about. Member Bryant

said that his bank would experience board member retirements in the next few years and his

observation was that newer, younger board members were envisioning short-term, perhaps three

year, commitments rather than 15 to 30 year commitments to the bank. He said that FDIC

resources for directors, including the video on fiduciary responsibilities, were helpful in

informing board members (and potential ones) about their responsibilities. Member Bryant

indicated that it is important to a bank's well-being that board members accept their fiduciary

responsibilities and take an active role.

In response to Member Tolomer's inquiry if the FDIC had detected patterns among the

bank failures, Mr. Osterman said the Inspector General conducted material loss reviews of many

failed banks and that many failures combined a very high growth rate with a failure to comply

with the bank's own policies and procedures. Chairman Gruenberg said that the FDIC board of

directors scrutinizes all PLP cases before they are approved; he noted that FDIC staff does not

bring close calls to the board and that the fact patterns tended to involve rather egregious failures

to follow a bank's own standards and procedures. Chairman Gruenberg observed that holding

bad actors accountable was important for the industry, as well as the FDIC, because when

persons do not fulfill their duties to a bank, the rest of the banking industry that do follow the

rules must pay the price. Chairman Gruenberg agreed that it is critically important for banks to

be able to attract qualified people to serve on their boards and there was a concern about

April 2, 2015
324

potentially discouraging such people; he indicated, however, that his perception was that board

members who did their jobs in a reasonable fashion did not put themselves at risk. Mr. Osterman

agreed and observed that the FDIC issued its 1992 policy statement in response to concerns

about a potential chilling effect. He said that the FDIC is careful concerning its responsibilities

because it is in the FDIC's interest, as well as banks', that qualified people are willing to serve.

Member Blankenship indicated that it appeared that directors from small institutions were

more likely to be sued than directors from large institutions and inquired if the FDIC had

analyzed that issue. Mr. Osterman said that the FDIC investigates every bank failure with the

same standards applied to every bank. He said he thought that the main issue was whether a

bank failed because only failed banks are examined for these types of lawsuits; he noted that

more small banks failed than large ones. Mr. Osterman observed that the FDIC brought actions

in several large failed banks such as IndyMac, Washington Mutual and Downey Savings. Mr.

Robinson added that, of the 510 failures in the recent crisis, only nine institutions had assets over

$10 billion. He observed that, working just from his memory, there were large director and

officer cases in at least five of those, or in over 50 percent of the larger failures; he contrasted

this rate against the more general statistic that the FDIC brings such suits in significantly less

than half of all failures. Member Blankenship observed that there has probably been a

misconception about the subject and suggested it would be helpful for the FDIC to communicate

that the size ofa bank does not affect the likelihood of being sued. Mr. Osterman agreed that it

was important to clarify these issues and conduct this type of communication. Member Hesser

said there was industry frustration because some of the largest institutions caused losses through

the Troubled Asset Relief Program, but avoided failure; thus, the institution was able to pay fines

for misconduct and no individuals were sued. This communicated to potential directors that it

made sense to be a director of an institution that was "too big to fail," he said.

Member Lundy inquired if and how the FDIC learned about the effectiveness of its

supervisory process from the PLP lawsuits that it brought. Mr. Osterman said the Inspector

General conducted material loss reviews of many of the banks that failed and the effectiveness of

supervision in those cases. He said those reviews sometimes suggested that earlier enforcement

action, cease and desist orders, and identifying underwriting flaws may have helped. Mr.

Osterman said the FDIC uses the review process to adjust its supervisory program. In response

to a question from Member Lundy, Mr. Osterman observed that PLP recoveries were a very

small percentage compared to the entire loss to the Deposit Insurance Fund.

Member Bryant suggested that persons being considered for board positions in

community banks misperceived what their potential liabilities would be because national media

report on problems and fines at large banks and the distinctions between large and small banks

are lost. Chairman Gruenberg said that he shared the concern about misperceptions about the

risk of serving on the board of a community bank. He observed that the banks that failed usually

had a strikingly different profile from the large majority of institutions that did not fail; they

often experienced rapid growth, engaged in high-risk activities funded by volatile deposits and

had boards who were not paying attention. Chairman Gruenberg contrasted those failed banks

with the 6,000 smaller institutions that did not fail during the last crisis. He suggested that a

person serving on the board of a bank that pursued a traditional community banking model and

did his or her job would experience a low risk of being sued. Chairman Gruenberg said he

April 2, 2015
325

wanted the FDIC's processes about bringing these cases to be transparent to help make that

distinction clear. He noted that the FDIC had published a number of resources about director

responsibilities and invited suggestions about other ways the FDIC could be helpful. Member

Blankenship suggested that the FDIC's directors' videos could include real life examples of how

directors have gotten into trouble to show where vulnerabilities might be and what questions

directors need to ask. Member Scully indicated that, ifmany lawsuits resulted from directors'

sins of commission rather than omission, the FDIC's videos could emphasize that point.

Member Williams suggested that directors' comfort with their responsibilities would be

increased if both the bank and FDIC resources helped explain to directors what is expected of

them; he noted that it is a bank's responsibility to educate their directors about the bank's

policies and practices. Member Bryant indicated that the FDIC's inquiries during the

examination process regarding the qualifications of senior management and directors, and their

professional development, helped board members be proactive in understanding their

responsibilities, including the necessity of hiring qualified management. Member Haskin

complimented the FDIC's directors' video series. She said that her bank's directors took their

liability seriously, and although they are seasoned, the videos help them be aware of current risks

such as cybersecurity. Member Haskin said the videos have prompted directors to ask

management to provide briefings to the board about how they are handling such risks.

Ms. Eberley provided an "Update on Cybersecurity" for the Committee. She first

described the various cybersecurity resources that the FFIEC has made available to banks and the

steps the FFIEC agencies have taken to identify and address current requirements in the area.

Ms. Eberley noted that the FFIEC agencies provided a webinar to more than 5,000 CEOs titled,

"What Do CEOs Need to Know About Cybersecurity?" which was also made available as a

video on the FFIEC website. She said the FFIEC agencies also issued statements about cyberthreats and risk mitigation steps financial institutions can take including ones concerning ATM

cash-out schemes; distributed denial of service attacks; theft of credentials; and destructive

malware. Ms. Eberley explained that the FFIEC agencies think it is important for financial

institutions to participate in a central place for sharing cyber-threat information and

recommended that they join the Financial Services Information Sharing and Analysis Center

("FS-ISAC"). She reported that the FS-ISAC receives cybersecurity information from various

intelligence agencies, puts it into actionable form and distributes it to the industry; she observed

that the FS-ISAC sends a weekly letter to community bank CEOs describing current

cybersecurity issues and has a community banking group. Ms. Eberley noted that the FFIEC

Task Force on Supervision has a long-standing information technology subcommittee that is

responsible for publishing the IT Handbook. In July 2013, the Task Force also established a

cybersecurity and critical infrastructure working group to focus on the cybersecurity threats and

how the FFIEC should address them. Ms. Eberley said that the working group undertook a yearlong cybersecurity risk assessment that reviewed FFIEC guidance and agency policies and

practices and compared those to the standards published by the National Institute for Standards

and Technology ("NIST") Cybersecurity Framework and other sources. She said that the review

identified parts of the FFIEC Handbooks that needed additional guidance or updating.

Ms. Eberley reported that the FFIEC agencies sent a March 2015 press release that

identified seven work streams that the agencies would be pursuing in the following year. The

first work stream would be a Cybersecurity Self-Assessment Tool to help institutions evaluate

April 2, 2015
326

their inherent cybersecurity risk and their risk management capabilities. She said the tool had

been piloted in more than 500 community institutions, that the pilot test gave examiners a base

from which to rework the tool, and provided the agencies insight into where additional guidance

was needed. Ms. Eberley said that the agencies plan to issue the tool in 2015 as a voluntary selfassessment tool for the industry. Institutions using the tool would first work through a risk

assessment matrix to identify the institution's inherent cyber-risk based on its connections to the

internet, its operations and how it does business. The second step would be to use the tool to

assess the institution's level of preparedness. Ms. Eberley described the five areas covered in the

self-assessment: cybersecurity risk management and oversight; how banks gather threat

intelligence and collaborate with the industry; cybersecurity controls; external dependency

management; and cyber incident management and resilience.

The second work stream Ms. Eberley described was incident analysis, the processes the

FFIEC agencies use to gather, analyze, and share information to inform each other during cyber

incidents to support a coordinated response. The third work stream was crisis management, or

how the FFIEC works with the rest of the government and as part of the public-private

partnership to handle cyber crises. Training is the fourth work stream. Ms. Eberley explained

that, while the FFIEC agencies ask financial institutions to work with their employees so that

they understand good cyber hygiene and how to identify and respond to cyber threats, the

agencies are taking similar steps with all their own employees. Ms. Eberley observed that this is

not a responsibility that could be assigned only to technology specialists. The fifth work stream

she described was policy development, noting that the FFIEC agencies are consulting the NIST

Cybersecurity Framework and other sources to fill in any gaps in their IT Handbooks to ensure

their scope is comprehensive. Specifically, Ms. Eberley said the FFIEC had released Appendix J

to the Business Continuity Handbook which addresses business continuity from a cyber

resilience perspective and provides guidance on those issues. The sixth work stream was the

examination program for Technology Service Providers ("TSPs"). Ms. Eberley observed that the

FFIEC agencies are expanding their focus on TSPs' practices and the examination program for

TSPs since so many community banks rely on them for their IT systems. Ms. Eberley noted that

TSPs are subject to the same guidance as the banks they service and that the agencies' focus is

on the TSPs' interconnectedness and their ability to respond to the growing cyber threats and

vulnerabilities. Developing relationships with law enforcement agencies was the seventh work

stream. Ms. Eberley said the FFIEC agencies encouraged financial institutions to know in

advance who they should contact in case of a cyber incident and said the agencies were similarly

building on their existing relationships with law enforcement.

Member Blankenship suggested that the FFIEC consider publishing videos about the

Cybersecurity Self-Assessment Tool. Ms. Eberley said that such a video was under

consideration. In response to Member Scully's request, Ms. Eberley described how the FDIC

ensured that it had staff that was properly trained on cybersecurity issues. She first described the

four year examiner commissioning process that includes five formal schools and on-the-job

training followed by testing and service as an acting examiner-in-charge. After the

commissioning process, Ms. Eberley explained that, since 2010, examiners receive postcommissioning training in four IT schools: basic IT concepts; understanding payment systems;

understanding applications; and understanding audit and control in an IT environment. She said

about one-third of FDIC's examiners had been through all four schools. Ms. Eberley also

April 2, 2015
327

described further training for cadres of examiners to become intermediate subject matter experts

and advanced subject matter experts. She said that developing these skills was important and

beneficial to the FDIC. Ms. Eberley observed that the FDIC hires some outside expertise in

specialized areas such as forensics to supplement its team, but noted that it was simultaneously

training examiners who had expressed an interest in the field. Member Scully also asked if the

FDIC could describe its conversations with TSPs; she noted that the FDIC's voice could be more

important to TSPs than individual banks. Ms. Eberley said that the FDIC has had recent

communications with the largest TSPs and anticipated that the FDIC would facilitate

collaboration between TSPs and client institutions. She added her view that TSPs are as

interested in collaboration as are financial institutions.

Member Hartings said that it would be helpful to community banks to be able to look at a

TSP's examination report before the bank entered into a multi-year contract with the TSP. He

observed that the current situation (of sharing examination reports only where there was an

existing contractual relationship) allowed for the possibility that a bank would engage a TSP

based on the TSP's representations only to later find those representations were not supported by

the examination. Ms. Eberley observed that TSPs were also interested in providing information

to prospective clients and are exploring the creation of information packages that could serve

banks' vendor management and due diligence needs. She noted that the issue was complicated

because every institution has different vendor management needs, but thought it was worthwhile

to explore approaches that served dual purposes. Member Hartings agreed that the basic

framework would be helpful and could be supplemented by individual banks to suit their needs.

Member Castillo inquired about discussions the FDIC had with TSPs regarding their readiness

for cybersecurity attacks. Ms. Eberley said the FDIC examines TSPs the same way as banks are

examined and that the FDIC has robust discussions with TSPs about cybersecurity. She

observed that even TSPs with the best defenses may still face a cybersecurity problem and must

be ready to deal with them. Chairman Gruenberg observed it was fair to say that cybersecurity

matters are a work in progress and that, in light oftheir potential risks, the FDIC was heightening

the priority of its TSP examinations and making them an expanded area of attention.

The Committee stood in recess at 12:10 p.m. and reconvened at 1:22 p.m. that same day.

Ms. Ryan introduced Barbara Pacheco, Senior Vice President, Financial Services

Division, Federal Reserve Bank of Kansas City, the speaker for the fifth panel, "Recent

Developments in the Retail Payment Systems." Ms. Pacheco commented that she had spoken

with the Committee in July 2013, a period when the Federal Reserve System staff was

developing a consultation paper to obtain feedback on modernizing the U.S. payments system.

She reviewed some issues community bankers had raised, including: maintaining the ability to

compete with larger financial institutions; community banks' heavy reliance on vendors for

technology services; the time and cost of implementing change; payments systems' security

issues; and, international payments issues. Ms. Pacheco reported that the Federal Reserve had

also consulted about modernization with banks of all sizes, non-banks, technology companies,

business users and consumers to develop the paper "Strategies for Improving the us. Payment

System," ("Strategies"), published January 26,2015. She said the Federal Reserve concluded

that the payment system needs modernization, a huge undertaking, but one which has broad

support for the hard work of further elaborating the plan and implementing it.

April 2, 2015
328

Ms. Pacheco described the genesis of the Payments Modernization Strategy. She noted

that the reserve banks, in their role as operators of the payments system, regularly update their

strategic plan and survey the environment, but also recognized that several factors converged to

warrant an expanded end-to-end review of the payments system. These factors included: greater

technological capabilities; increased consumer expectations; increased security threats; and

international competitiveness issues as other countries upgraded their payment systems. Ms. .

Pacheco observed that the Federal Reserve issued a modernization consultation paper in 2013

and received over 200 responses which agreed with the goals the Federal Reserve had identified.

In addition, the Federal Reserve conducted a series of research studies. One was a global case

study on faster, real-time payments systems that researched what business and consumer demand

was and their willingness to pay. Ms. Pacheco said the Federal Reserve attempted to identify

what types of payments benefited most from speed and reviewed various design options for

faster payments. She reported that the Federal Reserve also conducted a payment security

landscape study.

Ms. Pacheco observed that the 2015 Strategies paper set out five desired outcomes and

delineated multi-year actionable deliverables to achieve them. The first goal was speed. Ms.

Pacheco observed that checks are ubiquitous, widely accepted, fast once they enter the banking

system, and there is no comparable all-electronic alternative that has those characteristics to

make payments from one bank account to another. The second goal was security. Here, Ms.

Pacheco said, the desired outcome was a very strong payment system, with high public

confidence, that was responsive to changing threat landscapes. She remarked that the

complexity involved was great and that it was difficult to get all of the many players to adopt

common standards and implementing technology that will close the current payment system

gaps. The third goal was efficiency. Ms. Pacheco noted that the U.S. payment system still has a

large share of payments being made by check, often with a small business on one side of the

transaction, and that this provided a good opportunity for improving the system. She said that

efficiency would also benefit from having a platform for innovation that could find future

efficiencies. Finally, Ms. Pacheco also noted that the efficiency goal takes into account the

unbanked or underbanked consumers who currently may not have access to electronic payments.

The fourth goal is to increase choice, convenience and timeliness in international payments,

attributes which are not present in the current system. Regarding the final goal of collaboration,

Ms. Pacheco noted that there are about 6,500 commercial banks, about the same number of credit

unions, hundreds of service providers, and millions of businesses. She emphasized that the

success of the new payment system design depended on effective coordination among all those

groups. Ms. Pacheco said that the website FedPaymentsImprovement.org was established to

assist in the collaborative effort and allow virtual forums, presentations, blogs, social media, and

two-way conversations among the parties in the payment system.

Ms. Pacheco discussed two issue specific task forces, one focused on faster payments, the

other on secure payments. The task forces are chaired by Federal Reserve staff, but will elect

participants to assist in managing the work. Ms. Pacheco said that the faster payments task force

will identify alternatives for implementing a faster payment system and will address such issues

as: what the core infrastructure will be; what features will be included (such as credits, real-time

posting, availability, how often settlement happens); what access model will be used to provide

April 2, 2015
329

ubiquity of payments to unbanked and underbanked persons; what the cost of implementation

will be; and what type of governance and rule structure will be used. The second task force, Ms.

Pacheco explained, will focus on the requirements that a faster payment system needs to be

secure, safe and resilient. She said the secure payments task force will help set security

requirements that the faster payments task force can use to evaluate alternatives. In addition, the

secure payments task force would consider how to increase the speed of developing future

security standards and how best to share high-quality, actionable cybersecurity data. Ms.

Pacheco said that the Federal Reserve could make independent contributions on payments

security, including: studying what incentives drive investment (or non-investment) in payment

security; providing data collection and data reporting assistance; and facilitating collaboration

among the FFIEC and other government agencies to focus on payment security issues.

Ms. Pacheco discussed the strategy for increasing payments efficiency for both domestic

and international payments. She said the Federal Reserve studied the possible adoption of a

European standard for payments, messages and related information. Ms. Pacheco indicated that

the concept of directories was being considered for increasing payments efficiency, as well as

increased security and speed. The concept of directories, she explained, meant that a person's

bank account information would be kept and protected in the person's financial institution (or a

centralized directory) so payment messages could be routed from the payer to the receiver

without exposing account information. Ms. Pacheco reported that work is already underway to

consider how to implement payment directories securely and efficiently. Ms. Pacheco noted that

business-to-business payments remain reliant on check payments and indicated that there is

opportunity to achieve greater efficiency as smaller businesses transition to electronic payments.

Finally, Ms. Pacheco discussed the strategy to enhance the Federal Reserve Banks' financial

services to financial institutions. She said the Federal Reserve had embarked on improving the

national settlement service and risk management services for ACH and wire transfers. She

concluded that the modernization of the payment system would be a massive undertaking for the

industry, but was needed to support continued economic growth and ensure public confidence in

the payment system. Ms. Pachecho said that the Federal Reserve had committed its support to

the project, but needed private sector engagement, including community banks.

Member Haskin thanked the Federal Reserve for its work. She thought that a "credit

push" system using a directory was preferable to a "debit pull" approach because the credit push

and directory approach eliminated a significant amount of fraud risk that would exist with debit

pull. [The 2015 Strategies paper described the credit push methodology as requiring the payer to

specify the account number and routing number of the payee in the payment message; in

contrast, in a debit-pull payment, the payer supplies his/her account information to the payee.]

Member Haskin reported that community banks were concerned that, in a changed payments

system, they would have to do multiple daily settlements, but that with a credit push and

directory approach, that would not be necessary. Ms. Pacheco anticipated that settlement issues

would be a key area for discussion. She said a key element of the discussion would concern how

to manage the risk between the fund-sender's financial institution and the fund-receiver's

institution in committing to the payment. Ms. Pacheco said directories would be a key aspect of

the discussion and observed that decentralized directories could be used as long as they were

interoperable in achieving immediate delivery of the payment message. In response to a

question from Vice Chairman Hoenig about her vision ofthe operation of a directory, Member

April 2, 2015
330

Haskin said that a customer could register how they wanted to receive their funds, for example,

by providing a telephone number or email address. Member Haskin indicated that if the

receiving bank had some type of email or memorandum, they could use it as their method of

posting funds to the customer's account and then the funds would settle later that night. She

thought settlement seems to be a big issue, but that the key was to be sure of having good funds

on the credit push side.

Member Hartings asked what Ms. Pacheco viewed as the first step towards

standardization; was it a legislative action? Ms. Pacheco reported that the Strategies paper

encouraged a private sector solution over a regulatory solution. She observed that there is

significant fragmentation in payments system innovation and that it would be beneficial if

financial institutions could offer real-time payment services that are interoperable with nonfinancial institutions' services. Member Blankenship expressed concern about the continued role

of smaller community banks in payments systems because so many alternatives are available.

She said that bankers had heard that other countries had already adopted payments system

changes that were working relatively seamlessly and without much fraud or risk, and inquired

how difficult it would be to overlay an international model onto the U.S. system. Ms. Pacheco

observed that a lot could be learned from international examples and the U.S. did not need to

start from zero. She noted that the Federal Reserve's test for a new system included efficiency,

ubiquity and security, and that financial institutions' test was the ability to serve their customers

in a cost-effective way. Ms. Pacheco said that the collaborative effort would seek a solution that

met both the policy and the commercial interest test. Member Castillo suggested it would be a

challenge to get all the stakeholders to collaborate; if they did not, the result would be many

incompatible systems trying to achieve dominance. Ms. Pacheco agreed and indicated that the

goal was to negotiate a common commitment to the ultimate goal as opposed to what benefited a

particular business or business segment. In response to a question from Member Busse about

coordination between the two task forces, Ms. Pacheco said those issues were being actively

considered and that substantial collaboration would be required.

Member Lundy inquired how consumer protection issues weighed in the payments

systems modernization project. He observed that chargeback windows were lengthy and could

pose a risk to banks in a faster payments environment and inquired what the Federal Reserve

thought about the potentially conflicting agendas. Ms. Pacheco said that consumer views were

an important perspective to be included in the modernization project. She discussed ways that

consumer views could be represented in the task forces, including participation by the CFPB

and/or advocacy groups. Ms. Pacheco said the faster payments task force would define the

criteria for determining what is an effective faster payments system and that the consumer

perspective would be an important element of the criteria. Member Scully expressed concern

that alternative lending platforms threatened the viability and relevance of community banks.

She noted that credit cards --as opposed to debit cards, checks and ACH-- had become such a

viable payment form and observed that credit cards were an area where community banks did not

have much presence. Member Scully expressed the view that banks are not making much money

off the payment systems while companies such as Apple Pay and PayPal were making money off

the front-end of the payment systems. Ms. Pacheco indicated that, although she did not know

what the specific revenue generating opportunities would eventually be, she believed that banks

would be able to innovate and develop new products off of a modernized payments platform.

April 2, 2015
331

She observed that, two years previously, financial institutions did not believe that they would be

able to generate enough revenue to offset the cost of upgrading the payments system, but that

view had since changed. In response to a question from Chairman Gruenberg, Ms. Pacheco

explained that she often used "we" in her comments to express the need for collaboration in the

payments modernization project. She noted that the Federal Reserve does not have authority to

mandate improvements in the payment system and that the success of the project would require

collective effort by financial institutions, non-banks and other stakeholders.

George French, Deputy Director, RMS, Jonathan Miller, Deputy Director, DCP, and

Elizabeth Ortiz, Deputy Director, DCP then moderated a panel titled, "Recent Supervisory

Updates." Mr. French observed that IRR was an important topic for community banks as the

economy transitions from years of low interest rates into a period of rising interest rates. He said

the FDIC takes IRR seriously in its examinations and devotes significant effort to increasing IRR

awareness and providing technical resources to respond to it. Mr. French said that the recent

issue of the FDIC's Supervisory Insights journal was devoted to practical advice on IRR for

community banks and described four articles on the subject. The first article discussed the

fundamental role of corporate governance regarding IRR. Mr. French said that IRR management

is not about forecasting interest rates, but ensuring that the bank is prepared for a range of

outcomes. The article emphasized the importance of setting limits for items such as net income

and economic capital and establishing mitigating steps when those limits are breached. Mr.

French observed that the FDIC encourages gradual and prudent rebalancing of a bank's assets

and liabilities rather than a rapid, wholesale sell-off of long-term securities. He recognized that

mitigating risk by rebalancing involves the sacrifice of current income and observed that

examiners would not penalize a bank's CAMELS earnings' rating component if the bank was

undertaking a prudent rebalancing strategy. The second article involved developing key

assumptions for IRR. Mr. French said the emphasis is to help banks develop and support the

assumptions with their existing staff. He noted that examiners would look favorably on simple,

conservative assumptions that the bank management understands. The third article dealt with the

development by banks of an in-house, independent review of their IRR. Mr. French said the

independent review allows a bank board to have a second set of eyes appraising the bank's

critical IRR controls to ensure that the controls are working properly. He said there is no

requirement that banks engage third parties to perform independent reviews and the article

focused on ways banks can use their own resources to conduct them. The fourth article

described what banks can expect during an IRR review: items examiners will request to see; the

issues they will focus on; the topics they will typically want to discuss with bank management;

and, what a bank can do if it disagrees with the examiner.

Mr. French discussed the restrictions on banks that are less than well-capitalized from

accepting brokered deposits and the limits on their interest rates for deposits. He observed that,

over the years, the FDIC interpreted the statutory restrictions through regulations and in various

letters and advisory opinions and recently determined it would be useful to consolidate the

material into a single, user-friendly Frequently Asked Questions ("FAQ") format. Mr. French

said that the new FAQ document does not establish any new policies. He then emphasized two

points about brokered deposits. First, he said, brokered deposits can be a suitable funding source

when properly managed as part of a prudent overall funding strategy; FDIC examiners are

instructed to look at the totality of a bank's risk profile so that a bank's use of broker deposits

April 2, 2015
332

would not result in an automatic examiner criticism. Second, however, Mr. French observed that

the overuse of brokered deposits and the improper management of them by problem institutions

contributed to bank failures and losses to the Deposit Insurance Fund, and were, in fact, the

reasons the statutory restrictions exist. Mr. French said the FAQs describe the meaning of key

concepts concerning brokered deposits and provide specific examples of different products. He

noted that the FAQs generated helpful discussion with bankers, some of which prompted the

FDIC to clarify its meaning; he also said that the FDIC would sponsor an industry teleconference

to discuss the FAQ document. Mr. French recognized that many brokered deposit questions

depend on specific facts and said that banks that are unsure of the proper treatment could contact

their FDIC regional office or headquarters subject matter experts.

Member Lundy spoke about reciprocal deposit relationships such as the Certificate of

Deposit Account Registry Service ("CDARS") and the Insured Cash Sweep Program. He

indicated that they are beneficial for community banks because they allow certain organizations

to make deposits in community banks rather than limiting the placement ofthose organizations'

deposits in banks that are perceived as "too big to fail." Mr. French agreed and observed that

FDIC examiners look at the specific situation in assessing risk. He said that in many cases

CDARSs may be relationship deposits that pose little risk, while there could be other cases

where banks aggressively gather these deposits in a way that increases their risk profile. He also

noted that CDARSs meet the statutory definition of brokered deposits. Member Busse said the

clarification to the Brokered Deposits FAQ concerning whether insurance agents, lawyers or

accountants who refer clients to banks are considered deposit brokers was very helpful.

Mr. Miller described two CFPB proposed rule changes that would affect the application

of the CFPB's Ability to Repay / Qualified Mortgage ("ATR/QM") rule (as well as others). The

first revision proposed by the CFPB relates to the definition of "small creditor." Mr. Miller

noted that the small creditor definition currently has two parts, an "originations" test and a lender

"asset-size" test. The current originations test for a small creditor is - if the lender originates 500

or fewer first lien loans. Under the proposed revision, he said, a lender would be a small creditor

if it (and its affiliates) sold fewer than 2,000 first-lien loans. Mr. Miller noted that the CFPB

proposed no change to the second part of the definition: that the lender must have assets of $2

billion or less (as adjusted for inflation, so that the 2014 asset amount is $2.028 billion in assets).

He observed that other QM requirements concerning product restrictions, underwriting

requirements, and portfolio holding were also unchanged. Mr. Miller said that, under the

CFPB's proposed definition, community banks would be able to make as many portfolio loans as

they chose without jeopardizing their small creditor status. He also described the benefits to

lenders of having small creditor status. Mr. Miller said the CFPB estimated that the proposed

rule change would increase the number of small creditors from 9,700 to 10,400, although he

noted that most FDIC supervised institutions already qualified as small creditors.

When the presentation was later opened to Committee questions and comments, Member

Hartings observed that there was value to changing the definition of small lender from "500

loans originated" to "2,000 sold" for banks between $500 million and $2 billion in asset size. He

said his bank had made 490 such loans in 2012, thus coming close to the current threshold. Mr.

Miller agreed that it would not be good policy to discourage banks to stop lending at 499 loans in

order to avoid losing its small lender designation. He added that it was even more important that

the CFPB' s proposed rule changed the focus from the number of loans originated to the number

April 2, 2015
333

of loans sold; under the proposed definition, banks would be able to hold an unlimited number of

mortgages in their portfolio (if they met the other requirements). Member Hartings also

suggested that the CFPB apply its threshold for escrows on higher priced mortgages to the other

higher priced mortgage regulations, including appraisals and disclosures.

Mr. Miller also described the CFPB's proposed change in the definition of "rural" for the

purposes of the ATR/QM rule, a subject that had been of interest to many community banks. He

observed that a rural lender is defined by the location of the loans and mortgages the institution

makes, and that, to be rural, more than 50 percent of their loans have to be in a rural area. Mr.

Miller described the current CFPB definition of a rural county as including those counties that

(during a calendar year) were neither in a metropolitan statistical area ("MSA") nor in a

micropolitan statistical area that is adjacent to an MSA. He said the proposed rule change would

add an alternate definition of rural to include the situation where the property securing the loans

is in an area that is not designated as an "urban area." Mr. Miller said the proposed definition

change would be significant: it would increase the number of rural lenders from 2,400 to 4,100

(a number that includes banks and non-banks); and, it would increase the percentage of the

population that lives in a rural area from 9 to 22 percent. He also described the benefits of being

classified as a small rural creditor.

Ms. Ortiz discussed interagency guidance about encouraging youth savings programs and

two related FDIC initiatives focused on expanding youth financial capability. She said the

purpose of the interagency guidance was to encourage financial institutions, working with

schools, to develop savings programs to improve youth financial awareness and capability. Ms.

Ortiz said the guidance was not intended to create any new industry expectations, but rather to

clarify how the existing guidelines apply and to compile frequently asked questions and answers.

Ms. Ortiz said that many financial institutions collaborated with many schools, government, nonprofit and private partners to offer youth savings and financial education programs. She said that

there was no single approach to the various programs, but noted that there was consensus that

starting early in students' lives helped build good financial habits. Ms. Ortiz said the agencies

hoped the guidance would clarify some misconceptions about the application of the rules to

programs and thereby encourage new programs and the expansion of existing ones. She then

provided the Committee with an overview of the ten FAQs in the guidance, including: the

general rules that apply to financial institutions; how they may obtain CRA credit for their

programs; customer identification requirements; and when a branch application would be

required (or not). Ms. Ortiz said the early feedback from the guidance was positive and the

agencies planned to disseminate information about youth savings programs soon. She invited

banks to participate in the program and to contact her staff about any questions they might have.

Ms. Ortiz also discussed the FDIC youth saving pilot program that is intended to identify

and highlight promising approaches to offering financial education tied to safe, low-cost

accounts for students. She said the FDIC launched the program's Phase 1 last August with 9

banks participating and that invitations to participate in Phase 2, involving about 20 banks,

would be issued soon. Ms. Ortiz indicated that those joining created a community of

participation where banks could learn from each other and receive FDIC technical assistance. In

exchange, the FDIC asked participants to share data about their programs, such as: the number

of accounts opened; the average amount saved; if the accounts helped the institution establish

account relationships with the students' parents; and, what financial education strategy was used.

April 2, 2015
334

Ms. Ortiz also discussed the FDIC's Money Smart program for young people which, she said,

was completely updated and expanded to cover all grade levels. She noted that the program

included companion parent guides that allowed parents to follow what the students were learning

in school and that the FDIC also provided videos of selected exercises being taught in

classrooms, along with suggestions of how to adapt exercises for various uses.

Member Lundy asked if the FDIC had looked at other educational sources when it

revised its Money Smart curriculum and how the FDIC program compared to others. Ms. Ortiz

reported that the FDIC development contractor was familiar with other educational offerings.

She said the FDIC curriculum was distinguished by its comprehensiveness (covering all age

ranges with segments that are targeted and age-appropriate) and by its companion parent guide

which included exercises parents could engage in with their children. Member Haskin asked if

the Money Smart program for young people taught about the stock market. Ms. Ortiz responded

that the Money Smart program for young ages focused on understanding money and basic

financial concepts, then banks and banking relationships. She said the high school curriculum

was extensive and discussed federally insured investment options such as bank accounts and

non-FDIC insured investment vehicles, the relationship between risk and return, and market

fluctuation and the potential for loss.

Member Haskin expressed the opinion that youth financial education was particularly

important because young people will be responsible for their financial well-being in an

environment that does not generally include pension plans. She also emphasized that youth

financial education should include information about student loan debt. Member Haskin said her

bank was seeing financial statements of young people who had such significant student debt that

they would be precluded from borrowing money to purchase a home. She indicated that it is

easy for young people to incur student debt without understanding how difficult it can be to

repay it. Member Blankenship asked if there was a Money Smart program aimed at small

business entrepreneurs. Ms. Ortiz responded that there was a Money Smart for Small Business

geared toward emerging entrepreneurs which provides them with the information they need to

approach a bank, discuss their business and access capital for their business. She added that the

Money Smart programs are usually intended to be delivered by an instructor and so are not

available as videos. Ms. Ortiz said that the FDIC partnered with the Small Business

Administration and other networks of small business development centers to deliver the Money

Smart for Small Business training.

Chairman Gruenberg said that the Committee continued to be a great resource for the

FDIC and thanked the members for their participation.

There being no further business, the meeting was adjourned at 3:00 p.m.

Robert ~ . Feldman

Executive Secretary

Federal Deposit Insurance Corporation

And Committee Management Officer

April 2, 2015
335

Minutes

of the

Meeting of the FDIC Advisory Committee on Community Banking.

of the

Federal Deposit Insurance Corporation

Held at the

Federal Deposit Insurance Corporation

Board Room

Washington, D.C.

Open to Public Observation

April 2, 2015 - 9:00 A.M.

I hereby certify that, to the best of my knowledge, the attached minutes are accurate and complete.

~L

Martin J. Gr~nberg

Chairman

Board of Directors

Federal Deposit Insurance Corporation

April 2, 2015