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FDIC

Banking

Review

2001

Volume 14, No. 1

Failure Resolution and

Asset Liquidation

Merchant Banking

Recent Developments
Table of Contents 

FDIC
 

Banking

Review
 2001
 

Volume 14, No. 1
 

Chairman 

Donald E. Powell 

Division of Research 

and Statistics, 

Director 

Wm. Roger Watson 

Deputy Director 

Barry Kolatch 

Editor 

James A. Marino 

Managing Editors 

Detta Voesar
 

Lynne Montgomery
 

Editorial Secretary 

Cathy Wright
 

Design and Production
 

Geri Bonebrake
 

Cora Gibson
 

The views expressed are 

those of the authors and do 

not necessarily reflect official positions of the Federal 

Deposit Insurance Corporation. Articles may be 

reprinted or abstracted if 

the FDIC Banking Review 

and author(s) are credited. 

Please provide the FDIC’s 

Division of Research and 

Statistics with a copy of any 

publications containing reprinted material. 

Single-copy subscriptions 

are available to the public 

free of charge. Requests for 

subscriptions, back issues 

or address changes should 

be mailed to: FDIC Banking 

Review, Public Information 

Center, 801 17th Street, 

N.W., Washington, DC 

20434. 

Failure Resolution and Asset Liquidation: 

Results of an International Survey of Depositors 

by Rosalind L. Bennett Page 1 

The author summarizes and discusses results of a Federal Deposit Insurance 

Corporation survey of foreign deposit insurance organizations. 

focuses on procedures for resolving and liquidating failed banks. 

The article 

Merchant Banking: Past and Present 

by Valentine V. Craig Page 29 

Recent legislation permits financial holding companies to engage in merchant 

banking, a lucrative activity for a handful of large commercial and investment 

banks for many years. The author provides a history of merchant banking and 

commercial bank involvement in this specialty. 

Recent Developments Affecting Depository Institutions 

by Lynne Montgomery Page 37 

This regular feature of the FDIC Banking Review contains information on 

regulatory agency actions, state legislation and regulation, and articles and 

studies pertinent to banking and deposit insurance issues. 

Editor’s note: In “The Cost of the Savings and Loan Crisis: Truth and Consequences,” which 

appeared in the last issue of the FDIC Banking Review, footnote 2 referenced an American 

Banker commentary by Kenneth H. Thomas in which he wrote “The public did not realize the 

monster Congress had created until taxpayers got the roughly $500 billion bill for bailing out 

the thrift industry.” Subsequent to publication, Mr. Thomas informed us the $500 billion 

figure was a typographical error and that he meant to write $150 billion, a figure he had used 

in previous articles and more in concert with the cost of the S&L crisis calculated in this article. 
Failure Resolution and Asset Liquidation 

Failure Resolution and 

Asset Liquidation:
 

Results of an International
 

Survey of Deposit Insurers
 

by Rosalind L. Bennett*
 

Alarge part of any country’s financial safety net1 

is the winding up, or resolution and asset liquidation, of insolvent banks.2 Even in a healthy 

economy, banks may become troubled. When a bank 

is no longer a viable business, the financial safety net 

should provide for that bank’s resolution and asset liquidation. And often a majority of the claims on a failing bank are the deposits, which the deposit insurer is 

responsible for reimbursing. Thus, the deposit insurer plays a role in the resolution of insolvent banks. 

In January 2000, the Federal Deposit Insurance 

Corporation (FDIC) sent a survey on deposit insurance practices to 73 foreign deposit insurance organizations. These 73 insurance organizations represent 

all explicit deposit guarantee programs in existence at 

the beginning of the year 2000 (excluding those in the 

United States). The survey’s questions address the 

characteristics of deposit insurance systems by focusing on five general areas: (1) risk assessment, (2) funds 

availability, (3) failure-resolution methods, (4) the role 

of the receiver, and (5) asset liquidation. 

As of June 2000, 37 deposit insurers in 34 locations 

had completed and returned the survey.

3 The locations of the respondents can be categorized as 

“advanced economies,” “developing economies,” or 

“economies in transition.”4 At year-end 1999, these 

34 economies—which account for over one-half of 

world gross domestic product (GDP)—contained 

6,000 banks and over 65 percent of the banking assets 

in the world. (See Table 1.) 

This article reports on the nature and extent of the 

role played by the 37 survey respondents in winding 

up failed banks. The article summarizes and discusses only the results of questions that directly address 

the resolving and liquidating of failed banks.5 The 

article does not discuss relationships between the 

resolving and liquidating of failed banks and other 

topics in the survey (the supervision of banks, the 

funding of the deposit insurance scheme, and the 

transparency of financial reporting).6 

The article draws upon both the academic literature 

and the practical experience of the United States with 

deposit insurance systems. The lessons the FDIC has 

learned may help other countries design effective policies related to the winding up, or the resolution and 

asset liquidation, of failed banks. The position of this 

* Rosalind L. Bennett is a financial economist in the FDIC’s Division of 

Research and Statistics. 

1 For the purposes of this article, the safety net refers to the deposit 

insurance system, the resolution of failed banks, and the liquidation of 

failed-bank assets. 

2 For simplicity, in this article the term “bank” refers to any deposit-taking financial institution. 

3 Some locations have more than one deposit insurer. Not every question was answered by each respondent so there may be less than 37 

responses to each question. 

4 The classification of economies into “advanced,” “developing,” or “in 

transition” is from International Monetary Fund (2000). In the tables, 

the second and third categories are combined into one. 

5 Articles summarizing and discussing the risk assessment and funds 

availability portions of the survey will appear in future issues of the 

FDIC Banking Review. 

6 One example of these kinds of connections: how the appropriate 

authority will resolve a failed bank is affected by the funding of the 

deposit insurance scheme. 

1 
FDIC Banking Review 

Table 1
 

Survey Respondents, Summary Statistics, 1999
 

Population GDP Banking Industry 

Share of 

Share of Share of World 

Total World World Number Banking Banking 

Population Population Total GDP GDP of Assets Assets 

Deposit Insurer (millions) (percent) (US$ millions) (percent) Banks (US$ billions) (percent) 

Advanced Economies 

Austria 8.18 0.14% $ 208,949 0.69% 844 $ 608.3 1.32% 

Belgium 10.15 0.17 245,706 0.81 84 938.1 2.03 

Canada 30.49 0.52 612,049 2.03 112 584.6 1.27 

France 59.10 1.01 1,410,262 4.67 328 3,506.3 7.59 

Germany 82.09 1.40 2,081,202 6.89 2,517 6,877.7 14.89 

Greece 10.63 0.18 123,934 0.41 28 82.1 0.18 

Isle of Mana 0.08 0.00 985 0.00 49 n.a. n.a. 

Italy 57.34 0.98 1,149,958 3.81 363 2,263.2 4.90 

Japan 126.51 2.15 4,395,083 14.55 177 7,620.0 16.50 

Netherlands 15.81 0.27 384,766 1.27 80 1,328.5 2.88 

Portugal 9.96 0.17 107,716 0.36 50 334.2 0.72 

Spain 39.42 0.67 562,245 1.86 154 1,470.1 3.18 

Sweden 8.86 0.15 226,338 0.75 40 260.1 0.56 

Taiwan Province of China 22.00 0.37 362,000 1.20 49 n.a. n.a. 

United Kingdom 58.74 1.00 1,373,612 4.55 302 3,628.3 7.86 

Subtotal 539.36 9.18% $13,244,805 43.85% 5,177 >$29,501.5 >63.88% 

Developing Economies and Economies in Transition 

Africa 

Nigeria 108.95 1.85 43,286 0.14 81 9.5 0.02 

Tanzania 32.79 0.56 8,777 0.03 10 1.3 0.00 

Uganda 21.62 0.37 6,349 0.02 21 0.9 0.00 

Europe 

Czech Republic 10.28 0.17 56,379 0.19 36 84.5 0.18 

Hungary 10.07 0.17 48,355 0.16 46 26.7 0.06 

Latvia 2.43 0.04 6,664 0.02 25 3.2 0.01 

Lithuania 3.66 0.06 10,454 0.03 11 2.7 0.01 

Poland 38.65 0.66 154,146 0.51 87 76.2 0.17 

Romania 22.46 0.38 33,750 0.11 18 8.0 0.02 

Slovak Republic 5.40 0.09 19,307 0.06 25 15.6 0.03 

Turkey 64.39 1.10 188,374 0.62 67 96.2 0.21 

Middle East 

Bahrain 0.67 0.01 5,350 0.02 36 8.1 0.02 

Oman 2.46 0.04 14,962 0.05 18 9.4 0.02 

Western Hemisphere 

Brazil 163.95 2.79 760,345 2.52 208 286.5 0.62 

El Salvador 6.15 0.10 12,229 0.04 18 7.6 0.02 

Jamaica 2.56 0.04 6,134 0.02 16 4.1 0.01 

Mexico 97.37 1.66 474,951 1.57 63 202.7 0.44 

Peru 25.23 0.43 57,318 0.19 20 20.4 0.04 

Trinidad and Tobago 1.29 0.02 6,998 0.02 17 3.7 0.01 

Subtotal 620.38 10.54% $ 1,914,128 6.34% 823 $ 867.3 1.88% 

Total 1,159.74 19.72 15,158,933 50.18 6,000 >30,368.8 >65.77 

United States 273.13 4.65 8,708,870 28.83 8,907 7,956.9 17.23 

World 5,879.00 100.00% $30,211,993 100.00% n.a. $46,177.5 100.00% 

Note: 

Population—1999 midyear estimates. Source: International Monetary Fund (June 2000), International Financial Statistics. Taiwan Province of China 

and Isle of Man statistics from CIA (1999), World Factbook. 

GDP—1999. Source: World Bank, 2000, Development Indicators. Taiwan Province of China and Isle of Man statistics are 1998 estimates from CIA 

(1999), World Factbook. 

Banking Industry—Number of banks. Source: Thomson Bank Directory (2000), Thomson Financial Publishing. Banking assets as of 1999: International Monetary Fund (June 2000), International Financial Statistics (bank assets are summations of lines 20 through 22 in the International 

Financial Statistics, converted to December 1999 U.S. dollars). World total does not include Afghanistan, Dem. Rep. of Congo, People’s Dem. Rep. 

of Yemen, St. Pierre & Miquelon, and Vietnam. December 1999 data were not available for Djibouti, Greece, Guinea, Republic of Yemen, so data 

from second-quarter 1998 were used. aBritish Crown Dependency. 

2 
Failure Resolution and Asset Liquidation 

article, however, is that there are no universal best 

practices or one-size-fits-all policy prescriptions. 

Among other considerations, differences in the level 

of transparency of financial reporting, in the effectiveness of supervision, in legal structures, and in the 

accountability of public officials will determine which 

design features of the safety net will best fit any one 

country. 

Conceptual Background 

A financial safety net has three principal goals: (1) 

to maintain stability and public confidence in the 

financial system, (2) to minimize the cost of resolving 

failed banks but without weakening the financial system, and (3) to have the receiver dispose of the 

remaining assets as soon as practicable. 

When dealing with failed or failing banks, the challenge in achieving the first goal is to do it with the 

least possible interference with market mechanisms. 

Resolving failed banks in a manner that undermines 

market discipline (for example, by covering all deposit 

and creditor claims) will simply weaken the financial 

system in the long run by encouraging excessive risk 

taking. But not resolving failed banks promptly will 

also undermine the market mechanism—and may, in 

addition, substantially increase the costs of a resolution. 

Accordingly, the financial safety net includes policies on failure resolution, and it is advantageous to 

make the policies clear to the public. Transparency in 

the rules governing the resolution of failed banks 

helps to produce order in the financial system. Clear, 

specific, and publicly known regulatory policies provide banks and their customers with more information 

on which to base their decisions. And when depositors and other bank creditors know which claims the 

deposit insurer will honor quickly, they are unlikely to 

generate liquidity crises in well-run banks. In other 

words, policies that reduce the uncertainty of 

claimants about the amounts they will recover, especially when these policies are accompanied by prompt 

payment of claims, increase public confidence in the 

financial system. Unclear regulatory policies—along 

with poor bankruptcy or receivership laws and the 

lack of timely failure resolutions—can contribute to 

and exacerbate financial crises. 

The challenge posed by the second goal of any 

financial safety net (to minimize the cost of a failure 

resolution without weakening the financial system) 

lies in the fact that minimizing disruption to the economy and maintaining public confidence in the financial system can be costly. One way of meeting this 

challenge is to adhere to a least-cost requirement; that 

is, to evaluate the cost of different failure-resolution 

techniques and determine which is the least costly to 

the deposit insurer. If a strict least-cost requirement is 

in place, regulators are not allowed to weigh secondary 

damage to the community or to other banks when 

determining which resolution transaction to use. 

The third goal of the safety net applies to those resolution techniques that require some or all assets to 

remain with the receiver and calls for the receiver to 

dispose of the remaining assets as soon as is practicable. This goal is consistent with the other two goals. 

When assets held by the receiver are not returned to 

the private markets as soon as is practicable, the economy may be disrupted. Inversely, returning assets 

quickly to the private sector minimizes disruption to 

the local economy by allowing for quicker payments 

to the remaining creditors of the failed bank, thereby 

meeting goal one. In addition, liquidating assets 

quickly accomplishes goal two by eliminating costs 

associated with holding the assets, such as servicing 

costs. 

Practice in the United States 

In the United States, winding up the affairs of a 

bank that has failed typically involves two stages. The 

first stage—the resolution stage—is the process of 

resolving a failed bank; the second stage is the process 

of liquidating the assets of the failed bank (the 

receivership process). The receivership process is 

used for all resolutions except open-bank assistance. 

In the resolution stage of most transactions the 

FDIC values the assets of the failed bank, solicits bids 

for the sale of the bank, and evaluates the bids to 

determine which one is the least costly to the insurance fund.7 If the least costly bid involves the acquisition by a bank of some or all of the assets and 

liabilities of the failed bank, the FDIC works with the 

acquiring bank until the end of the closing process. If 

the least costly bid does not involve an acquirer, the 

FDIC ensures timely payment to insured depositors 

and liquidates the assets over time. 

7 Typically, the FDIC places similar assets in pools and allows bidders to 

bid on the asset pools. Bidders have the option to bid on some or all of 

the asset pools and on some or all of the deposits of the failed bank. 

3 
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FDIC Banking Review 

During the second stage—the receivership 

process8—the FDIC liquidates any remaining assets 

of the failed bank and distributes the proceeds, first to 

the uninsured depositors, then to the general creditors, and finally to the shareholders.9 

When and How a Bank is Closed and
 

Resolved
 

Before the winding-up process, the bank must first 

be closed. This section discusses three issues surrounding bank closure: the rules for closure, the timing of closure, and who has the authority to close 

banks. After the bank is closed, and before the winding-up process can begin, a receiver must be appointed for the failed bank. This section also discusses 

many aspects of the appointment of a receiver, such as 

who appoints the receiver and who usually acts as the 

receiver. The last part of the section discusses the differences between the receivership process for a failed 

bank, as conducted in the United States, and the corporate bankruptcy process. 

Bank Closure Rules 

Banks are typically closed for one of two reasons: 

insolvency or illiquidity. Insolvency occurs when the 

value of the assets held by a bank is less than the value 

of the liabilities held. Illiquidity occurs when a bank 

is not able to meet its current obligations as they come 

due. 

Insolvency can be measured by either book value or 

market value. Accounting conventions usually require 

that banks report assets and liabilities at book value, 

and the Federal Deposit Insurance Corporation 

Improvement Act of 1991 (FDICIA) requires regulatory agencies in the United States to close banks 

before they reach book-value insolvency.10 The reason for this closing rule is that the market value of the 

assets of a bank is uncertain and in troubled banks is 

typically below the book value. Closing a bank before 

it reaches book-value insolvency allows for this uncertainty and helps limit the losses incurred by the 

deposit insurance funds. 

Illiquidity may arise because banks issue demand 

deposits—obligations due upon demand—to fund 

lending activity, and are therefore susceptible to bank 

runs. When depositors know or believe that a bank is 

in danger of failing, they may attempt to withdraw 

their deposits as quickly as possible, causing a liquidity crisis at the bank. 

A bank can be illiquid without being insolvent. In 

the United States, primarily because of deposit insurance and the central bank’s ability to provide liquidity, 

banks usually fail because they are insolvent rather 

than because they are illiquid. In most of the cases 

when a U.S. bank was closed for illiquidity, the liquidity problem had been caused by a belief that the bank 

was insolvent, even though the insolvency had not yet 

been realized in the accounting statements. 

In contrast, the European Union (EU) directive on 

deposit-guarantee schemes (94/19/EEC) is concerned 

with illiquid—not necessarily insolvent—banks. The 

directive requires the activation of the deposit-guarantee scheme when deposits become unavailable. 

Although the EU also has adopted directives 

89/647/EEC and 89/299/EEC that outline capital standards consistent with the Basel capital standards, no 

EU directive currently requires the closure of an insolvent bank.11 

The responses to the survey of deposit insurers 

indicate that in practice a majority of respondents 

close banks when they become insolvent. Of the 37 

deposit insurers that had responded as of June 2000, 

over two-thirds answered “Yes” to the following survey question: Are troubled insured depository institutions 

routinely closed and liquidated or otherwise reorganized 

when equity capital is exhausted? This proportion was 

roughly similar for both groups of deposit insurers, 

those in advanced economies and those in developing 

economies and economies in transition. (See Table 2.) 

Timing of Bank Closure 

When the resolution of a failed bank is performed 

quickly and smoothly, benefits accrue to the economy 

and to the financial system. The swift resolution of a 

small bank minimizes disruption to the local community. The swift resolution of a large bank is especially 

critical because the failure of the bank may affect the 

national economy. 

8 The receivership process is similar to the bankruptcy process used in 

countries other than the United States. However, as discussed later in 

the article, the receivership process differs from the bankruptcy 

process in important ways. 

9 In the resolution stage, the FDIC provides timely payment to the 

insured depositors; then, during the receivership process, the FDIC 

stands in the place of the insured depositors. Claimants on the 

receivership (including the FDIC itself, as the receiver that has administrative expenses and as the stand-in for the insured depositors) 

receive payment according to their assigned priority, as dictated by the 

Omnibus Budget Reconciliation Act of 1993; the relevant provisions 

are commonly known as National Depositor Preference. The priority 

is as follows: administrative expenses of the receiver, secured claims, 

domestic deposits (insured and uninsured), foreign deposits and other 

general creditor claims, subordinated creditor claims, and shareholders. 

For more detail on National Depositor Preference, see Marino and 

Bennett (1999). 

10 The prompt corrective action provisions of FDICIA require the regulatory agency to close a bank that has a ratio of tangible equity to assets 

that is less than or equal to 2 percent. 

11 For more information on financial developments in the EU, see 

Murphy (2000). 

4 
Failure Resolution and Asset Liquidation 

Table 2
 

Bank Closures
 

Are troubled depository institutions routinely 

closed and liquidated or otherwise reorganized 

when equity capital is exhausted? 

Have there been examples where equity-insolvent, 

insured depository institutions have been 

allowed to operate for extended periods? 

Deposit Insurer Yes No Yes No 

Advanced Economies 

Austria (AAR) X X 

Austria (AABB) X X 

Belgium X X 

Canada X X 

France X 

Germany (EdB) X X 

Germany (E) X X 

Greece X X 

Isle of Mana X X 

Italy (IDPF) X X 

Italy (DPFCB) X X 

Japan X X 

Netherlands X X 

Portugal X 

Spain X X 

Sweden X 

Taiwan Province of China X X 

United Kingdom X 

Subtotal 11 7 3 11 

Developing Economies and Economies in Transition 

Africa
 

Nigeria X X
 

Tanzania X X
 

Uganda X X
 

Europe 

Czech Republic X X 

Hungary X 

Latvia X 

Lithuania X X 

Poland X X 

Romania X X 

Slovak Republic X X 

Turkey X 

Middle East 

Bahrain X X 

Oman X X 

Western Hemisphere 

Brazil X 

El Salvador X X 

Jamaica X X 

Mexico X 

Peru X X 

Trinidad and Tobago X X 

Subtotal 14 5 7 7 

Total 25 12 10 18 

Note: Classification of economies into “Advanced,” “Developing,” or “Economies in Transition” is from International Monetary Fund (2000). Deposit 

insurers without an “X” in either the Yes or No column did not answer the question on the survey or did not provide an answer that was easily categorized as yes or no. 

aBritish Crown Dependency. 

AAR = Association of Austrian Raiffesenbanks 

AABB = Association of Austrian Banks and Bankers 

EdB = Entschadigungseinrichtung deutscher Banken 

E = Einlagensicherungs 

IDPF = Interbank Deposit Protection Fund 

DPFCB = Deposit Protection Fund for Co-operative Banks 

5 
FDIC Banking Review 

Banks typically fail after a gradual deterioration 

rather than after a single adverse event. Thus, the 

timing of the closure of a bank directly affects the costs 

to the deposit insurer: generally the longer the condition of a bank deteriorates, the higher the resolution 

cost to the deposit insurer. As a bank approaches failure, uninsured, unsecured liabilities will either flee or 

attempt to become insured or secured.12 In addition, 

managers of the bank will have an incentive to take on 

more risk in an attempt to earn sufficient returns to 

save the bank from failure. Usually, however, these 

actions result not in high returns to the bank but in 

higher losses to the deposit insurer. 

In the United States, FDICIA contains prompt corrective action provisions that formalize the timing of 

regulatory actions and closure on the basis of capital 

ratios. As the capital of a bank deteriorates, prompt 

corrective action requires bank regulators to initiate 

progressively more-stringent restrictions on the activities of the bank. Thus, prompt corrective action 

requires the bank regulators to intervene early; and, by 

formalizing the process, prompt corrective action significantly reduces the potential for regulators to apply 

forbearance.13 Formalizing early intervention may 

also limit excessive risk taking by making bank managers aware of the consequences of their actions.14 

Outside the United States, formal early-intervention rules are not widespread, but in practice most survey respondents generally do intervene when a bank 

is insolvent. Eighteen of the 28 respondents replied 

“No” to the following survey question: Have there been 

examples where equity-insolvent, insured depository institutions have been allowed to operate for extended periods? 

(See Table 2.) An insolvent bank is more likely to continue to operate in developing economies or 

economies in transition: one-half of the respondents 

in this group (7 of 14) have allowed insolvent banks to 

operate, whereas only 3 of the 14 deposit insurers in 

advanced economies have done so. 

Authority to Close a Bank 

How long an insolvent bank is allowed to linger 

may be influenced by who has the authority to close a 

bank. Insolvent banks may be more likely to linger if 

the authority to close a bank does not lie with the entity that is accountable for the costs of forbearance. The 

costs of forbearance are borne by the creditors of the 

impending receivership—including the deposit insurer (as explained in note 9). In a government-sponsored deposit insurance system, the ultimate cost of 

forbearance may be borne by the taxpayer. 

In the United States, the entity that charters the 

bank has the authority to revoke the charter—essentially, to close the bank.15 After closing the insured 

bank, the chartering agency usually appoints the 

FDIC as receiver (see next subsection). Alternatively, 

in some circumstances the FDIC itself has the authority to close a bank, or terminate deposit insurance.16 

Thirty-seven survey respondents answered the following question: Who can declare a commercial bank 

legally insolvent? Thirty-five of the 37 specified that a 

government agency (including the court system) has 

the authority to declare a bank insolvent. In the 

remaining two economies (Canada and Bahrain), a 

government agency can declare a bank insolvent or a 

private party—specifically the creditors of the bank— 

can petition the court for a winding-up order. 

Appointment of a Receiver 

Once the authorized entity closes a bank, usually 

the bank requires a receiver. The duties of a receiver 

for a bank are to market its assets, sell them, and distribute the proceeds, after expenses, to the creditors of 

the bank. As mentioned in the previous subsection, in 

the United States the chartering authority closes the 

bank and appoints the FDIC as receiver. Thus, the 

FDIC acts as both the deposit insurer and the receiver of failed banks. Having one agency discharge both 

these functions simplifies procedures, eliminates the 

duplication of records, and places the responsibility of 

asset liquidation on the largest creditor who has an 

incentive to obtain the maximum possible recovery.17 

12 For evidence on the shifting of liabilities in large banks, see Marino 

and Bennett (1999). 

13 When regulators refrain from taking actions that are normally required 

by statute, they are adopting a policy of forbearance. The reasons 

behind using forbearance can be complex. In the United States, regulators have applied forbearance successfully in the past to avoid a 

financial crisis. Forbearance, however, can create an opportunity for 

the troubled bank to deteriorate further and may therefore increase 

resolution costs. 

14 For a discussion of early intervention, see European Shadow Financial 

Regulatory Committee (1998). 

15 To engage in the business of deposit-taking in the United States, 

organizations must obtain a charter. The chartering authority for statechartered banks is usually the state banking department; for national 

banks, the Office of the Comptroller of the Currency (OCC); and for 

federal savings institutions, the Office of Thrift Supervision (OTS). 

16 FDICIA gave the FDIC the authority to close any bank that is considered to be critically undercapitalized and that does not have a plan 

to restore capital to an adequate level. FDICIA also gave the FDIC 

authority to close any bank that (1) has a substantial dissipation of 

assets because of the violation of law, (2) is operating in an unsafe and 

unsound manner, (3) is engaging in a willful violation of a cease-anddesist order, (4) is concealing records, or (5) is no longer insured. 

Twice the FDIC has closed banks and appointed itself receiver (see 

note 18). Section 8 of the Federal Deposit Insurance Act provides 

details of the conditions under which the Board of Directors of the 

FDIC can terminate deposit insurance. 

17 Chapter 8 of FDIC (1998a) and Chapter 7 of FDIC (1998b) discuss 

the role of the FDIC as receiver in more detail. 

6 
Failure Resolution and Asset Liquidation 

The FDIC not only has the authority to act as a 

receiver but also, under FDICIA, has the authority to 

appoint itself as receiver.18 That authority was given 

to the FDIC to make it independent of the chartering 

authorities and able to act in a timely fashion to protect 

the insurance fund. The deposit insurer has an incentive to protect the insurance fund and therefore might 

act more swiftly than the supervisory authorities that 

are not directly accountable for protecting the fund. 

As receiver, the FDIC is responsible for settling the 

affairs of the closed bank or thrift—including (as mentioned above) collecting on the assets of the failed 

bank and, from the proceeds, satisfying the creditor 

claims against the receivership. When the FDIC is 

appointed receiver, it succeeds to the rights, powers, 

and privileges of the bank. It may collect all obligations and money due to the bank, preserve and liquidate its assets and property, and perform any other 

function of the bank consistent with being a receiver. 

Some of the powers of the FDIC as a receiver of 

failed banks are similar to those of a bankruptcy 

trustee, but the FDIC has additional powers that 

make its role as a receiver critically different from that 

of a bankruptcy trustee. These additional powers are 

discussed in the next subsection. 

Thirty-seven deposit insurers responded to the following survey question: Who generally appoints a 

receiver? Only 13 of the 37 respondents have a structure similar to that in the United States. These 13 

respondents indicated only the central bank, the ministry of finance, or the supervisory authority appoints 

the receiver. The court appoints a receiver in most of 

the remaining locations, either alone or in conjunction 

with the central bank, the ministry of finance, and/or 

the deposit insurer. In two places (Mexico and 

Romania) the deposit insurer is solely responsible for 

appointing a receiver. (See Table 3.)19 

The survey responses indicate that the role of the 

FDIC as both insurer and receiver is uncommon. 

Many countries do not give their deposit insurers the 

authority to act as receiver. Only 10 of the 36 respondents answered “Yes” to the following survey question: Does the deposit insurer have the authority to act as 

the receiver of a failed depository institution? Of the 10, 

only 3 operate in advanced economies. (See Table 3.) 

The deposit insurer typically does not act as the 

receiver; in most places a private party acts as receiver, 

either alone or in conjunction with a government 

agency other than the deposit insurer. Thirty deposit 

insurers responded to the following survey question: 

If the deposit insurer is not the receiver, is another government agency or a private party the receiver? Of these 

30 respondents, 21 indicated that only a private party 

is the receiver, 5 indicated a combination of a private 

party and a government agency, and only 4 indicated a 

government agency acts alone as receiver. 

The deposit insurer rarely has the authority to 

appoint itself receiver. Of the ten deposit insurers that 

do have the authority to act as receiver, only three 

answered “Yes” to the following survey question: Does 

the deposit insurer have the authority to appoint itself 

receiver of the failed depository institution? Two of 

these three respondents (Mexico and Uganda) are in 

developing economies, and one (Canada) is in an 

advanced economy. (See Table 3.) 

Bankruptcy or Receivership Process 

As mentioned above, in the United States the liquidation system that is used to resolve a bank differs 

from bankruptcy proceedings for other types of business entities. The liquidation system is governed by 

receivership laws that seek to ensure the speedy resolution of banks and that therefore allow the receiver 

broader powers than the bankruptcy laws allow. 

There are many reasons for the FDIC’s special 

powers as a receiver. One is to ensure common standards and uniform expectations among creditors, 

shareholders, and the public. Another is to allow for 

prompt reimbursement of insured depositors and a 

speedy liquidation process. The special powers conferred on the FDIC allow it to expedite the liquidation process for banks and thus maintain confidence in 

the banking system; for example, the special powers 

do not allow any of the creditors of the bank to delay 

closure, although they do have the right to sue the 

receivership after the closure of the bank. The special 

powers also allow the FDIC to protect the insurance 

fund by minimizing receivership costs. 

FDIC (1998a) outlines five essential differences 

between receivership and bankruptcy. These differences involve (1) the claims determination process, (2) 

contract repudiation, (3) stay of litigation, (4) avoidance powers, and (5) special defenses. 

18 The FDIC has appointed itself receiver twice since 1991: in 1994 and 

1999. In 1994 the FDIC closed and appointed itself receiver of the 

Meriden Trust & Safe Deposit Company in Meriden, Connecticut. 

For more details, see FDIC (1998a), 181. In 1999 the FDIC closed 

and appointed itself receiver of Victory State Bank in Columbia, South 

Carolina. 

19 On Table 3 and many of the subsequent tables, the total number of 

respondents differs from the sum of the total number of responses in 

each column because some deposit insurers gave more than one 

answer. 

7 
FDIC Banking Review 

Table 3
 

Receivership Authority
 

Who generally 

appoints a receiver?a 

Does the deposit insurer 

have the authority to act 

as the receiver of a failed 

depository institution? 

Does the deposit insurer 

have the authority to appoint 

itself receiver of a failed 

depository institution? 

Deposit Insurer 

Central Bank, 

Ministry of 

Finance, or 

Supervisory Deposit 

Court Authority Insurer Other Yes No Yes No 

Advanced Economies 

Austria (AAR) X X X 

Austria (AABB) X X X 

Belgium X X X 

Canada X X X X 

France X X X 

Germany (EdB) X X X 

Germany (E) X X X 

Greece X X X 

Isle of Manb X X X 

Italy (IDPF) X X X 

Italy (DPFCB) X X X 

Japan X 

Netherlands X X X X 

Portugal X X X 

Spain X X X 

Sweden X X X X 

Taiwan Province of China X X X 

United Kingdom X X X 

Subtotal 10 8 1 2 3 14 1 16 

Developing Economies and Economies in Transition 

Africa 

Nigeria X X X 

Tanzania X X X 

Uganda X X X 

Europe 

Czech Republic X X X 

Hungary X X X 

Latvia X X X 

Lithuania X X X X 

Poland X X X 

Romania X X X 

Slovak Republic X X X 

Turkey X X X 

Middle East 

Bahrain X X X X X 

Oman X X X 

Western Hemisphere 

Brazil X X X 

El Salvador X X X 

Jamaica X X X 

Mexico X X X 

Peru X X X 

Trinidad and Tobago X X X 

Subtotal 10 9 2 1 7 12 2 17 

Total 20 17 3 3 10 26 3 33 

Note: Classification of economies into “Advanced,” “Developing,” or “Economies in Transition” is from International Monetary Fund (2000). 

aIf entities work together to appoint a receiver, an “X” will appear in more than one column. 

bBritish Crown Dependency. 

AAR = Association of Austrian Raiffesenbanks 

AABB = Association of Austrian Banks and Bankers 

EdB = Entschadigungseinrichtung deutscher Banken 

E = Einlagensicherungs 

IDPF = Interbank Deposit Protection Fund 

DPFCB = Deposit Protection Fund for Co-operative Banks 

8 
Failure Resolution and Asset Liquidation 

Claims determination process. The FDIC as 

receiver has the power to allow or disallow claims. If 

the receiver disallows a claim, the holder has the right 

to litigate the claim in federal court. In contrast, 

although a bankruptcy trustee can object to a claim, 

only the bankruptcy court can allow or disallow claims. 

Contract repudiation. The FDIC as receiver has 

the power, within a reasonable period, to repudiate 

contracts it deems burdensome. Banks often enter 

contracts that, at the time of receivership, are burdensome to the receiver in terms of duration or cost. In 

contrast, a bankruptcy trustee can repudiate only contracts that the parties have not fully executed. 

Stay of litigation. After the FDIC has been 

appointed receiver, it is responsible for any pending 

litigation against the bank but has the option of 

requesting a stay of legal proceedings of up to 90 days. 

Avoidance powers. Both the FDIC as receiver 

and a bankruptcy trustee have avoidance powers, or 

the power to pursue fraudulent transfers and recover 

property. However, the FDIC as receiver can pursue 

transfers made five years before or after the date of the 

receiver’s appointment. 

Special defenses. To defeat claims, a bankruptcy 

trustee can use only defenses that are available to the 

debtor to defeat claims. In contrast, the FDIC as 

receiver has special statutory defenses it can use. For 

example, improperly documented agreements are not 

binding on the receiver: the receiver relies solely on 

the records of the failed bank to evaluate the assets 

and liabilities accurately. Being able to disallow 

improperly documented agreements contributes to 

the efficiency and cost effectiveness of failure resolutions. 

Another important difference between the receivership process and bankruptcy proceedings for other 

types of business entities is that the FDIC is not subject to the direction or supervision of any other agency 

or department of the United States in the operation of 

the receivership. The court does not supervise the 

administration of the assets and liabilities of the failed 

bank and cannot review the decisions of the receiver 

except under limited circumstances. 

The granting of special authority to the FDIC as 

receiver is based on history. Before the FDIC was created, the Office of the Comptroller of the Currency 

(OCC) supervised the liquidation of national banks, 

and state banks were liquidated according to state 

laws, which varied from state to state. Even so, most 

liquidations of state banks were handled like any other 

business insolvency. During the 1933 banking crisis in 

the United States there was a shortage of experienced 

receivers. In addition, there were concerns that the 

receivership appointments had been made as political 

favors. Such appointments were desirable because 

receivers earned large commissions and therefore had 

an incentive to extend the receivership work. On 

average, it took six years to liquidate the assets of a 

failed bank and to pay depositors.20 (Depositors were 

treated like any other creditors in a bankruptcy, receiving funds after the bank’s assets had been liquidated.) 

When Congress created the FDIC, it believed that 

making the largest creditor (the FDIC) responsible for 

liquidating the assets of failed banks would simplify 

procedures. After all, it is in the best interest of the 

largest creditor to obtain the maximum recovery as 

quickly as possible. 

Outside the United States, most failed banks go 

through a regular corporate bankruptcy process. 

Approximately 62 percent of the 37 respondents 

answered “Yes” to the following survey question: Does 

a failed bank go through the regular corporate bankruptcy process? (See Table 4.) The proportions in both 

advanced economies and developing economies and 

economies in transition were roughly similar. 

The Least-Cost Requirement and
 

Exceptions to It
 

The least-cost resolution refers to the resolution 

method that minimizes the present value of net losses 

incurred by the deposit insurer, regardless of other factors. Without a least-cost requirement, the choice 

among resolution methods would involve trade-offs 

among minimizing the cost of the resolution transaction, imposing market discipline, and limiting risk to 

the banking sector as a whole. Requiring the deposit 

insurer to resolve banks in the least costly manner 

imposes market discipline inasmuch as the deposit 

insurer must structure resolutions that impose losses 

on uninsured and unsecured creditors. 

However, policy considerations other than cost to 

the deposit insurer may be important to the deposit 

insurer. For example, the deposit insurer may be concerned about the systemwide implications of the resolution of a particular bank, especially one that is very 

large and has many interbank relationships. When 

such a bank fails, a resolution structure that controls 

risk to other banks in the financial system may not be 

20 FDIC (1998b), 64. 

9 
FDIC Banking Review 

Table 4 sidered a variety of policy issues and objectives. 

Bankruptcy Process The four primary ones were (1) to maintain pubDoes a failed bank go through 

the regular corporate 

bankruptcy process? 

Deposit Insurer Yes No 

Advanced Economies 

Austria (AAR) X
 

Austria (AABB) X
 

Belgium X
 

Canada X
 

France X
 

Germany (EdB) X
 

Germany (E) X
 

Greece X
 

Isle of Mana X
 

Italy (IDPF) X
 

Italy (DPFCB) X
 

Japan X
 

Netherlands X
 

Portugal X
 

Spain X
 

Sweden X
 

Taiwan Province of China X
 

United Kingdom X
 

Subtotal 12 6
 

Developing Economies and Economies in Transition 

Africa
 

Nigeria X
 

Tanzania X
 

Uganda X
 

Europe
 

Czech Republic X
 

Hungary X
 

Latvia X
 

Lithuania X
 

Poland X
 

Romania X
 

Slovak Republic X
 

Turkey X
 

Middle East
 

Bahrain X
 

Oman X
 

Western Hemisphere
 

Brazil X
 

El Salvador X
 

Jamaica X
 

Mexico X
 

Peru X
 

Trinidad and Tobago X
 

Subtotal 11 8
 

Total 23 14
 

Note: Classification of economies into “Advanced,” “Developing,” or “Economies in Transition” is from International Monetary Fund (2000). 

aBritish Crown Dependency. 

AAR = Association of Austrian Raiffesenbanks 

AABB = Association of Austrian Banks and Bankers 

EdB = Entschadigungseinrichtung deutscher Banken 

E = Einlagensicherungs 

IDPF = Interbank Deposit Protection Fund 

DPFCB = Deposit Protection Fund for Co-operative Banks 

the least costly to the deposit insurer. A least-cost requirement that has enough flexibility to allow the deposit insurer 

to deal with systemic risks may be advantageous. 

In the United States at the beginning of the 1980s, when 

the FDIC determined the structure of a resolution, it conlic confidence and stability in the U.S. banking 

system, (2) to encourage market discipline so as 

to prevent excessive risk taking, (3) to resolve 

failed banks in a timely and cost-effective manner, and (4) to be equitable and consistent in 

using resolution methods. There were also certain secondary objectives, one of which was the 

desire to minimize the FDIC’s role in owning, 

financing, and managing banks and their assets. 

After passage of FDICIA, which mandated the 

least-cost requirement, all policy objectives 

became secondary to cost considerations in 

determining the resolution method.21 

To implement FDICIA, the FDIC evaluates 

all bids for failed banks solely on the basis of 

cost, not factoring into the decision any other 

policy considerations. The FDIC computes the 

cost of a resolution on a present-value basis, 

using a realistic discount rate. As discussed later 

in this section, the one exception to the leastcost test is the “systemic-risk” exception. 

Outside the United States, a least-cost 

requirement like the one imposed on the FDIC 

is far from universal. Nineteen of the 35 respondents answered “Yes” to the following survey 

question: Is the deposit insurer required to resolve 

failed or failing insured depository institutions in 

a manner that is least costly to the deposit insurer? 

(See Table 5.) Of the respondents in advanced 

economies, fewer than 50 percent have a leastcost requirement; in developing economies and 

economies in transition, approximately 63 percent have one. 

In the United States, as already mentioned, 

FDICIA provided for one exception to the 

least-cost requirement, namely, the systemicrisk exception. Before the FDIC can invoke 

this exception, two-thirds of the FDIC Board of 

21 Before passage of FDICIA, resolution transactions were subject to a different type of cost test: the FDIC could resolve a 

bank using any transaction that was less costly than a deposit 

payoff, except that, if a bank was deemed to be essential to 

the provision of adequate banking services in the community, 

the FDIC could vary from the cost test and use a transaction 

that was more costly than a deposit payoff. Cost was always 

an important element of the decision on resolution structure, 

but other considerations (for example, avoiding disruption to 

the local community or passing more assets to the acquirer) 

sometimes influenced the choice. Under FDICIA, the FDIC 

no longer has that flexibility but is required to choose the least 

costly resolution transaction (except that a “systemic-risk” 

exception is possible, as discussed below). 

10 
Failure Resolution and Asset Liquidation 

Table 5
 

Least-Cost Test and Exceptions
 

Is the deposit insurer If yes, Does either the size of an 

required to resolve failed or under what institution or the fact that it 

failing insured depository exceptions, if any, is owned by a governmental 

institutions in a manner can the deposit insurer entity influence the decision 

that is least costly to the deviate from the whether and how an insured 

deposit insurer? least-cost approach? bank should be resolved? 

Deposit Insurer Yes No None Systemic Risk Other Yes No 

Advanced Economies 

Austria (AAR) X X
 

Canada X X X
 

France X X X
 

Japan X X X
 

Austria (AABB) X X
 

Belgium X X X
 

Germany (EdB) X X
 

Germany (E) X X
 

Greece X X
 

Isle of Mana X X
 

Italy (IDPF) X X X
 

Italy (DPFCB) X X X
 

Netherlands X
 

Portugal X X
 

Spain X X
 

Sweden X X
 

Taiwan Province of China X X X
 

United Kingdom X
 

Subtotal 7 9 3 1 3 7 11
 

Developing Economies and Economies in Transition
 

Africa
 

Nigeria X X X
 

Tanzania X X X
 

Uganda X X X
 

Europe
 

Czech Republic X X
 

Hungary X X X
 

Latvia X X
 

Lithuania X X
 

Poland X X X
 

Romania X X
 

Slovak Republic X X
 

Turkey X X X
 

Middle East
 

Bahrain X X
 

Oman X X X
 

Western Hemisphere
 

Brazil X X X
 

El Salvador X X X
 

Peru X X X
 

Jamaica X X X
 

Mexico X X X
 

Trinidad and Tobago X X
 

Subtotal 12 7 5 3 4 11 8
 

Total 19 16 8 4 7 18 19
 

Note: Classification of economies into “Advanced,” “Developing,” or “Economies in Transition” is from International Monetary Fund (2000). 

aBritish Crown Dependency. 

AAR = Association of Austrian Raiffesenbanks 

AABB = Association of Austrian Banks and Bankers 

EdB = Entschadigungseinrichtung deutscher Banken 

E = Einlagensicherungs 

IDPF = Interbank Deposit Protection Fund 

DPFCB = Deposit Protection Fund for Co-operative Banks 

11 
FDIC Banking Review 

Directors22 and two-thirds of the Board of Governors 

of the Federal Reserve System must agree that complying with the least-cost test would have serious 

adverse effects on economic conditions or financial 

stability; the two boards forward a written recommendation to the Secretary of the U.S. Treasury; and 

the Secretary, in consultation with the president of 

the United States, must agree. Since its creation in 

FDICIA, the systemic-risk exception has never been 

used. In imposing this rather stringent requirement, 

FDICIA clearly outlined the FDIC’s options in resolving large banks. 

The European Union directives on banking have 

not yet specifically addressed limits on the bailout of 

large banks that are considered “too big to fail.” In 

fact, as Murphy (2000) points out, under the current 

system a large European bank that has a home office 

in a small country would probably be considered too 

big to fail. This decision could be made because the 

cost to the small country of resolving the large bank 

might be prohibitive. 

In locations outside the United States, some flexibility is built into the least-cost requirement. 

Respondents who have a least-cost requirement 

answered the following survey question: Under what 

exceptions, if any, can the deposit insurer deviate from the 

least-cost approach? Of the 19 respondents to the question, 8 said the least-cost requirement cannot be violated for any reason; 4 said it can be violated for 

reasons of systemic risk; and 7 mentioned other reasons for violating it, including “political interference,” 

“social connections,” and “size.” (See Table 5.) 

In many economies, size or government ownership 

does affect the nature of the resolution of banks. 

Eighteen of the 37 respondents answered “Yes” to the 

following survey question: Does either the size of an 

institution or the fact that it is owned by a governmental 

entity influence the decision whether and how an insured 

bank should be resolved? (See Table 5.) Size or government ownership is more likely to influence the resolution decisions in developing economies and 

economies in transition than in advanced economies 

(58 percent and 39 percent, respectively). 

Types of Resolution 

There are two basic types of resolution transactions: 

open-bank transactions and closed-bank transactions. 

Closed-bank transactions, in turn, are of two kinds: (1) 

purchase-and-assumption transactions and (2) deposit 

payoffs. Another type of resolution is a bridge bank, 

which is a temporary banking structure that the FDIC 

controls until it finds a permanent resolution. Bridge 

banks are not used very often, inside or outside the 

United States, but in some circumstances they may be 

useful. 

Open-Bank Assistance 

In an open-bank assistance (OBA) transaction, the 

deposit insurer provides financial assistance to the 

bank while the bank remains open. The assistance 

can take the form of loans, asset purchases, or a note or 

cash to restore capital to a positive level; private 

investors will provide additional capital to restore the 

bank to an adequate capital position. Consequently, 

OBA transactions usually require the shareholders to 

dilute their ownership interests significantly; however, 

their interests may retain some value, so they could 

benefit from the government assistance. 

The primary advantage of open-bank assistance is 

that it is least disruptive to the relationships between 

the bank and its customers. Another advantage is that 

most of the bank’s assets remain in the private sector. 

Both of these advantages may be particularly important for averting a widespread financial crisis. 

Open-bank assistance also has a number of disadvantages. First, it can increase the amount of moral 

hazard and decrease market discipline within the 

financial system. Moral hazard may increase because, 

according to general belief, if a bank thinks it will be 

bailed out when it gets into trouble, it will take on 

more risk than if the assistance were not available. 

Market discipline will be eroded because customers 

with uninsured and unsecured claims are protected, 

and shareholders may be partially protected. A second 

disadvantage is that OBA transactions raise the fairness issue: weak banks are allowed to remain open 

with government assistance and compete with banks 

that are not given assistance. Finally, OBA transactions can prove to be somewhat more costly to the 

deposit insurer: there may be recurring losses, and the 

process of preparing proposals and completing assistance transactions can be long and difficult.23 

22 The Board of Directors of the FDIC is composed of the Comptroller 

of the Currency, the Director of the Office of Thrift Supervision, and 

three members appointed by the president of the United States and 

confirmed by the Senate. One of the appointed members of the 

Board must have experience supervising state banks. For more detail 

about the Board of Directors of the FDIC, see Section 2 of the 

Federal Deposit Insurance Act. 

23 Recurring losses characterized the case of First City Bancorporation. 

In 1988 the FDIC provided open-bank assistance to resolve the failure of 59 branches of First City, but the bank continued to incur losses. Finally, in 1992, the FDIC used a closed-bank transaction to 

resolve the bank. 

12 
Failure Resolution and Asset Liquidation 

Originally the FDIC provided open-bank assistance to banks that were considered essential to the 

community. Typically the FDIC would restore capital 

to a positive level by providing the distressed bank 

with a cash contribution, an FDIC note, or a loan, and 

private investors would provide additional capital to 

restore the bank to an adequate capital position. 

Because of the restrictions imposed by FDICIA, the 

FDIC no longer commonly uses OBA transactions. 

Closed-bank resolutions usually have a cost advantage 

over open-bank transactions. In a closed-bank transaction, costs are reduced because contingent liabilities 

are eliminated, burdensome contracts can be terminated, and troublesome assets can be left in the 

receivership. 

Many deposit insurers have the authority to provide 

open-bank assistance. Of 35 survey respondents, 23 

answered “Yes” to the following question: Do you 

have the legal authority to provide financial assistance to 

an operating insured depository institution (open-bank 

assistance), either as a stand-alone entity or to facilitate 

an open-bank merger with a healthy insured depository 

institution? (See Table 6.) Approximately one-half of 

the deposit insurers that said “Yes” indicated they 

have provided financial assistance to an operating 

bank in the last ten years. 

Closed-Bank Resolutions 

Closed-bank resolutions—purchase-and-assumption transactions and deposit payoffs—have the advantage of not allowing the problems in the bank to recur. 

Another advantage is that they are transparent. 

Deposit payoffs, however, are typically more disruptive to customers of the bank and perhaps the local 

economy. In purchase-and-assumption transactions, 

in contrast, there are ways of minimizing the disruption. For example, in the United States, when a bank 

is resolved by a purchase-and-assumption transaction, 

the chartering agency usually closes the bank on a 

Friday and the new bank reopens on Monday. The 

only change visible to most of the customers of the 

bank is a change in the name of the bank. 

Purchase-and-assumption transactions. A purchase-and-assumption (P&A) transaction is a closedbank transaction in which a healthy bank purchases 

some or all of the assets of a failed bank and assumes 

some or all of the liabilities.24 The acquirer usually 

receives assistance from the deposit insurer to complete the transaction. As part of the P&A transaction, 

the acquiring bank usually pays a premium to the 

deposit insurer for the deposits it acquires; the premium decreases the total resolution cost to the insurer. 

The reason the acquirer pays this premium is that the 

deposit base has value in terms of the established customer relationships, usually referred to as franchise 

value.25 

A P&A transaction has some of the advantages of an 

open-bank assistance transaction while eliminating 

some of the disadvantages. Like open-bank assistance, a purchase-and-assumption transaction is not 

disruptive to the customers of the bank. In addition, 

because most of the assets of the failed bank are transferred to the acquiring bank, they are kept in the private sector.26 A P&A transaction can maintain market 

discipline to differing degrees, depending on the 

structure of the transaction. At the very least, shareholders will lose all of their investment.27 If all 

deposits are not transferred to the acquiring bank, 

uninsured depositors may also incur a loss. However, 

if uninsured deposits are transferred to the acquiring 

bank as part of a least-cost transaction, they will be 

fully reimbursed even though they are uninsured. 

This transfer is more likely to occur when uninsured 

deposits are a relatively small portion of the failed 

bank’s total deposits. 

Many deposit insurers outside the United States 

have the authority to use a P&A transaction. Twenty 

of the 30 respondents answered “Yes” to the following 

survey question: Do you have the legal authority to use 

a P&A transaction in handling failed or failing depository institutions? (See Table 6.) Ten of these respondents have used a purchase-and-assumption 

transaction in the last ten years. 

Deposit payoffs. In a deposit payoff, the appropriate authority closes the bank, and then the deposit 

insurer pays all of the failed bank’s depositors the full 

amount of their insured deposits. No assets or liabilities are assumed by another bank; the receiver is 

responsible for liquidating the assets and paying off 

the claimants. A deposit payoff may be disruptive to 

the local community because the depositors are paid 

24 In the United States, banks that are interested in acquiring failed 

banks must have approval from their primary regulator and must meet 

the bid criteria established by the FDIC. The FDIC shares a list of 

eligible bidders with the other regulatory agencies and contacts potential bidders four or five days before the bank closing. 

25 For more detail on the types of P&A transactions the FDIC has used, 

see FDIC (1998b), chap. 3. 

26 Typically the acquirer will take the higher-quality assets and leave the 

distressed assets, such as nonperforming loans, in the receivership (see 

discussion of asset liquidation below). 

27 In the rare case when receivership proceeds remain after all the other 

claimants are paid in full, shareholders may recover some of their 

investment. 

13 
FDIC Banking Review 

Table 6
 

Resolution Methods
 

Open-Bank Assistance 

Purchase and 

Assumption Deposit Payoff Bridge Bank 

Deposit Insurer 

Has 

authority 

Has used 

authority in 

past 10 years 

Has 

authority 

Has used 

authority in 

past 10 years 

Has 

authority 

Has used 

authority in 

past 10 years 

Has 

authority 

Has ever 

used the 

authority 

Advanced Economies 

Austria (AAR) X
 

Austria (AABB) X
 

Belgium X X X X X
 

Canada X X X X X X X
 

France X X X X
 

Germany (EdB) X
 

Germany (E) X X X X X
 

Greece X X
 

Isle of Mana X X
 

Italy (IDPF) X X X X X X
 

Italy (DPFCB) X X X X X X
 

Japan X X X X X
 

Netherlands X
 

Portugal X
 

Spain X X X X X X
 

Sweden X
 

Taiwan Province of China X X X X X
 

United Kingdom
 

Subtotal 11 6 9 6 15 8 4 0 

Developing Economies and Economies in Transition 

Africa 

Nigeria X X X X X X 

Tanzania X X X 

Uganda X X X X X X 

Europe 

Czech Republic X X 

Hungary X X X X X X 

Latvia 

Lithuania X X 

Poland X X X X 

Romania X X 

Slovak Republic X X X 

Turkey X X X X X X 

Middle East 

Bahrain 

Oman X X X 

Western Hemisphere 

Brazil 

El Salvador X X X 

Jamaica X X X X 

Mexico X X X X X X X 

Peru X X X X 

Trinidad and Tobago X X X X 

Subtotal 12 6 11 4 16 11 4 1 

Total 23 12 20 10 31 19 8 1 

Note: Classification of economies into “Advanced,” “Developing,” or “Economies in Transition” is from International Monetary Fund (2000). 

aBritish Crown Dependency. 

AAR = Association of Austrian Raiffesenbanks 

AABB = Association of Austrian Banks and Bankers 

EdB = Entschadigungseinrichtung deutscher Banken 

E = Einlagensicherungs 

IDPF = Interbank Deposit Protection Fund 

DPFCB = Deposit Protection Fund for Co-operative Banks 

14 
Failure Resolution and Asset Liquidation 

the insured balance on their accounts as of the time of 

the bank failure. Any outstanding checks drawn on 

the accounts are not paid, for there is no successor 

bank to pay them. The depositors must quickly establish checking accounts in, and lending relationships 

with, another bank and must arrange with their creditors to cover the unpaid checks. In the United States, 

the FDIC makes the insured deposits available on the 

next business day in almost every bank failure.28 In 

other countries, depositors are reimbursed over time 

after the resolution of the bank. The longer depositors 

must wait to receive their insured funds, the more 

severe the disruption becomes.29 

In the United States, there are two types of deposit 

payoff: a straight deposit payoff and an insureddeposit transfer. In a straight deposit payoff, the 

FDIC determines the amount of insured deposits and 

pays each depositor the appropriate amount by issuing 

a check. In an insured-deposit transfer, the insured 

deposits are transferred to a healthy bank that is willing to serve as an agent of the FDIC. Depositors may 

either withdraw their deposits or keep them in the 

new bank and continue using its deposit services. 

Banks bid to serve as an agent of the FDIC, hoping to 

retain some of the customers of the failed bank. 

The straight deposit payoff is usually more costly to 

the deposit insurer than other resolution methods, 

because all of the failed bank’s assets must be liquidated by the receiver and the bank’s franchise value is 

lost. Furthermore, the deposit insurer incurs additional costs from paying off all the insured depositors. 

Straight deposit payoffs are costly to the customer as 

well, because (as mentioned above) checks that are in 

process are not paid. The insured-deposit transfer 

eliminates the disruption to the customer and the 

costs of paying off the deposits, but the receiver still 

incurs the costs of managing and disposing of all the 

failed-bank assets. The bank that assumes the insured 

deposits, however, is able to realize some of the franchise value of the failed bank, even if the assuming 

bank is unwilling to acquire some of the assets (for 

example, is unwilling to enter into a purchase-andassumption transaction). A straight deposit payoff is 

usually used only when no bank is interested in the 

deposit franchise and an insured-deposit transfer cannot be arranged. 

Overall, deposit insurers outside the United States 

have the authority to pay off depositors, and they use 

this authority more often than they use any other type 

of resolution technique. Of the 36 respondents, 31 

answered “Yes” to the following survey question: Do 

you have the legal authority to use a [deposit] payoff in 

handling failed or failing insured depository institutions? (See Table 6.) Nineteen of these respondents 

have used a deposit payoff in the last ten years. 

Bridge banks. In the United States, a bridge-bank 

transaction is a type of P&A transaction in which the 

FDIC itself acts temporarily as the acquirer, taking 

over the operations of a failing bank and maintaining 

banking services for the customers.30 As the name 

implies, the bridge-bank structure is designed to 

“bridge” the gap between the failure of a bank and the 

time when the FDIC can implement a satisfactory resolution of the bank. Initially the FDIC organizes a 

bridge bank for up to two years, with the possibility of 

as many as three one-year extensions.31 The temporary bridge structure provides the FDIC with time to 

take control of the business of the failed bank, stabilize the situation, and determine an appropriate permanent resolution. It also enables the FDIC to gain 

sufficient flexibility for reorganizing and marketing 

the bank. 

A bridge-bank resolution is especially useful in two 

types of situations: when the failing bank is large or 

unusually complex, such as a multibank holding company, or when the bank is in a liquidity crisis. In the 

first situation, a bridge-bank structure allows the condition of the bank to be thoroughly examined and further resolution alternatives to be completely 

evaluated. Before the failed bank goes into the bridge 

bank, the FDIC applies the least-cost test, and at this 

point the uninsured and unsecured creditors suffer 

losses. The bridge-bank structure also provides additional time for due diligence by all interested potential 

acquirers. In the second situation (a liquidity crisis), a 

bridge-bank structure allows the FDIC to assure 

depositors that their deposits are safe. 

A bridge bank operates in a conservative manner 

while serving the banking needs of the community. 

Its management goal is to preserve the franchise value 

and lessen any disruption to the local community. It 

accepts deposits, makes low-risk loans to regular cus28 Banks are generally closed at the end of business on Friday, and
 

depositors are given access to their funds on the following Monday.
 

29 For a discussion of the treatment of depositors at failed banks, see
 

Kaufman and Seelig (2000). 

30 The FDIC Board of Directors selects the chief executive officer of the 

bridge bank and retains a presence on the bank’s board of directors. 

31 Most of the bridge banks created by the FDIC lasted less than seven 

months. For more detail on the FDIC’s experience with bridge 

banks, see FDIC (1998a), chap. 6. 

15 
FDIC Banking Review 

tomers, and honors the commitments made by the 

failed bank if those commitments would not create 

additional losses. By continuing the failed bank’s 

lending relationships, it supports the franchise value of 

the bank. 

Not many deposit insurers outside the United 

States have bridge-bank authority. Only 8 of the 37 

respondents answered “Yes” to the following survey 

question: Does the deposit insurer have the authority to 

temporarily own a bridge bank, an institution into which 

some or all of the assets and liabilities of a failed insured 

depository institution can be transferred? (See Table 6.) 

Of these 8 respondents, only 1 (Mexico) has ever used 

its bridge-bank authority. Outside the United States, 

therefore, a bridge bank is by far the least commonly 

used resolution technique. 

Asset Liquidation 

Asset liquidation can be a complex process. To be 

effective, the receiver must first be familiar with the 

goals of asset liquidation. The responsibility for asset 

liquidation must be clearly established as part of the 

financial safety net. It also is useful if the receiver is 

familiar with past asset-liquidation experience, in 

order to determine the most effective manner of marketing the assets to meet the established goals of asset 

liquidation. 

Goals of Asset Liquidation 

With the exception of a transaction where the 

acquirer purchases all of the assets of the bank, all 

types of closed-bank resolutions require a receiver to 

liquidate some or all of the assets of the failed bank. 

Three possible goals of asset liquidation are (1) to sell 

the assets as quickly as possible, (2) to maximize net 

present value of the assets in liquidation, and (3) to 

manage the assets to obtain the highest price. 

The three goals can be mutually exclusive. For 

example, suppose the deposit insurer intends to manage assets to obtain the highest price (meeting goal 3), 

but prices are currently low. The deposit insurer may 

keep the assets until the price of the assets increases 

again, but in doing so the insurer will not be meeting 

the goal of selling the assets quickly as stated in goal 1. 

In addition, by holding and managing the assets the 

insurer will incur costs—including the time cost of 

money—that will cause the net present value to 

decline, and the insurer will not meet goal 2. 

During the banking crisis in the United States in 

the 1980s and early 1990s, the FDIC had two basic 

goals in asset disposition: (1) to dispose of assets as 

soon as possible and (2) to maximize the return on the 

receiverships. Disposing of assets quickly minimizes 

disruption to the public during the resolution of failed 

banks. Maximizing the return on the receivership 

minimizes the loss to the insurance fund. These two 

goals are linked, since disposing of assets quickly 

allows the receiver to avoid asset-management and 

servicing costs and any loss in value that might occur 

simply because the asset is held by a receiver. On the 

other hand, if there is an excess supply of assets in a 

market that has depressed prices, disposing of the 

assets quickly may bring an abnormally low price and 

thereby a low return on the receivership. 

Currently, the FDIC is required by law to minimize 

the loss to the insurance funds and to maximize the 

return on the assets of the failed bank or thrift.32 

Beyond these statutory requirements, the FDIC has 

an incentive to maximize the return on assets of the 

failed bank: by paying insured depositors and then 

standing in their place, the FDIC becomes a major 

creditor of the receivership—typically the largest creditor. Thus, it is in the FDIC’s own best interest to 

maximize the return on assets. 

In places outside the United States, obtaining the 

highest prices for the assets is the most common goal 

of asset disposition. This goal was mentioned by 11 of 

the 31 respondents who answered the following survey question: What is the primary goal of the asset liquidation process (for example, maximize the net present 

value of assets in liquidation, sell the assets as quickly as 

possible, manage the assets to obtain the highest price)? 

(See Table 7.) The next most often cited goal, mentioned by 10 of the 31 respondents, was to liquidate 

the assets as quickly as possible; 9 respondents mentioned maximizing the net present value of assets in 

liquidation; and 8 mentioned satisfying the creditors of 

the receivership. Most respondents mentioned a combination of asset-disposition goals, indicating that the 

asset-liquidation process entails several competing 

goals. 

32 FDICIA contains provisions that explicitly define standards for asset 

disposition. In Section 123 (amending Section 11 of the FDI Act), 

FDICIA states that the FDIC shall conduct operations in a manner 

that (1) maximizes the net present value of return from the sale or disposition of assets, (2) minimizes the amount of any loss realized in the 

resolution of cases, (3) ensures adequate competition and fair and consistent treatment of those who submit bids for the assets, (4) prohibits 

discrimination on the basis of race, sex, or ethnic group in the solicitation and consideration of bids, and (5) preserves to the greatest 

extent possible the availability and affordability of residential realestate property for low- and moderate-income individuals. 

16 
Failure Resolution and Asset Liquidation 

Table 7
 

Goals of Asset Liquidation
 

Liquidate Maximize the 

the assets net present value Obtain the Satisfy the 

as quickly (NPV) of assets highest prices creditors of the 

Deposit Insurer as possible in liquidation for the assets receivership Other 

Advanced Economies 

Austria (AAR)
 

Austria (AABB) X
 

Germany (EdB)
 

Germany (E)
 

Japan
 

Sweden
 

United Kingdom
 

Belgium X
 

Canada X
 

France X
 

Greece X X
 

Isle of Mana X
 

Italy (IDPF) X
 

Italy (DPFCB) X X
 

Netherlands X
 

Portugal X X
 

Spain X
 

Taiwan Province of China X X
 

Subtotal 3 3 4 5 1
 

Developing Economies and Economies in Transition
 

Africa
 

Nigeria X X
 

Tanzania X
 

Uganda X X
 

Europe
 

Czech Republic X
 

Hungary X
 

Latvia X
 

Lithuania X
 

Poland X
 

Romania X
 

Slovak Republic X
 

Turkey X
 

Middle East
 

Bahrain X X X
 

Oman X
 

Western Hemisphere
 

Brazil X
 

El Salvador X X
 

Jamaica X
 

Mexico X X
 

Peru X
 

Trinidad and Tobago X X
 

Subtotal 7 6 7 3 3
 

Total 10 9 11 8 4
 

Note: Classification of economies into “Advanced,” “Developing,” or “Economies in Transition” is from International Monetary Fund (2000). 

aBritish Crown Dependency. 

AAR = Association of Austrian Raiffesenbanks 

AABB = Association of Austrian Banks and Bankers 

EdB = Entschadigungseinrichtung deutscher Banken 

E = Einlagensicherungs 

IDPF = Interbank Deposit Protection Fund 

DPFCB = Deposit Protection Fund for Co-operative Banks 

17 
FDIC Banking Review 

In most places, the primary goal of asset liquidation is set either by policy or by regulation. Thirtyone respondents answered the following survey 

question: Is the primary goal of the asset-liquidation 

process established by regulation, statute, or policy? (See 

Table 8.) Fifteen of the 31 respondents mentioned 

policy, 14 mentioned regulation, and 4 mentioned 

statute. Some of the deposit insurers indicated that 

asset-liquidation goals were established by some 

combination of regulation, statute, and policy. 

Responsibility for Asset Liquidation 

Responsibility for asset liquidation can lie with 

either a government entity or a private party. If the 

government entity is responsible for asset liquidation, it may be allowed to contract out the responsibility to the private sector. This power is particularly 

useful if the amount of failed-bank assets that needs 

to be liquidated is large and/or the number of experienced asset liquidators employed by the government 

is insufficient. The government may choose to keep 

its liquidation staff small and contract out to the private sector the greater part of the responsibility. In 

that case, the challenge is to develop contracts that 

align the interests of the private asset-management 

companies with the interests of the government. 

Such contracts must include provisions for effective 

monitoring by the government. At the same time, 

however, for the private sector to operate efficiently, 

there must be minimal interference from the government. The way to balance these objectives is to have 

identifiable and measurable performance outcomes. 

Finally, contractors should be contractually bound to 

operate fairly, equitably, and legally. 

In the United States during the banking crisis of 

the 1980s and early 1990s, the FDIC used the private 

sector to manage and liquidate receivership assets.33 

In the peak period of 1988 to 1993, private-sector 

firms managed more than 45 percent of the FDIC’s 

post-resolution assets.34 The FDIC designed its 

asset-management and disposition contracts to facilitate the disposition of distressed and repossessed 

assets (especially nonperforming loans and owned 

real estate), using many forms of contracts and modifying them over the years as it gained experience.35 

Early in the process, the asset-liquidation contracts 

required payment of the private asset liquidators on a 

cost-plus basis: the FDIC would reimburse liquidators for all expenses and overhead costs incurred during liquidation and would pay a fixed incentive fee. 

However, this type of liquidation contract did not 

Table 8
 

Establishing the Goals of Asset Liquidation
 

Is the primary goal of the assetliquidation process established 

by regulation, statute, or policy? 

Deposit Insurer Regulation Statute Policy Other 

Advanced Economies 

Austria (AAR)
 

Austria (AABB) X
 

Belgium
 

Canada X
 

France X
 

Germany (EdB) X
 

Germany (E) X
 

Greece X
 

Isle of Mana X
 

Italy (IDPF) X
 

Italy (DPFCB) X
 

Japan
 

Netherlands X
 

Portugal X
 

Spain X
 

Sweden
 

Taiwan Province of China X
 

United Kingdom
 

Subtotal 5 2 6 0
 

Developing Economies and Economies in Transition
 

Africa
 

Nigeria X
 

Tanzania X
 

Uganda X
 

Europe
 

Czech Republic X
 

Hungary X
 

Latvia X X X
 

Lithuania X
 

Poland X
 

Romania
 

Slovak Republic X
 

Turkey X
 

Middle East
 

Bahrain X X
 

Oman X
 

Western Hemisphere
 

Brazil X
 

El Salvador X
 

Jamaica X
 

Mexico X
 

Peru X
 

Trinidad and Tobago X
 

Subtotal 9 2 9 1
 

Total 14 4 15 1
 

Note: Classification of economies into “Advanced,” “Developing,” or 

“Economies in Transition” is from International Monetary Fund (2000). 

aBritish Crown Dependency. 

AAR = Association of Austrian Raiffesenbanks 

AABB = Association of Austrian Banks and Bankers 

EdB = Entschadigungseinrichtung deutscher Banken 

E = Einlagensicherungs 

IDPF = Interbank Deposit Protection Fund 

DPFCB = Deposit Protection Fund for Co-operative Banks 

33 This discussion focuses on the evolution of asset-liquidation contracts 

at the FDIC. For more information on the development of asset-liquidation and management contracts at the Resolution Trust 

Corporation (RTC), see FDIC (1998a), chap. 13. 

34 FDIC (1998a), 50. 

35 For details on the evolution of asset-disposition practices, see FDIC 

(1998b), chap. 12. 

18 
Failure Resolution and Asset Liquidation 

give the private asset liquidators any incentive to contain costs. To maximize the net present value of cash 

flows from the liquidation, the FDIC had to build in 

incentives for the private contractors to control costs, 

and more complicated contract structures evolved. 

For example, incentive fees came to be based on the 

ratio of net collections to the value of the asset pool. 

Thus, the FDIC learned from experience to design 

contracts that more closely aligned contractors’ incentives with its own goals of asset liquidation. 

In many places the receiver is responsible for the 

liquidation of assets. Twenty-nine of the 34 respondents answered “Yes” to the following survey question: Is the receiver responsible for the liquidation of the 

assets of the receivership? (See Table 9.) But being 

responsible for the liquidation does not always mean 

that the deposit insurer directly liquidates the assets of 

failed banks. Thirty-seven respondents answered the 

following survey question: What role does the deposit 

insurer have in the asset-liquidation process? Only 6 of 

the 37 indicated that the deposit insurer has a direct 

role in liquidating assets, and 5 of the 6 are located in 

developing economies and economies in transition. 

Sixteen of the 37 respondents indicated that the 

deposit insurer has no role in asset liquidation. The 15 

remaining respondents said the deposit insurer oversees asset liquidation, exerts some influence over asset 

liquidation as a creditor of the receivership, or is 

involved in asset liquidation in some other capacity. 

In some economies, both the public sector and the 

private sector liquidate assets of failed banks. Sixteen 

deposit insurers responded to the following survey 

question: What percentage of effort involved in selling 

assets is handled by the private sector (as compared to 

government employees)? (See Table 10.) Nine respondents indicated that the private sector handles all the 

asset sales, and two respondents (Turkey and Brazil) 

indicated that the private sector does not handle any of 

the asset sales, but the remaining five said the responsibility for asset sales is shared by the government and 

the private sector. 

Eight deposit insurers responded to the following 

survey question: What is the percentage [of effort 

involved in] asset management [handled by the private 

sector (as compared with government employees)]? (See 

Table 10.) Only one deposit insurer (Isle of Man) 

indicated that the private sector is solely responsible 

for asset management; three said the private sector has 

no involvement; and four said the private sector and 

the government share the responsibility. 

Asset-Liquidation Experience 

Typically the assets that remain with the receivership are those that are hardest to liquidate. For example, in a purchase-and-assumption transaction the 

distressed assets are left in the receivership while the 

higher-quality assets are taken by the acquirer. 

Because distressed assets are usually retained in the 

receivership, they are sold after the resolution is completed. Or, instead of attempting to sell the assets, the 

receiver can wait for borrowers to repay the troubled 

loans, or negotiate compromises with the borrowers. 

In the United States during the banking crisis of the 

1980s and early 1990s, the focus was on attempting to 

sell the assets. At first, employees at the FDIC managed and liquidated each asset individually. But as the 

volume of assets held by the FDIC increased, it 

became less practical to manage and sell individual 

assets (a $100,000 loan required roughly the same 

amount of labor as a $1,000,000 loan). So the FDIC 

gradually developed more-sophisticated methods of 

liquidating assets; these included selling assets in 

bulk, providing representations and warranties, forming equity partnerships, and securitizing the sales of 

assets.36 

The first step, when it became apparent that selling 

assets individually was increasingly less practical, was 

to sell them in bulk: the FDIC began to package 

together loans with similar characteristics. At that 

time an established market did not exist for such loan 

packages, so the FDIC began by creating small packages, ranging from $1 million to $2.5 million in book 

value. These small packages generated interest and 

the FDIC gathered information on potential buyers. 

As the initial buyers gained experience, they were able 

to attract capital and funding that enabled them to 

expand their businesses. Gradually, the book value of 

the loan packages grew, and the FDIC was able to sell 

large portfolios to an expanded marketplace of buyers. 

To facilitate the sale of troubled assets, the FDIC 

and the Resolution Trust Corporation (RTC) also provided representations and warranties. These are legally binding statements made to buyers to assure them 

that the assets being sold meet certain minimum quality criteria. If these criteria are not met, the seller is 

obligated either to cure the condition or to offer a remedy, such as a repurchase or a substitution of another 

36 For more details on the evolution of asset-disposition practices in the 

United States, see FDIC (1998a), chap. 12. 

19 
FDIC Banking Review 

Table 9
 

Responsibility for Asset Liquidation
 

Is the receiver responsible What role does the deposit insurer have

for the liquidation of in the asset liquidation process?

the assets of the 

receivership Oversees Exerts influence 

Liquidates asset as a creditor of 

Deposit Insurer Yes No None assets liquidation the receivership Other 

Advanced Economies 

Austria (AAR) X
 

Austria (AABB) X X
 

Belgium X X
 

Canada X X
 

France X X
 

Germany (EdB) X X
 

Germany (E) X X
 

Greece X X
 

Isle of Mana X
 

Italy (IDPF) X X
 

Italy (DPFCB) X X
 

Japan X X
 

Netherlands X X
 

Portugal X X
 

Spain X X
 

Sweden X
 

Taiwan Province of China X X
 

United Kingdom X X
 

Subtotal 14 1 9 1 1 4 3
 

Developing Economies and Economies in Transition
 

Africa
 

Nigeria X X
 

Tanzania X X
 

Uganda X X
 

Europe
 

Czech Republic X X
 

Hungary X X
 

Latvia X X
 

Lithuania X X
 

Poland X X
 

Romania X X
 

Slovak Republic X X
 

Turkey X X
 

Middle East
 

Bahrain X X
 

Oman X X
 

Western Hemisphere
 

Brazil X X
 

El Salvador X X
 

Jamaica X X
 

Mexico X X
 

Peru X X
 

Trinidad and Tobago X X
 

Subtotal 15 4 7 5 3 1 3
 

Total 29 5 16 6 4 5 6
 

Note: Classification of economies into “Advanced,” “Developing,” or “Economies in Transition” is from International Monetary Fund (2000). 

aBritish Crown Dependency. 

AAR = Association of Austrian Raiffesenbanks 

AABB = Association of Austrian Banks and Bankers 

EdB = Entschadigungseinrichtung deutscher Banken 

E = Einlagensicherungs 

IDPF = Interbank Deposit Protection Fund 

DPFCB = Deposit Protection Fund for Co-operative Banks 

20 
Failure Resolution and Asset Liquidation 

Table 10
 

Private-Sector Involvement in Asset Sales and Management
 

What percentage of effort involved in 

selling assets is handled by the private sector What is the percentage 

Deposit Insurer (as compared with government employees)? for asset management? 

Advanced Economies 

Austria (AAR) 

Austria (AABB) 

Belgium 0 

Canada 100 

France 

Germany (EdB) 

Germany (E) 

Greece 

Isle of Mana 100 100 

Italy (IDPF) 

Italy (DPFCB) 

Japan 

Netherlands 

Portugal 

Spain 100 

Sweden 

Taiwan Province of China 

United Kingdom 

Developing Economies and Economies in Transition 

Africa 

Nigeria 100 

Tanzania 100 

Uganda 100 

Europe 

Czech Republic 100 

Hungary 

Latvia 

Lithuania 80–100 80–100 

Poland 100 

Romania 100 

Slovak Republic 

Turkey 0 0 

Middle East 

Bahrain 

Oman 

Western Hemisphere 

Brazil 0 

El Salvador 10 10 

Jamaica 70 98 

Mexico 30 30 

Peru 

Trinidad and Tobago <1 0 

Number of Respondents 16 8 

Note: Classification of economies into “Advanced,” “Developing,” or “Economies in Transition” is from International Monetary Fund (2000). 

aBritish Crown Dependency. 

AAR = Association of Austrian Raiffesenbanks 

AABB = Association of Austrian Banks and Bankers 

EdB = Entschadigungseinrichtung deutscher Banken 

E = Einlagensicherungs 

IDPF = Interbank Deposit Protection Fund 

DPFCB = Deposit Protection Fund for Co-operative Banks 

21 
FDIC Banking Review 

asset. Representations and warranties are used when 

assets are being sold in a secondary market where representations and warranties are customary and where 

their omission will cause lower prices to be offered for 

the assets.37 

Representations and warranties can be as simple as 

a representation that the seller is the owner of the loan 

or as complex as a representation and warranty 

addressing environmental concerns. As an example of 

the latter, the sellers can offer the buyers the opportunity to perform an environmental inspection before 

bidding or can offer an indemnification if environmental contamination turns out to be present. 

Because representations and warranties create ongoing obligations, or contingent liabilities, for the deposit 

insurer, estimating the expected costs of the transaction may be difficult. Representations and warranties 

usually include termination dates; thus, the contingent 

liability of the deposit insurer expires on a particular 

date. 

Another asset-disposition technique used in the 

United States was equity partnerships: the FDIC 

structured joint ventures with private investors. The 

FDIC acted as a limited-liability partner, contributing 

the asset pools and arranging for financing to the partnership. The private investor contributed both equity 

capital and asset-management services. Once the 

partnership’s debt was paid off, the proceeds from the 

assets were split between the partners according to a 

previously agreed-upon percentage of ownership.38 

The FDIC and the RTC also successfully used 

securitization to dispose of a sizable portion of assets. 

Securitization of assets entails packaging assets with 

similar features and somewhat predictable cash flows 

into an interest-bearing security. In the United States 

in the 1980s, the market for mortgage-backed securities—securities backed by a pool of residential loans— 

was already well established by the Federal Home 

Loan Mortgage Corporation (Freddie Mac) and the 

Federal National Mortgage Association (Fannie Mae). 

Marketing mortgage-backed securities was therefore 

much easier than marketing less-conventional securities that were backed by other assets, such as commercial loans. 

In most places, assets of failed banks have been liquidated during the past ten years. Twenty-eight of 

the 34 respondents answered “Yes” to the following 

survey question: Have assets of failed banks been liquidated during the past ten years? (See Table 11.) Of the 

19 respondents in developing economies and 

economies in transition, four have not liquidated 

assets of failed banks in the past ten years. 

Twenty-eight deposit insurers responded to the follow-up survey question: If yes, what has been the most 

commonly used strategy for converting the assets into cash 

(for example, asset sales, securitizations, compromises 

with borrowers, loan repayments, sale to the bank that 

takes deposits)? Nineteen of the 28 respondents mentioned asset sales; eight mentioned loan repayments; 

eight mentioned selling the assets to banks that take 

deposits; and one mentioned the securitization of 

assets. (See Table 11.) 

The choice of strategy for disposing of assets is 

influenced by many factors. Twenty-seven deposit 

insurers responded to the following survey question: 

What factors influence the determination of the strategy 

used to dispose of assets? (See Table 12.) Eight indicated that the nature and quality of the assets influenced the disposition strategy, and three mentioned 

the size and condition of the market for failed-bank 

assets. Four of the respondents, however, indicated 

that the strategy was determined case by case. 

Overall, the reasons for using particular asset-disposition strategies were varied. 

The survey respondents found that nonperforming 

loans and owned real estate were the two most difficult assets to liquidate. Twenty deposit insurers 

responded to the following question: What types of 

assets have you found to be the most difficult to dispose 

of? (See Table 13.) Five of the respondents indicated 

nonperforming loans and five indicated owned real 

estate. Also mentioned were commercial and industrial loans and commercial and industrial real estate. 

Many of the respondents indicated that these assets 

were hard to dispose of either because they were large 

relative to the economy or because encumbrances 

made them hard to market. 

37 For more information on representations and warranties, see 

Moreland-Gunn et al. (1995). 

38 For more detail on the use of equity partnerships in the United States, 

see FDIC (1998a), chap. 17. 

22 
 

Failure Resolution and Asset Liquidation 

Table 11
 

Asset-Liquidation Experience
 

Have assets of failed 

banks been liquidated 

during the past 10 years? 

If yes, what has been the most commonly used strategy for converting the 

assets into cash (for example, asset sales, securitizations, compromises 

with borrowers, loan repayments, sale to bank that takes deposits)? 

Deposit Insurer Yes No 

Asset 

sales 

Compromises 

with 

Securitizations borrowers 

Loan 

repayments 

Sale to bank 

that takes 

deposits 

Strategy 

decided case 

by case 

Advanced Economies 

Austria (AAR) X 

Austria (AABB) X X 

Belgium X X X 

Canada X X X X 

France X X 

Germany (EdB) X X 

Germany (E) X X 

Greece X X X X 

Isle of Mana X X 

Italy (IDPF) X X 

Italy (DPFCB) X X 

Japan 

Netherlands X 

Portugal 

Spain X X 

Sweden X X 

Taiwan Province of China X 

United Kingdom X 

Subtotal 13 2 5 0 2 2 3 6 

Developing Economies and Economies in Transition 

Africa 

Nigeria X X X 

Tanzania X X X 

Uganda X X X X 

Europe 

Czech Republic X X X 

Hungary X X 

Latvia X X X X X X 

Lithuania X X X 

Poland X X X 

Romania X X 

Slovak Republic X 

Turkey X X X 

Middle East 

Bahrain X 

Oman X 

Western Hemisphere 

Brazil X 

El Salvador X X X 

Jamaica X X X 

Mexico X X 

Peru X X X 

Trinidad and Tobago X X 

Subtotal 15 4 14 1 3 6 5 1 

Total 28 6 19 1 5 8 8 7 

Note: Classification of economies into “Advanced,” “Developing,” or “Economies in Transition” is from International Monetary Fund (2000). 

aBritish Crown Dependency. 

AAR = Association of Austrian Raiffesenbanks 

AABB = Association of Austrian Banks and Bankers 

EdB = Entschadigungseinrichtung deutscher Banken 

E = Einlagensicherungs 

IDPF = Interbank Deposit Protection Fund 

DPFCB = Deposit Protection Fund for Co-operative Banks 

23 
FDIC Banking Review 

Table 12
 

Reasons for Using Asset-Sales Strategy
 

What factors influence the determination of the strategy used to dispose of assets? 

Nature and Minimizing Size or Macroeconomic 

quality the time to Statute, condition conditions, interest 

of the reimburse regulation, of the rates, state of Factors differ Deposit Insurer assets depositors or policy asset market credit markets case by case Other 

Advanced Economies 

Austria (AAR)
 

Austria (AABB)
 

Belgium X
 

Greece
 

Italy (IDPF)
 

Japan
 

Netherlands
 

Portugal
 

United Kingdom
 

Canada X X X
 

France X
 

Germany (EdB) X
 

Germany (E) X
 

Isle of Mana X
 

Italy (DPFCB) X
 

Spain X X
 

Sweden X
 

Taiwan Province of China X X X
 

Subtotal 2 1 1 1 2 3 5
 

Developing Economies and Economies in Transition
 

Africa
 

Nigeria X
 

Tanzania X X X
 

Uganda X X
 

Europe
 

Czech Republic X
 

Hungary
 

Latvia
 

Slovak Republic
 

Lithuania X
 

Poland X
 

Romania X
 

Turkey X X
 

Middle East
 

Bahrain X
 

Oman X
 

Western Hemisphere
 

Brazil
 

El Salvador X
 

Jamaica X
 

Mexico X
 

Peru X
 

Trinidad and Tobago X
 

Subtotal 6 1 3 2 1 1 5
 

Total 8 2 4 3 3 4 10
 

Note: Classification of economies into “Advanced,” “Developing,” or “Economies in Transition” is from International Monetary Fund (2000). 

aBritish Crown Dependency. 

AAR = Association of Austrian Raiffesenbanks 

AABB = Association of Austrian Banks and Bankers 

EdB = Entschadigungseinrichtung deutscher Banken 

E = Einlagensicherungs 

IDPF = Interbank Deposit Protection Fund 

DPFCB = Deposit Protection Fund for Co-operative Banks 

24 
Failure Resolution and Asset Liquidation 

Table 13
 

Types of Assets Most Difficult to Liquidate
 

What types of assets have you found to be the most difficult to dispose of? 

Non- Commercial Commercial 

Deposit Insurer Loans 

performing 

loans 

Owned 

real estate 

and industrial 

loans 

and industrial 

real estate 

Bank 

premises 

Obsolete 

assets Other 

Advanced Economies 

Austria (AAR) 

Austria (AABB) 

Belgium 

Canada X X 

France 

Germany (EdB) 

Germany (E) 

Greece 

Isle of Mana 

Italy (IDPF) X 

Italy (DPFCB) X 

Japan 

Netherlands 

Portugal 

Spain X X 

Sweden 

Taiwan Province of China X 

United Kingdom 

Subtotal 0 3 0 2 0 0 0 2 

Developing Economies and Economies in Transition 

Africa 

Nigeria X X 

Tanzania X 

Uganda X 

Europe 

Czech Republic X 

Hungary 

Latvia 

Lithuania 

Poland X 

Romania X 

Slovak Republic 

Turkey X 

Middle East 

Bahrain 

Oman 

Western Hemisphere 

Brazil 

El Salvador X 

Jamaica X 

Mexico X X X X X X X X 

Peru X 

Trinidad and Tobago X 

Subtotal 2 2 5 1 3 2 3 2 

Total 2 5 5 3 3 2 3 4 

Note: Classification of economies into “Advanced,” “Developing,” or “Economies in Transition” is from International Monetary Fund (2000). 

aBritish Crown Dependency. 

AAR = Association of Austrian Raiffesenbanks 

AABB = Association of Austrian Banks and Bankers 

EdB = Entschadigungseinrichtung deutscher Banken 

E = Einlagensicherungs 

IDPF = Interbank Deposit Protection Fund 

DPFCB = Deposit Protection Fund for Co-operative Banks 

25 
FDIC Banking Review 

Conclusions 

The results of the survey of deposit insurers clearly 

indicate that, compared with other deposit insurers, 

the FDIC has a unique role in resolving bank failures 

and disposing of failed-bank assets. In contrast to the 

FDIC’s role as a receiver, in other places the court 

establishes a receivership and court-appointed 

receivers run the receivership. The FDIC’s authority 

to act as receiver of a failed bank, and the special powers it possesses as receiver, allow it to reimburse 

insured depositors quickly and to expedite the assetliquidation process. However, these additional powers 

should not, and do not, go unchecked. 

One check is a least-cost requirement. The FDIC 

is allowed to deviate from the least-cost requirement 

only if a systemic-risk determination has been made. 

In places outside the United States, some flexibility is 

built into the least-cost test: many deposit insurers are 

allowed some exceptions to their least-cost requirement. 

In arriving at the least costly resolution, the FDIC 

has authority to choose among various types of resolution structures. Deposit insurers in other places also 

have some flexibility in the type of resolution they can 

choose. Most commonly, insurers have the authority 

to use open-bank assistance or a deposit payoff, but 

many can also use a P&A transaction. Not many 

deposit insurers have the authority to use a bridgebank structure. Consistent with the general finding 

that deposit insurers act as paying agents and not as 

receivers, the most commonly used resolution type 

outside the United States is a deposit payoff. 

Even so, some deposit insurers have liquidated 

failed-bank assets in the past ten years, and for these 

insurers, the assets hardest to liquidate are the same 

types that are hardest to liquidate in the United States. 

Perhaps the experience of the FDIC and the RTC in 

liquidating failed-bank assets, and the techniques 

they created during the U.S. banking crisis of the 

1980s and early 1990s, will help other locations to market distressed assets in the future. 

More generally, despite the uniqueness of the 

FDIC’s role in resolving failed banks, the FDIC’s 

experience may be helpful to other countries that are 

designing financial safety nets. Of course, it is crucial 

to take into account each country’s political, cultural, 

and market infrastructure. Nevertheless, some of the 

resolution and asset-liquidation techniques developed 

by the FDIC can very likely be applied effectively in 

other countries. 

26 
Failure Resolution and Asset Liquidation 

BIBLIOGRAPHY 

Bartholomew, Philip F., and Benton E. Gup. 1997. A Survey of Bank Failures, Near Failures, and 

Significant Incidents in the Foreign G-10 Countries since 1980. Unpublished manuscript. 

Cobos, Dean Forrester. 1989. Forbearance: Practices and Proposed Standards. FDIC Banking Review 2, no. 1:20–28. 

Commission of the European Communities (CEC). 1988. Amended Proposal for a Council Directive Concerning the Reorganisation and the Winding Up of Credit Institutions and Deposit 

Guarantee Schemes (CEC). 

Cooke, David C. 1998. Failure-Resolution Practices. In FDIC Conference Papers: FDIC International Conference on Deposit Insurance. Vol. 2. 

Cooke, David C., and Ryoji Kitami. 1998. Cross-Country Comparisons—Examination of the Continuum of Failure-Resolution Practices Workshop. In FDIC Conference Papers: FDIC 

International Conference on Deposit Insurance. Vol. 1. 

European Shadow Financial Regulatory Committee. 1998. Dealing with Problem Banks in Europe. Statement no. 1. 

———. 1999. A New Role for Deposit Insurance in Europe. Statement no. 5. 

European Union. 1989a. Council Directive 89/647/EEC of 17 April 1989 on the Own Funds of 

Credit Institutions. Official Journal of the European Communities, no. L124. 

———. 1989b. Council Directive 89/299/EEC of 18 December 1989 on a Solvency Ratio for 

Credit Institutions. Official Journal of the European Communities, no. L386. 

———. 1994. Directive 94/19/EEC of the European Parliament and the Council on Deposit 

Protection Schemes. Official Journal of the European Communities, no. L135. 

Federal Deposit Insurance Corporation (FDIC). 1997. History of the Eighties—Lessons for the Future: 

An Examination of the Banking Crises of the 1980s and Early 1990s. 2 vols. FDIC. 

———. 1998a. Managing the Crisis: The FDIC and RTC Experience 1980–1994. FDIC. 

———. 1998b. Resolutions Handbook: Methods for Resolving Troubled Financial Institutions in the 

United States. FDIC. 

Garcia, Gillian. 1999. Deposit Insurance: A Survey of Actual and Best Practices. WP 99/54. International Monetary Fund. 

Interbank Deposit Protection Fund (IDPF). 1999. International Deposit Insurance Systems. 

International Monetary Fund (IMF). 2000. World Economic Outlook. IMF. 

Kane, Edward J. 2000. Designing Financial Safety Nets to Fit Country Circumstances. Unpublished manuscript. 

Kaufman, George G., and Steven A. Seelig. 2000. Post-Resolution Treatment of Depositors at 

Failed Banks: Implications for the Severity of Banking Crises, Systemic Risk, and Too-BigTo-Fail. Working Paper Series, no. 2000-16. Federal Reserve Bank of Chicago. 

27 
FDIC Banking Review 

Marino, James A., and Rosalind L. Bennett. 1999. The Consequences of National Depositor 

Preference. FDIC Banking Review 12, no. 2, 19–38. 

McKenzie, George, and Manzoor Khalidi. 1994. The EU Directive on Deposit Insurance: A Critical Evaluation. Journal of Common Market Studies 32, no. 2:171–90. 

Moreland-Gunn, Penelope, Peter J. Elmer, and Timothy J. Curry. 1995. Reps and Warranties. 

FDIC Banking Review 8, no. 3, 1–9. 

Moysich, Alane K. 1991. Summary of Proceedings: International Conference on Deposit Insurance and Problem-Bank Resolution Policies. FDIC Banking Review 4, no. 1:27–34. 

Murphy, Neil B. 2000. European Union Financial Developments: The Single Market, the Single 

Currency, and Banking. FDIC Banking Review 13, no. 1:1–18. 

28 

Merchant Banking: Past and Present 

Merchant Banking:
 

Past and Present
 

by Valentine V. Craig*
 

Merchant banking has been a very lucrative— 

and risky—endeavor for the small number of 

bank holding companies and banks that 

have engaged in it under existing law. Recent legislation has expanded the merchant-banking activity that 

is permissible to commercial banks and is therefore 

likely to spur interest in this lucrative specialty on the 

part of a greater number of such institutions. Although 

for much of the past half-century commercial banks 

have been permitted (subject to certain restrictions) to 

engage in merchant-banking activities, the term merchant banking itself is undefined in U.S. banking and 

securities laws and its exact meaning is not always 

clearly understood. 

This article begins by defining merchant banking 

and provides a short history of it. The article then 

looks at the private equity market in the United 

States, examining that market in terms of its evolution, typical uses of funds, and forms taken by the 

investments. (In examining the private equity market, one needs to be aware that the private equity market is, in fact, private. Data are limited and could be 

subject to error.) Discussed next is commercial bank 

involvement in merchant banking: the structure of 

commercial bank involvement, the evolution of that 

involvement, and the recent track record. The major 

provisions of the Gramm-Leach-Bliley Act of 1999, 

legislation which authorizes financial holding companies to engage in merchant banking, is looked at next. 

The final section focuses on the relationship among 

merchant banking, risk, and the regulators. 

Definition and Early History of 


Merchant Banking
 

Although not defined in U.S. federal banking and 

securities laws, the term merchant banking is generally understood to mean negotiated private equity investment by financial institutions in the unregistered 

securities of either privately or publicly held companies. 

Both investment banks and commercial banks engage 

in merchant banking, and the type of security in which 

they most commonly invest is common stock. They 

also invest in securities with an equity participation 

feature; these may be convertible preferred stock or 

subordinated debt with conversion privileges or warrants. Other investment bank services—raising capital 

from outside sources, advising on mergers and acquisitions, and providing bridge loans while bond financing 

is being raised in a leveraged buyout (LBO)—are also 

typically offered by financial institutions engaged in 

merchant banking. 

Merchant banks first arose in the Italian states in 

the Middle Ages,1 when Italian merchant houses— 

generally small, family-owned import-export and commodity trading businesses—began to use their excess 

capital to finance foreign trade in return for a share of 

the profits. This trade generally consisted of lengthy 

* Valentine V.	 Craig is a Chartered Financial Analyst in the FDIC’s 

Division of Research and Statistics. The author gratefully acknowledges the comments of the FDIC’s Legal Division in preparing this 

article. 

1 Much of the history of merchant banking is derived from Banks (1999). 

29 
FDIC Banking Review 

sea voyages. Thus, the investments were very high 

risk: war, bad weather, and piracy were constant 

threats, and by their nature the voyages were longterm and illiquid. 

Later, the center for merchant banking shifted from 

the Italian states to Amsterdam and then, in the eighteenth century, to London, where immigrants from 

Prussia, France, Ireland, Russia, and the Italian states 

formed the core of early British merchant banking. 

Like the Italian and Dutch houses before them, these 

British houses were generally small, family-owned 

partnerships, and most of them continued both to 

trade for their own businesses and to finance the trading by others. By the end of the eighteenth century, 

however, the British merchant houses had increased in 

size and sophistication and began specializing in trade, 

marketing, or finance. As the nineteenth century 

opened, virtually no mercantile houses remained 

focused on both trade and finance. 

The Private Equity Market in the 


United States
 

The private equity market in the United States has 

evolved over the years, with financial institution 

involvement only becoming significant in the 1960s 

and 1970s. Where these funds are invested also has 

changed over time. Currently, most private equity 

funding is used to fund start-up or early-stage companies or to bring large public companies private. Private 

equity investments can be made through limited partnerships or they can be direct investments. Subsidiaries of banking organizations are probably the 

largest direct investors in this market. 

Evolution of the Private Equity Market 

Given its history, merchant banking is often 

thought of as a European, and especially British, financial specialty, and British institutions continue to 

maintain a major presence in this area. Since the 

1800s and even earlier, however, U.S. firms (such as 

J.P. Morgan) also have been active in merchant banking. However, although both investment banks and 

commercial banks, as well as other types of businesses, have been authorized to engage in private equity 

investment in the United States, financial institutions 

have not been major providers of private equity. 

Until the 1950s, U.S. investors in private equity 

were primarily wealthy individuals and families. In 

the 1960s and 1970s, corporations and financial institutions joined them in this type of investment. (In the 

1960s, commercial banks were the major providers of 

one kind of private equity investing, venture-capital 

financing.) Through the late 1970s, wealthy families, 

industrial corporations, and financial institutions, for 

the most part investing directly in the issuing firms, 

constituted the bulk of private equity investors. 

In the late 1970s, changes in the Employee 

Retirement Income Security Act (ERISA) regulations, 

in tax laws, and in securities laws brought new 

investors into private equity. In particular, the 

Department of Labor’s revised interpretation of the 

“prudent man rule” spurred pension fund investment 

in private equity capital.2 Currently, the major 

investors in private equity in the United States are 

pension funds, endowments and foundations, corporations, and wealthy investors; financial institutions— 

both commercial banks and investment banks— 

represent approximately 20 percent of total private 

equity capital, divided approximately equally between 

the two. The U.S. Department of the Treasury 

(Treasury) estimates that at year-end 1999, commercial banks accounted for approximately $35 billion to 

$40 billion, and investment banks for approximately 

another $40 billion, of the $400 billion total investment in the private equity market. 

At $400 billion as of year-end 1999, the private equity market is approximately one-quarter the size of the 

commercial and industrial bank-loan market and the 

commercial-paper market.

3 In recent years, funds 

raised through private equity have approximately 

equaled and sometimes exceeded funds raised 

through initial public offerings and public high-yield 

corporate bond issuance.4 The market also has grown 

dramatically in recent years, increasing from approximately $4.7 billion in 1980 to its 1999 figure. Despite 

this tremendous growth, the private equity market is 

extremely small compared with the public equity market, which was approximately $17 trillion at year-end 

1999. 

Typical Uses of Private Equity 

Private equity financing is an alternative to raising 

public equity, issuing public debt, or arranging a private placement of debt or bank loan. The reasons 

2 The “prudent man rule” refers to the fiduciary responsibility of investment managers. In the earlier interpretation, each investment in a 

portfolio was expected to meet safety standards in and of itself. Under 

the revised interpretation, the Department of Labor accepted the concept of portfolio diversification of risk, thereby permitting portfolio 

managers to invest a small portion of the portfolio in riskier investments as long as the portfolio in the aggregate met fiduciary standards 

of risk. 

3 Fenn, Liang, and Prowse (2000). 

4 Ibid. 

30 
Merchant Banking: Past and Present 

Table 1 

U.S. Private Equity Funds Raised by Year 

($ Billions) 

Total Private Venture Buyout/Mezzanine 

Year Equity Capital Financinga Other 

1999 $108.1 $46.6 $44.6 $16.9 

1998 105.4 28.0 61.2 16.3 

1997 73.8 15.7 48.7 9.4 

1996 45.2 10.6 29.8 4.9 

1995 41.1 8.2 27.3 5.6 

1994 30.9 7.2 20.5 3.2 

1993 22.0 3.9 16.9 1.2 

Source: Venture Economic News. 

aMezzanine financing generally consists of subordinated debt with equity conversion privilege or warrants issued in 

tandem with the equity issue in a buyout. 

companies seek private equity financing are varied. 

For example, other forms of financing may be unavailable or too expensive because the company’s track 

record is either nonexistent or poor (that is, the company is in financial distress). Or a private company 

may want to expand or change its ownership but not 

go public. Or a firm may not want to take on the fixed 

cost of debt financing. 

Public firms may seek private equity financing 

when their capital needs are very limited and do not 

warrant the expense, time, and regulatory paperwork 

required for a public issue. They also may seek private equity to keep a planned acquisition confidential 

or to avoid other public disclosures. They may use the 

private equity market because the public market for 

new issues in general is bad or because the public 

equity market is temporarily unimpressed with their 

industry’s prospects. Finally, very often in recent 

years, managements of large public firms have felt 

their firms will benefit from a change in capital structure and ownership and will choose to go private by 

means of a leveraged buyout (LBO).5 

Although companies seek private equity for all 

these reasons, most private equity funding has been 

used for one of two purposes: to fund start-up or earlystage companies (venture capital) or to bring large 

public companies private in LBOs. Of the $400 billion 

in outstanding private equity investment at year-end 

1999, venture-capital investments accounted for 

approximately $125 billion and nonventure-capital 

investments for approximately $275 billion. LBOs 

were by far the most common use of nonventure-capital private equity. 

Table 1 provides estimates of the private equity 

raised, and its uses, for each year from 1993 to 1999. 

From the table one can see that private equity investment increased substantially over this seven-year period, going from $22 billion raised in 1993 to over $108 

billion raised in 1999. In 1999, for the first time since 

1985, venture-capital fundraising accounted for a larger percentage of total private equity fundraising than 

buyout/mezzanine financing. Before the mid-1980s, 

two-thirds of private equity investments were used to 

finance venture-capital investments. 

Forms Taken by Investments 

Currently, more than 80 percent of private equity 

investments are made by limited partnerships, with 

professional private equity managers acting on behalf 

of institutional investors. In a limited partnership, the 

professional equity managers serve as general partners, and the institutional investors serve as limited 

partners. The general partners manage the investment and contribute an insignificant part of the investment, generally approximately 1 percent. These 

limited partnerships have a contractually fixed life, 

usually ten years. The investments are highly illiquid 

over the partnership’s life, with a return not expected 

until the partnership’s later years, when the business 

5 A leveraged buyout is the purchase of a company’s stock or assets by a 

very leveraged acquirer, one whose debt financing is based solely on 

the value of the acquired firm. The LBO began as a means for the 

owners of small, privately held companies to cash out and shift ownership to family or management when these buyers did not have much 

equity capital (the major LBO transactions of the 1970s). Today’s 

LBOs more typically involve bringing large public companies private, 

with a small group of investors acquiring most of a firm’s common stock 

and issuing a combination of private equity and a large amount of debt, 

much of it junk bonds. 

31 
FDIC Banking Review 

is sold through a public offering or a private sale, or the 

shares are repurchased by the company. Banks 

(through subsidiaries) often act as limited partners in 

private equity limited partnerships, and infrequently 

as general partners. 

Direct investments in private equity are made also. 

Through subsidiaries, bank holding companies and 

banks are probably the largest direct investors in the 

private equity market. 

Commercial Bank Involvement in
 

Merchant Banking
 

Commercial banks have historically utilized Small 

Business Investment Corporations (SBICs) or “5 percent subs” (defined below) for their domestic private 

equity investments, and Edge Act Corporations or foreign subsidiaries to make their foreign private equity 

investments. Several very large bank holding companies have come to dominate merchant banking, directing as much as 10 percent of their capital to these 

activities. For the most part, reported earnings from 

these merchant-banking activities have been very 

good. 

Structure 

Before passage of the Gramm-Leach-Bliley Act 

(GLBA), commercial banks and bank holding companies (BHCs) had two primary vehicles for making private equity investments in domestic corporations. 

They could make these investments through SBICs 

and/ or through “5 percent subs.” Typically, banks 

engaged in domestic merchant banking have used both 

of these vehicles; for equity investments in foreign 

companies, they have used foreign subsidiaries or 

Edge Act Corporations. As mentioned above, although 

these subsidiaries have sometimes organized limited 

partnerships in which they acted as general partners, 

more often they have invested directly in private equity or have acted as limited partners in a partnership. 

Small Business Investment Corporations. 

SBICs were authorized by the Small Business 

Investment Act of 1958 to promote small-business 

equity funding. This act authorized BHCs and banks 

to provide equity capital to small companies through 

SBICs, which can be subsidiaries of either BHCs or 

banks. A very significant percentage of the largest 

SBICs are subsidiaries of banks rather than of BHCs. 

Investments in SBICs are direct and subject to certain limits. Banks are allowed to invest only 5 percent 

of their capital and surplus in their SBICs; bank holding company investments are capped at 5 percent of 

the BHC’s interest in the capital and surplus of its subsidiary banks. The investments of the SBICs also are 

limited. Investments can be made only in companies 

with pre-investment net worth of no more than $18 

million, and each investment is capped at 50 percent 

of the recipient’s outstanding shares of stock. 

5 Percent Subs. The Bank Holding Company Act 

of 1956 permitted bank holding companies to make 

passive equity investments in nonfinancial companies. 

Specifically, the legislation allowed bank holding companies to own a maximum of 5 percent of the voting 

shares (hence the “5 percent sub” designation) and a 

maximum of 25 percent of the total equity of companies engaged in any activity. There is no limit on the 

total amount of equity that a BHC can invest through 

all of its 5 percent subs. 

Because these investments are passive equity interests only, bank holding companies often have used 

unregulated independent general partners to oversee 

them. And because of the 5 percent sub investment 

limits, in the case of growing businesses 5 percent subs 

often have been forced to raise outside capital and 

limit their role to that of a minority investor or agent. 

Foreign Subsidiaries or Edge Act Corporations. As mentioned above, banks have made private equity investments in foreign firms through 

foreign subsidiaries of bank holding companies or 

through Edge Act Corporations, which are generally 

organized as bank subsidiaries. Edge Act Corporations 

are permitted to own up to 20 percent of the voting 

shares or 40 percent of the total equity of a foreign 

company. 

Evolution 

A few very large BHCs dominate merchant banking, directing as much as 10 percent of their capital to 

these activities. Citigroup, Chase, Bank of America, 

FleetBoston, and Wells Fargo have the largest presence in this area. In 1999, Chase, FleetBoston, Wells 

Fargo, J.P. Morgan, and First Union reported an aggregate investment of over $5 billion in venture-capital 

investments, and they expect to continue to expand 

this area of their business.6 

6 What’s Really Driving Banks’ Profits (2000). 

32 
0

0

0

Merchant Banking: Past and Present 

Many banks entered merchant banking in the 

1960s to take advantage of the economies of scope 

produced when private equity investing is added to 

other bank services, particularly commercial lending. 

As lenders to small and medium-sized companies, 

banks become knowledgeable about individual firms’ 

products and prospects and consequently are natural 

providers of direct private equity investment to these 

firms. As mentioned above, commercial banks were 

the largest providers of venture capital in the 1960s. 

In the middle to late 1980s, the decision to enter 

merchant banking was thrust on other banks and bank 

holding companies by unforeseen events. In those 

years, as a result of the LDC (less-developed-country) 

debt crisis, many banks received private equity from 

developing nations in return for their defaulted loans. 

At that time, many of these banks set up merchantbanking subsidiaries to try to get some value from this 

private equity. 

Also at about that time, most commercial banks 

began refocusing their private equity investments to 

middle-market and public companies (often low-tech, 

already profitable companies) and, rather than providing seed capital, financed expansion or changes in capital structure and ownership. Most particularly, they 

took equity positions in LBOs, takeovers, or recapitalizations or provided subordinated debt in the form of 

bridge loans to facilitate the transaction. Often they 

did both. Commercial banks financed much of the 

LBO activity of the 1980s. 

Then, in the mid-1990s, major commercial banks 

began once again focusing on venture capital, where 

they had substantial expertise from their previous 

exposure to this kind of investment. Some of these 

recent venture-capital investments have been spectacularly successful. For example, the Internet search 

engine Lycos was a 1998 investment of Chase 

Manhattan’s venture-capital arm. 

Recent Track Record 

Commercial banks are permitted to report either 

realized or unrealized gains on their merchant-banking 

portfolios, as long as they are consistent in the reporting.7 This option makes it difficult for one to compare 

different entities’ financial results and could lead to an 

overly liberal reporting of profits. However, the 

Federal Reserve Board (FRB) generally considers 

bank holding companies that are engaged in merchant 

banking to have reported their earnings conservatively on these equity investments. 

These reported earnings have been good. The 

FRB estimates that revenue from private equity 

investment for the small number of BHCs with a significant presence in this field8 was approximately 12 

percent to 13 percent of total BHC net income in the 

three-year period from 1995 through 1997. The FRB 

further estimates that rates of return on merchantbanking activities have averaged approximately 30 

percent annually over the past five years. Another 

source, the National Venture Capital Association, estimates an overall 85 percent rate of return for venture 

capital funds invested in early-stage companies in 

1999.9 Most bank subsidiaries’ venture-capital investments have recently been averaging returns of approximately 40 percent, compared with 10 percent to 15 

percent on commercial lending.10 

The merchant-banking subsidiaries of Chase, Wells 

Fargo, J.P. Morgan, First Union, and FleetBoston 

reported in the aggregate $5 billion in net income for 

1999. Chase’s merchant-banking subsidiary Chase 

Capital Partners reported $2.5 billion in net income in 

1999—22 percent of Chase’s total reported net 

income. Wells Fargo’s merchant-banking activities 

accounted for 13 percent of its 1999 reported income; 

J.P. Morgan’s for 15 percent; First Union’s for 8 percent; and FleetBoston’s for 9 percent. 

These merchant-bank subsidiary returns are particularly good when one considers that merchant banking requires very low overhead. For instance, Wells 

Fargo has 92,000 employees, but only 14 partners ran 

its merchant-bank subsidiary, which was responsible 

for 16 percent of Wells Fargo’s total fourth-quarter 

1999 net income. Similarly, First Union has 70,000 

employees, but only 16 people conducted its merchant-banking activities, which brought in 13 percent 

of First Union’s fourth-quarter 1999 net income.11 

With the long bull market in stocks—and a particularly hot IPO market for technology stocks in 1999— 

BHC merchant-banking subsidiaries have increased 

their venture-capital investments in recent years. As 

already mentioned, Chase, Wells Fargo, J.P. Morgan, 

First Union, and FleetBoston invested over $5 billion 

7 Unrealized gains generally occur after a company has an initial public 

offering (IPO) but the stock has not been sold because of its lock-up 

period. A bank would typically apply a discount, or “haircut,” to the 

value of the unsold IPO shares to account for volatility, with the gain 

being the difference between this discounted value and the investment’s cost. 

8 The FRB does not identify the institutions or their individual financial 

information. 

9 The New York Times (1999). 

10 What’s Really Driving (2000). 

11 Ibid. 

33 
FDIC Banking Review 

in venture-capital investments in 1999 and plan to 

continue to expand this area of their business. Chase 

alone has tripled its venture-capital investments since 

1996.12 

The Gramm-Leach-Bliley Act of 1999 

To some extent, commercial bank activities have 

been restricted throughout U.S. history.13 

Restrictions of particular importance to banks’ merchant-banking activities are contained in the 1933 

Glass-Steagall Act,14 which formalized the separation 

between commercial banking and certain investmentbanking activities. Blaming bank failures of the 1930s 

on the banks’ speculative securities activities, 

Congress passed this legislation to draw a firm line 

between commercial and investment banking. 

Although there is little evidence that the investmentbanking activities of commercial bank affiliates actually were a major factor in the bank failures of that time, 

differences of opinion have continued to exist 

between those who seek to exclude commercial banks 

from investment-banking activities and those who 

favor permitting such activities. GLBA, enacted on 

November 12, 1999, specifically recognizes merchant 

banking as an activity “financial in nature” and provides authority to financial holding companies (FHCs) 

to provide merchant-banking services. (The legislation does not define merchant banking.) To qualify as 

a financial holding company, a bank holding company 

and all of its insured depository subsidiaries must be 

well-capitalized and well-managed and its 

Community Reinvestment Act rating must be at least 

satisfactory. According to the FRB, as of May 2000, 

270 domestic banking institutions and 17 foreign 

banking organizations had filed to become financial 

holding companies.15 

GLBA specifically authorizes FHCs to “directly or 

indirectly acquire or control any kind of ownership 

interest in an entity engaged in any kind of trade or 

business whatsoever” if (1) the shares are purchased 

and held through a securities affiliate or “an affiliate 

thereof” of the FHC; (2) the shares are held for the 

sole purpose of appreciation and ultimate resale; and 

(3) the FHC does not routinely manage the company 

in which it has invested except as necessary to obtain 

an ultimate reasonable return on investment. 

Maintaining the historical separation between 

banking and commerce, this legislation specifically 

disallows routine management by the FHC subsidiary 

of the nonfinancial company in which it has invested. 

These investments are for investment purposes only 

and are not to be used as a back door for the holding 

company to control or operate a commercial business. 

This legislation also prohibits subsidiaries of banks 

from engaging in merchant-banking activities, 

although that prohibition may be reexamined by the 

FRB and the Treasury in 2004. 

Under the new law, FHCs’ portfolio investments in 

nonfinancial companies are not limited to the 5 percent sub limits restricting control of the portfolio company. In a major departure from existing policy 

regarding 5 percent sub investments, GLBA provides 

that investments made under the new law need not be 

passive; FHCs may in fact purchase a controlling interest in a company. Nor does GLBA restrict these merchant-banking subsidiaries to SBIC investment limits 

on the size of the company in which the SBIC can 

invest, on the percentage of shares that can be owned, 

and on the amount of BHC or bank capital devoted to 

these investments. 

Final Word: Attention to Risk 

GLBA opens up new opportunities for commercial 

banks that wish to enter or expand their merchantbanking activities. For the most part, pre-GLBA commercial bank merchant-banking activities were very 

lucrative, and often spectacular. However, in the years 

2000–2001 the stock market and the IPO market 

became substantially more volatile. It is hoped that 

this greater volatility will emphasize to newer merchant-banking participants the risky nature of this 

market. Participants might also pay heed to the fact 

that in the not-so-distant past some financial institutions engaged in merchant banking suffered substantial losses, albeit in their nonventure-capital 

investments. In particular, in 1990, with the collapse 

of Drexel Burnham Lambert and the junk-bond market, First Boston’s losses were so severe that Credit 

Suisse, its parent, had to launch a multimillion-dollar 

rescue. In that same year, Merrill Lynch left the merchant-banking business altogether. 

The FRB and the Treasury have been concerned 

with the increased risks to which merchant-banking 

activities expose commercial banks. Although GLBA 

12 Ibid.
 

13 For more information on this issue, see Blair (1994). 


14 Sections 16, 20, 21, and 32 of the Banking Act of 1933 are commonly
 

referred to as the Glass-Steagall Act. 

15 Ferguson (2000). 

34 
Merchant Banking: Past and Present 

was largely silent on limitations to banks’ merchantbanking activities, the FRB and the Treasury have not 

been. On March 17, 2000, the FRB and the Treasury 

jointly adopted an interim rule implementing the merchant-banking authority of the GLBA: the interim 

rule placed a cap on the amount of merchant-banking 

investments that financial holding companies may 

hold. Specifically, the interim rule placed an aggregate 

limit of $6 billion or 30 percent of Tier 1 capital on the 

amount the FHC may devote to merchant-banking 

activities. In addition, the interim rule required that 

investments be sold within ten years—although this 

time limit could be extended on a case-by-case basis. 

Merchant-banking participants expressed vehement opposition to the FRB–Treasury interim rule’s 

restrictions on the amount and time limit of merchantbanking investments. On January 10, 2001, the FRB 

and the Treasury issued a final rule replacing the earlier interim rule. The final rule removed the $6 billion 

cap on merchant-banking investments of financial 

holding companies. Although the final rule maintained the ten-year limit on investments, the rule simplified ways to obtain extensions to this limit. 

The FRB also offered for comment last year a proposal that would have required FHCs to set aside significant capital for their merchant-banking investments. A capital charge of 50 percent on all nontrade-account equities held by banking organizations 

was proposed. Merchant-banking participants 

expressed particular opposition to this proposed rule. 

On January 18, 2001, the FRB released a revised proposal. It proposed a sliding scale tying a company’s 

capital requirements to the amount of its equity 

investments in nonfinancial companies. The proposed scale ranges from an 8 percent capital charge for 

equity investments of up to 15 percent of Tier l capital; a 12 percent capital charge for equity investments 

of between 15 percent and 25 percent of Tier l capital; 

and a maximum 25 percent capital charge for those 

banking companies with equity investments exceeding 25 percent of Tier 1 capital. These capital charges 

also are to be applied to equity investments by banks 

and BHCs made under other authorities besides 

GLBA.16 An exception applies to SBIC investments. 

Under the proposal, no capital charge would be 

required for SBIC investments if they do not exceed 

15 percent of the organization’s capital.17 The FRB 

also issued regulations prohibiting FHCs from crossmarketing with any company in which the BHC 

makes a merchant-banking investment that exceeds 5 

percent of the company’s equity. 

Observers will be paying close attention to how the 

FRB proceeds regarding FHC merchant-banking 

activity, as this represents the latest chapter in the 

debate over the mixing of banking and commerce in 

the United States. How banks fare in their merchantbanking activities during the next economic downturn 

will also be followed with great interest. 

16 These capital charges apply to some investments held by state banks 

under Section 24 of the Federal Deposit Insurance Act. Section 24(d) 

allows a state bank to hold, through subsidiaries, equity investments 

that are not permissible for a national bank if the investment poses no 

harm to the deposit fund and the bank is and continues to be in compliance with applicable capital standards. Under the proposed rule, 

the FDIC may permit a lower capital deduction for such investments 

under Section 24 in certain instances. The FDIC and the other banking agencies also reserve the authority to impose higher capital charges 

where appropriate. 

17 Also exempt are investments held under Section 24(f) of the Federal 

Deposit Insurance Act. Section 24(f) permits state banks to retain and 

acquire stock that does not exceed 100 percent of the bank’s capital if 

the bank is located in a state that permitted, as of September 30, 1991, 

investment in publicly traded companies and registered investment 

companies, and the bank made or maintained an investment in such 

securities during the period beginning September 30, 1990, and ending November 26, 1991. 

35 
FDIC Banking Review 

BIBLIOGRAPHY 

Banks, Erik. 1999. The Rise and Fall of the Merchant Banks. Kogan Page Ltd. 

Blair, Christine E. 1994. Bank Powers and the Separation of Banking from Commerce: An 

Historical Perspective. FDIC Banking Review 7, no. 1:28–38. 

Business Week. 2000. What’s Really Driving Bank Profits. April 3. 

Cook, Kate W., and Noreen Doyle. 2000. Leveraged Buyouts. In Handbook of Modern Finance 

2000 Edition, edited by Dennis E. Logue and James K. Seward, E-2: 1–26. Warren, 

Gorham & Lamont/RIA Group. 

Fenn, George W., Nellie Liang, and Stephen Prowse. December, 1995. The Economics of the 

Private Equity Market. Staff Study 168, Board of Governors of the Federal Reserve 

System. 

———. 2000. The Private Equity Market. In Handbook of Modern Finance 2000 Edition, edited 

by Dennis E. Logue and James K. Seward, D-10: 1–51. Warren, Gorham & Lamont/RIA 

Group. 

Ferguson, Roger W. 2000. Remarks before the National Association of Urban Bankers, Urban 

Financial Services Coalition, San Francisco, California. May 26. 

Gensler, Gary. 2000. Remarks before the House Banking Subcommittee on Capital Markets, 

Securities, and Government Sponsored Enterprises. June 7. 

Greenspan, Alan. 2000. Banking Evolution. Remarks before the 36th Annual Conference on 

Bank Structure and Competition of the Federal Reserve Bank of Chicago, Chicago, Illinois. 

May 4. 

Marshall, John F., and M. E. Ellis. 1994. Investment Banking and Brokerage. Probus 

Publishing. 

New York Times. 1999. Old Money Chasing the New. December 24. 

Shorter, Gary. 1999. Financial Modernization Legislation in the 106th Congress: Merchant 

Banking. Congressional Research Service, Library of Congress. 

Venture Economic News. 2000. Thomson Financial Securities Data and National Venture Capital 

Association. Various issues. 

36 
Recent Developments 

Recent Developments 

Affecting Depository 

Institutions
 

by Lynne Montgomery*
 

REGULATORY AGENCY ACTIONS
 

Interagency Actions 

Consumer-Protection Rule for Insurance 

The federal bank and thrift regulatory agencies 

announced on December 4, 2000, a final consumerprotection rule for the sale of insurance products by 

depository institutions. The rule outlines disclosures 

that are required before the completion of the sale of 

an insurance product or annuity. The rule applies to 

any depository institution and any person selling, 

soliciting, advertising, or offering insurance products 

or annuities to a consumer at an office of the institution or on behalf of the institution. The disclosures 

must be made orally and in writing, and the consumer must acknowledge in writing that the disclosures were received. The final rule, which is 

effective October 1, 2001, implements Section 305 of 

the Gramm-Leach-Bliley Act. PR-87-2000, FDIC, 12/4/00. 

CRA Sunshine Regulation 

On December 21, 2000, the federal bank regulatory agencies approved a final regulation that governs 

how banks and community organizations disclose 

their community lending agreements. The rule 

implements the CRA Sunshine Requirements of the 

Federal Deposit Insurance Act, which were enacted 

by the Gramm-Leach-Bliley Act. The rule requires 

banks and thrifts to make available for public disclosure agreements they have with community groups 

and other organizations in connection with compliance under the Community Reinvestment Act. The 

rule also requires banks and thrifts to send copies of 

such agreements to the appropriate banking regulator. The rule, which was issued by the Board of 

Governors of the Federal Reserve System, the Office 

of the Comptroller of the Currency (OCC), the 

Federal Deposit Insurance Corporation (FDIC), and 

the Office of Thrift Supervision (OTS), becomes 

effective April 1, 2001. NR 2000-105, OCC, 12/21/00; BBR, 

1/8/01, p. 9–10. 

Customer Information Security Guidelines 

The federal bank and thrift regulatory agencies 

adopted guidelines for safeguarding confidential customer information. The purpose of the safeguards is 

to ensure the security and confidentiality of customer 

records and information. The guidelines implement 

Section 501(b) of the Gramm-Leach-Bliley Act and 

are effective July 1, 2001. The guidelines require 

financial institutions to establish an information 

security program to: (1) identify and assess the risks 

that may threaten customer information; (2) develop 

a written plan containing policies and procedures to 

manage and control these risks; (3) implement and 

*Lynne Montgomery is a senior financial analyst in the FDIC’s Division 

of Research and Statistics. 

Reference sources: American Banker (AB), Federal Register (FR), and 

BNA’s Banking Report (BBR). 

37 
FDIC Banking Review 

test the plan; and (4) adjust the plan on a continuing 

basis to account for changes in technology, the sensitivity of customer information, and internal or external threats to information security. The guidelines 

also outline responsibilities of directors of financial 

institutions in overseeing the protection of customer 

information. OTS 01-04, OTS, 1/17/01. 

Debt Requirements for Banks that Own 

Financial Subsidiaries 

On January 22, 2001, the Federal Reserve Board 

and the Treasury Department approved a final rule 

that sets the criteria that a specific class of national 

banks and state-member banks must meet to own 

financial subsidiaries. A national bank or a statemember bank wishing to control a financial subsidiary must rank as one of the 100 largest insured 

banks in the nation. The largest 50 banks in that 

group may control a financial subsidiary if their longterm debt receives a top investment-grade rating. 

The remaining 50 banks in the group also may control financial subsidiaries by meeting this long-term 

debt requirement or by meeting an alternative debt 

requirement, which is the focus of the final rule. The 

final rule allows the second group of 50 banks to 

meet the requirement if they have a current longterm issuer credit rating from a nationally recognized 

statistical rating organization that is within the three 

highest investment-grade categories used by the rating organization. In addition to the debt requirement, national and state-member banks must meet 

capital, management, and other requirements to 

operate financial subsidiaries. BBR, 1/29/01, p. 131. 

Federal Deposit Insurance Corporation 

Tanoue Resigns 

On July 11, 2001, Donna Tanoue resigned from 

the FDIC, where she served as chairman since May 

26, 1998. Under Ms. Tanoue’s leadership, the FDIC 

conducted a review of the deposit-insurance system 

and proposed important changes to the federal 

deposit-insurance program. The Corporation also 

addressed the risk of subprime lending and initiated 

proposals to address the problems of predatory and 

payday lending. Before coming to the FDIC, Ms. 

Tanoue was a partner in the Hawaii law firm of 

Goodsill Anderson Quinn & Stifel. PR-45-2001, FDIC, 

6/12/01; BBR, 6/18/01, p. 1022. 

Board Member Appointed 

John M. Reich was sworn in on January 16, 2001, 

to a six-year term as a Director on the FDIC’s Board 

of Directors. Before joining the FDIC, Mr. Reich 

served for 12 years on the staff of U.S. Senator 

Connie Mack (R-FL), where he was the chief of staff 

from 1998 through 2000. Mr. Reich directed and 

oversaw all committee activity, including Senator 

Mack’s activity on the Senate Banking Committee. 

Before working with Senator Mack, Mr. Reich spent 

23 years in the banking business in Illinois and 

Florida. AB, 12/19/00. 

Final Regulation on State Banks’
 

Activities and Investments
 

The FDIC released a final regulation on 

December 21, 2001, governing how the agency 

approves activities and investments of insured statechartered banks. The rule was required by the 

Gramm-Leach-Bliley Act (GLBA), which created a 

new Section 46 of the Federal Deposit Insurance 

Act. Section 46 outlines the FDIC’s approval procedures for various activities of state nonmember 

banks. Before GLBA, approvals of state-bank activities were handled under Section 24 of the Federal 

Deposit Insurance Act. The final rule permits state 

banks to seek approval under either Section 24 or 

Section 46. In addition, the final rule grandfathers 

activities by a state bank that has already received 

approval under Section 24, if the Treasury 

Department and the Federal Reserve Board have not 

already made certain other determinations under 

Section 46. The final rule also eases the approval 

process by permitting banks to enter into a new activity as soon as the FDIC receives notice from the 

bank that it complies with all requirements for that 

activity. BBR, 1/8/01, p. 15. 

Money Smart Program 

The FDIC and the Department of Labor 

announced on January 1, 2001, a joint initiative called 

Money Smart, which offers basic financial education 

to people taking part in Welfare-to-Work and 

Workforce Investment Act programs nationwide. 

Money Smart consists of 10 training modules covering 

basic financial education topics. The program is 

designed to help adults currently outside the financial mainstream build financial knowledge and 

develop positive relationships with financial institutions. Beginning in the second quarter of 2001, 

38 
Recent Developments 

Money Smart will be available through a national network of more than 800 centers that provide employment and training services for persons seeking new 

jobs or entering the workforce, including individuals 

participating in Welfare-to-Work programs. PR-6-2001, 

FDIC, 1/19/01. 

Report on Underwriting Practices 

The October 2000 issue of the FDIC’s semiannual Report on Underwriting Practices reported a slight 

increase in the occurrence of risky underwriting practices for construction, commercial (nonresidential) 

real-estate, and home-equity lending during the sixmonth period ending September 30, 2000. The risks 

associated with current underwriting practices, loan 

growth, and credit risk in banks’ loan portfolios also 

increased during the six-month period. In contrast, 

the occurrence of risky underwriting practices for 

agriculture lending decreased. The survey of loan 

underwriting practices is aimed at providing early 

warnings of potential problems in underwriting practices at FDIC-supervised, state-chartered nonmember banks. The focus of the survey is threefold: 

material changes in underwriting standards for new 

loans, degree of risk in current practices, and specific 

aspects of the underwriting standards for new loans. 

The October report includes surveys from 1,124 

FDIC-supervised banks that were examined during 

the six months ending September 30, 2000. Report on 

Underwriting Practices, FDIC, October 2000. 

In the April 2001 issue of the Report on 

Underwriting Practices, the FDIC reported that the 

occurrence of risky underwriting practices by banks 

increased for both construction and consumer lending, but the risks associated with general underwriting practices decreased slightly. The April report 

summarizes responses from FDIC examiners to survey questions regarding the lending practices at 

1,181 FDIC-supervised banks examined during the 

six-month period ending March 31, 2001. Report on 

Underwriting Practices, FDIC, April 2001. 

Real-Estate Survey—July 2000 

The July 2000 issue of the Survey of Real Estate 

Trends reported continued favorable views of local 

residential and commercial real-estate markets. 

Survey respondents were asked if general conditions 

for U.S. real-estate markets had changed (as characterized by vacancy rates, market prices, and the pace 

of sales) in the first six months of 2000. The percentage of respondents reporting no change was high 

across all property markets: single-family (58 percent), multifamily (72 percent), office (72 percent), 

retail (78 percent), and industrial (73 percent). 

Where general market conditions were reported to 

have changed, improving conditions were observed 

more often than worsening conditions. The July 

report summarized the opinions of 256 survey 

respondents, which consisted of FDIC senior examiners and asset managers as well as bank examiners of 

the Federal Reserve System, the Office of the 

Comptroller of the Currency, and the Office of Thrift 

Supervision. Survey of Real Estate Trends, FDIC, July 2000. 

Real-Estate Survey—January 2001 

The January 2001 issue of the Survey of Real 

Estate Trends reported that conditions generally 

remained favorable in the nation’s real-estate markets during the second half of 2000, although there 

was some deterioration, particularly involving singlefamily homes and local retail properties. The percentage of respondents reporting no change in the 

condition of U.S. real-estate markets was high across 

all property markets: single-family (56 percent), 

multifamily (75 percent), office (69 percent), retail 

(75 percent), and industrial (76 percent). However, 

reports of slight deterioration in conditions were 

more frequent than those of improvement for all 

property markets except industrial. This development was in contrast to the first half of 2000 when 

reports of improving conditions outnumbered those 

of worsening ones. Single-family markets had the 

highest proportion of respondents noting somewhat 

worsening conditions—27 percent of respondents 

reported worsening conditions versus 17 percent 

reporting better conditions. Eighteen percent of 

respondents reported deterioration in local retail 

markets, while only 7 percent reported better conditions. The January report summarized the opinions 

of 265 survey respondents, which consisted of FDIC 

senior examiners and asset managers as well as bank 

examiners of the Federal Reserve System, the Office 

of the Comptroller of the Currency, and the Office of 

Thrift Supervision. Survey of Real Estate Trends, FDIC, January 

2001. 

Insurance Funds’ Financial Results for
 

2000
 

The FDIC reported that the Bank Insurance 

Fund (BIF) experienced comprehensive income (net 

39 
FDIC Banking Review 

income plus unrealized gains/losses on available-forsale securities) of $1.6 billion for the 12 months ending December 31, 2000, compared to a loss of $198 

million during 1999. At December 31, 2000, the BIF 

balance was approximately $31 billion, up from $29.4 

billion at year-end 1999. The increase in income was 

primarily attributable to low estimated losses recognized on institutions that failed in 2000 and an 

increase in the market value on available-for-sale 

securities. BIF revenues totaled $1.9 billion in 2000, 

including $1.8 billion in interest on investments in 

U.S. Treasury obligations and $45 million in deposit 

insurance assessments. The Savings Association 

Insurance Fund (SAIF) reported comprehensive 

income of $478 million in 2000, compared to $441 

million in 1999. The SAIF closed the year with a 

fund balance of $10.8 billion, an increase from $10.3 

billion at year-end 1999. The SAIF earned $664 million in revenue during 2000, consisting of $644 million in interest on investments in U.S. Treasury 

obligations and $19 million in deposit insurance 

assessments. PR-29-2001, FDIC, 4/10/01. 

Bank Failures 

On September 29, 2000, Mississippi’s 

Commissioner of Banking and Consumer Finance 

closed the Bank of Falkner, Falkner, Mississippi, and 

named the FDIC as receiver. The Bank of Falkner 

had total assets of approximately $88.8 million and 

deposits of $77.1 million in approximately 5,827 

accounts. Citizens Bank & Savings Company, 

Russellville, Alabama, paid a premium of $2.5 million 

to purchase the failed institution’s insured deposits 

and approximately $21.7 million of the assets. The 

FDIC retained the remaining assets for later disposition. The Bank of Falkner is the fourth failure of a 

BIF-insured institution in 2000. PR-66-2000, FDIC, 9/29/00. 

Hawaii’s Commissioner of Financial Institutions 

closed the Bank of Honolulu, Honolulu, Hawaii, on 

October 13, 2000, and the FDIC was named receiver. The failed institution had total assets of approximately $66.9 million and total deposits of $59.5 

million in approximately 5,900 accounts. The Bank 

of the Orient, San Francisco, California, paid the 

FDIC a premium of $1 million to assume the failed 

bank’s insured deposits and paid an additional premium of $855,000 to purchase approximately $52.2 

million of the failed bank’s assets. Additionally, the 

Bank of the Orient was given a 30-day exclusive purchase option on another $9.3 million of the failed 

bank’s assets. The FDIC retained the remaining 

assets for later disposition. The FDIC estimates that 

the failure will cost the BIF approximately $2.5 million. The Bank of Honolulu is the fifth failure of a 

BIF-insured institution in 2000. PR-70-2000, FDIC, 

10/13/00. 

National State Bank, Metropolis, Illinois, was 

closed by the Office of the Comptroller of the 

Currency (OCC) on December 14, 2000, and the 

FDIC was appointed receiver. The OCC used its 

authority under the FDIC Improvement Act of 1991 

(FDICIA) to close the bank when it discovered that 

the bank was critically undercapitalized—the bank’s 

tangible equity capital was less than 2 percent of its 

total assets. Inadequate control of the credit and 

transaction risks associated with its merchant-processing activities involving the settlement of creditcard-sales transactions for merchants resulted in a 

high volume of losses, which depleted capital and 

threatened the bank’s liquidity. The FDIC entered 

into an agreement with Banterra Bank, Marion, 

Illinois, to assume the insured deposits of the failed 

bank, which were approximately $67 million at the 

time of closing. Banterra Bank also paid the FDIC a 

premium of approximately $2 million for the right to 

purchase $23.7 million of the failed bank’s assets. 

The FDIC retained the remaining assets of approximately $68 million for later disposition. This is the 

sixth failure of a BIF-insured institution in 2000, and 

the seventh failure of an institution insured by the 

FDIC in 2000. PR-90-2000, FDIC, 12/14/00. 

On February 2, 2001, the Bank Commissioner for 

the state of New Hampshire closed First Alliance 

Bank & Trust Company, Manchester, New 

Hampshire, and the FDIC was named receiver. The 

failed bank had approximately $18.4 million in assets 

and $17.5 million in deposits. Southern New 

Hampshire Bank & Trust, Salem, New Hampshire, 

paid the FDIC a premium of $150,000 for the right to 

assume the deposits and to purchase $17.1 million of 

the failed bank’s assets. The FDIC retained the 

remaining $1.3 million of assets for later disposition. 

The FDIC estimates this transaction will cost the 

BIF approximately $119,000. First Alliance is the 

first failure of a BIF-insured institution in 2001. PR11-2001, FDIC, 2/2/01. 

On May 3, 2001, the OCC closed The Malta 

National Bank, Malta, Ohio, and appointed the 

FDIC as receiver. The OCC used its statutory 

receivership authority to close the bank after finding 

40 
 

Recent Developments 

that the bank had engaged in unsafe-and-unsound 

practices and had incurred significant losses. The 

failed bank had total deposits of approximately $8.8 

million and total assets of $9.5 million. The FDIC 

entered into an agreement with North Valley Bank, 

Zanesville, Ohio, to assume all of the failed bank’s 

deposits. North Valley Bank also purchased $9.2 

million of the failed bank’s assets at a discount 

of approximately $800,000 from book value. 

The FDIC retained the remaining assets for later 

disposition. The FDIC estimates the transaction will 

cost the BIF approximately $80,000. This was the 

second failure of a BIF-insured institution in 2001. 

PR-32-2001, FDIC, 5/3/01. 

Federal Reserve Board 

Interest Rates 

Between January 3, 2001, and June 27, 2001, the 

Federal Open Market Committee (FOMC) lowered 

the targeted federal funds rate by 275 basis points, 

decreasing the rate from 6.50 percent to 3.75 percent. 

The Board of Governors decreased the discount rate 

by 275 basis points during the same time period, lowering the rate from 6.00 percent to 3.25 percent. The 

federal funds rate is the fee that banks charge each 

other for overnight loans, and the discount rate is the 

fee charged to financial institutions for borrowing 

from their district Federal Reserve Banks. PR-FRB, 

1/3/01, 1/31/01, 3/20/01, 4/18/01, 5/15/01, 6/27/01. 

Regulation Z 

The Federal Reserve Board adopted a final rule 

aimed at helping consumers decipher credit-card 

companies’ marketing pitches about interest rates, 

late fees, grace periods, and other terms. The rule 

amends Regulation Z, which implements the Truth 

in Lending Act, to revise the disclosure requirements 

for credit-card solicitations and applications. Under 

the new rule, credit-card issuers will have to include 

an easy-to-read chart on all credit-card solicitations 

and applications, laying out in simple terms the interest rate consumers will pay to carry debt on the card. 

The rule comes in response to rising concern among 

bank regulators about overly aggressive marketing 

tactics by credit-card issuers that can confuse consumers and make credit-card purchases more 

expensive than anticipated. The rule is effective 

September 27, 2000, and compliance is mandatory as 

of October 1, 2001. The Washington Post, 9/29/00; FR, 10/3/00. 

Assessment of Foreign Banks’ U.S.
 

Operations
 

On October 24, 2000, the Federal Reserve 

announced a series of steps to update its five-year-old 

system of supervising foreign banking organizations 

that operate in the United States. The Federal 

Reserve plans to improve its “Strength of Support 

Assessment” (SOSA) process, through which it ranks 

foreign banks’ ability to offer financial, liquidity, and 

management support to its American operations. 

The rankings help provide a point of reference for 

U.S. bank supervisors to assess the risks of a foreign 

bank’s operations in the United States. Under the 

new system, the five current SOSA rankings will be 

streamlined into three rankings. The new initiative 

provides that the Federal Reserve will inform foreign 

banking organizations, as well as the banks’ homecountry supervisors, of the SOSA rankings. In addition, the new initiative calls for the creation of a combined assessment rating for all of a foreign banking 

organization’s U.S. branches, agencies, and commercial lending companies. BBR, 10/30/00, p. 545. 

New Annual Reserve and Reporting
 

Requirements
 

On November 21, 2000, the Federal Reserve 

Board published in the Federal Register annual 

adjustments used to calculate reserve requirements 

and reporting requirements for depository institutions. The reserve requirements determine how 

much depository institutions must keep on hand 

either in cash, deposits at Federal Reserve Banks, or 

pass-through accounts at correspondent institutions. 

For the year 2001, the first $5.5 million in net transaction accounts will be exempt from the reserve 

requirements. Amounts between $5.5 million and 

$42.8 million will be subject to a 3 percent requirement, and amounts above $42.8 million are subject to a 10 percent reserve requirement. Effective 

September 2001, institutions must file reports on 

their deposit levels on a weekly, quarterly, or annual 

basis, depending on their deposit levels and their 

classification with respect to reserve requirements. 

However, U.S. branches and agencies of foreign 

banks must file deposit reports weekly, regardless of 

their size. BBR, 11/27/00, p. 681. 

Financial Holding Companies Permitted to 

Offer Finder Services 

On December 13, 2000, the Federal Reserve 

41 
FDIC Banking Review 

Board approved a rule defining “finder” activities as 

financial in nature and therefore within the bounds of 

banks’ legitimate business functions. A “finder” acts 

as an intermediary in a transaction that is negotiated 

between the buyer and seller, and facilitates the 

identification of the potential buyers and sellers. 

The rule, which amends Subpart I of Regulation Y, 

requires banks acting as finders to differentiate clearly between products and services they offer directly 

and those that are offered by third parties. Under the 

rule, financial holding companies acting as a finder 

can: identify third parties that may be interested in 

engaging in a transaction between themselves; ask 

third parties about their interest in engaging in a 

transaction with another party; introduce and refer 

potential parties to each other; arrange contacts and 

meetings between interested parties; and transmit 

information concerning products and services to 

potential parties in connection with the above activities. BBR, 12/18/00, p. 783. 

Disclosure of ATM Fees 

The Federal Reserve Board published a final rule 

amending Regulation E (Electronic Fund Transfers) 

to implement provisions of the Gramm-Leach-Bliley 

Act requiring disclosure of automated-teller machine 

(ATM) fees. Under the final rule, an ATM operator 

who imposes a fee on a consumer for an electronicfund-transfer service is required to provide notice of 

the fee in a prominent and conspicuous location on or 

at the ATM where the electronic service is initiated. 

The ATM operator also must disclose the amount of 

the fee either on the screen of the ATM or on a paper 

notice before the consumer is committed to completing the transaction. A fee may not be imposed unless 

proper notice is provided and the consumer chooses 

to complete the transaction. The rule is effective 

March 1, 2001, and compliance with the rule is 

mandatory as of October 1, 2001. PR-FRB, 3/1/01. 

HMDA Reporting Exemption Threshold 

Increased 

The Federal Reserve Board raised the asset-size 

exemption threshold from $30 million to $31 million 

for depository institutions that are required to report 

data under the Home Mortgage Disclosure Act 

(HMDA). In 2001, depository institutions with 

assets of $31 million or less will be exempt from 

reporting data on their housing-related lending activities. The final rule amends Regulation C, which 

implements the Home Mortgage Disclosure Act. 

The asset level that releases institutions from reporting data under HMDA is adjusted each year on the 

basis of changes in inflation as measured by the 

Consumer Price Index for Urban Wage Earners and 

Clerical Workers. NR 2001-10, OCC, 2/20/01. 

Daylight Overdrafts 

On May 30, 2001, the Federal Reserve issued an 

interim rule permitting banks to accumulate negative 

balances in their accounts with the Federal Reserve 

during the course of the business day. The regulation, which is effective upon issuance, allows banks 

to seek “daylight credit” above their normal overdraft caps. The action reflects ongoing efforts by the 

Federal Reserve Board to balance the costs, risks, 

and benefits associated with the provision of Federal 

Reserve intraday credits. Dow Jones Newswires, 5/31/01. 

Survey on Bank Lending Practices 

In its May 2001 Senior Loan Officer Opinion Survey 

on Bank Lending Practices, the Federal Reserve Board 

reported that both domestic and foreign banks were 

continuing a trend of stricter business lending practices. Slightly more than 50 percent of domestic 

banks reported tightened standards for commercial 

and industrial (C&I) loans to large and middle-market firms since the last survey in January 2001. 

About 36 percent of domestic banks tightened standards on loans to small firms over the same period. 

Both foreign and domestic institutions indicated that 

the most important reasons for tightening standards 

and terms on C&I loans were a less favorable economic outlook and a worsening of industry-specific 

problems. For the report, the Federal Reserve surveyed loan officers from 55 large domestic banks and 

21 U.S. branches and agencies of foreign banks. The 

survey focused on changes during the preceding 

three months in the supply and demand for bank 

loans to households and businesses. Senior Loan Officer 

Opinion Survey on Bank Lending Practices, FRB, May 2001. 

Office of the Comptroller of the Currency 

Fees for Third-Party Exams 

A rule issued on May 8, 2001, permits the OCC to 

charge for special examinations of banks’ third-party 

service providers. Some banks recently have entered 

42 
Recent Developments 

new lines of business, or introduced potentially highrisk products, relying substantially on third-party service providers to enable the bank to conduct the 

activities. Since banks involved in such activities 

may be exposed to higher-than-normal levels of risk, 

examiners have an increased need to examine the 

third-party providers. The new rule, which becomes 

effective June 7, 2001, applies to a wide range of 

activities, including credit-card issuing, subprime 

lending, and check cashing. Before the rule, the 

OCC was permitted to assess a fee for a special examination of a bank, but not for special examinations of 

a third-party provider. AB, 5/9/01. 

Pilot Program to Enhance National Banks’ 

Lending Capacity 

The OCC announced on June 8, 2001, a three-year 

pilot program intended to reduce the competitive 

disparity that exists in states that have single-borrower lending limits that are higher than the federal limits available to national banks. National banks are 

generally permitted to lend no more than 15 percent 

of their capital on an unsecured basis to a single borrower; however, many states have higher limits for 

their state-chartered institutions. The pilot program 

will allow national banks with the highest supervisory ratings to lend up to the state limit—but not more 

than 25 percent of capital—to single borrowers for 

small-business loans and for loans secured by singlefamily-residential real estate. Because the program is 

aimed primarily at community banks, only banks 

with assets of less than $1 billion are able to participate. To participate in the program, a bank must be 

rated 1 or 2 under the five-point Uniform Financial 

Institutions Rating System scale, which evaluates an 

institution’s capital adequacy, asset quality, management capability, earnings strength, liquidity, and sensitivity to market risk. Eligible banks must also have 

a rating of at least 2 for the asset and management 

components of the test. NR 2001-52, OCC, 6/8/01. 

Survey of Credit Underwriting Practices 

The OCC’s annual Survey of Credit Underwriting 

Practices reported that underwriting standards for 

commercial and retail loans tightened during the 12­

month period ending March 31, 2001. Fifty-five percent of banks tightened commercial loan standards in 

2001, compared to 25 percent in 2000; 6 percent loosened standards in 2001, compared to 16 percent in 

2000. The survey found that 32 percent of banks 

tightened underwriting standards for retail loans, 

while 20 percent eased standards. The 2001 survey 

covered the 66 largest national banks with an aggregate loan portfolio of $2 trillion—approximately 90 

percent of national bank loans. The survey, which is 

completed by OCC senior examiners, consists of a 

series of questions concerning 16 types of commercial and retail lending. The questions focus on the 

direction of lending standards and the level of inherent risk in the portfolio and products of the banks. NR 

2001-59, OCC, 6/27/01. 

Office of Thrift Supervision 

Seidman Offers Resignation 

On July 3, 2001, Ellen Seidman announced that 

she submitted her resignation as the Director of the 

Office of Thrift Supervision (OTS). Her resignation 

is effective upon the confirmation and appointment 

of a replacement. Ms. Seidman has served as the 

Director of the OTS since October 27, 1997. Before 

becoming director, Ms. Seidman was a Special 

Assistant to President Clinton for Economic Policy at 

the White House National Economic Council. OTS 01­

43, OTS, 7/3/01. 

Liquidity Requirements 

The OTS issued a final rule that removes the regulation requiring savings institutions to maintain an 

average daily balance of liquid assets of at least 4 percent of their liquidity base. The final rule requires 

thrifts to maintain adequate liquidity to ensure safeand-sound operation. The rule, which is effective 

July 18, 2001, will give thrifts greater flexibility in 

adjusting their asset mix. BBR, 3/19/01, p. 478; FR, 7/18/01. 

Federal Housing Finance Board 

Chairman Appointed 

President Bush designated J. Timothy O’Neill 

Chairman of the Federal Housing Finance Board on 

June 18, 2001. Mr. O’Neill has served as a director of 

the Finance Board since June 1995. Before joining 

the Finance Board, Mr. O’Neill was a partner in the 

Washington, D.C., law firm of O’Connor & Hannan, 

where he focused on trade and international law and 

legislative and regulatory issues. Mr. O’Neill was 

also Director of Congressional Affairs at the Finance 

Board in 1991 and 1992. FHFB 01-13, FHFB, 6/19/01. 

43 
FDIC Banking Review 

Board Member Appointed 

On December 28, 2000, President Clinton 

announced the recess appointment of Allan I. 

Mendelowitz to serve as a member of the Board of 

Directors for the Federal Housing Finance Board. 

Mr. Mendelowitz served as Chairman of the Board 

from December 28, 2000, until June 18, 2001, when 

President Bush appointed J. Timothy O’Neill as 

chairman. Mr. Mendelowitz served as the executive 

director of the U.S. Trade Deficit Review 

Commission from October 1999 to December 2000. 

From January 1999 to September 1999, he was vice 

president of the Economic Strategy Institution, 

where he supervised research on trade policy, international competitiveness, and telecommunications 

policy. FHFB 00-41, FHFB, 12/28/00. 

Collateral Rules Eased 

The Federal Housing Finance Board (FHFB) 

announced on November 30, 2000, that four regional 

Home Loan Banks expanded the type of loans small 

member banks can pledge as collateral for advances. 

Member banks typically have used mortgages as collateral for advances, but the Dallas, Topeka, Des 

Moines, and Seattle Home Loan Banks will now permit member institutions with assets less than $500 

million to use small-business, farm, and agriculturebusiness loans as collateral. The FHFB will permit 

the other Home Loan Banks to adopt similar plans at 

any time. AB, 12/1/00. 

Final Rule on Capital Standards 

The Federal Housing Finance Board approved a 

final rule on December 20, 2000, implementing a 

new capital structure for the Federal Home Loan 

Banks. The final rule replaces the FHLBanks’ subscription capital structure with a more flexible, riskbased capital structure, and the rule contains 

risk-based and leverage-capital requirements similar 

to those for depository institutions. The final rule 

implements provisions of the Gramm-Leach-Bliley 

Act (GLBA) that establish two classes of capital 

stock: Class A, which is redeemable on six months’ 

notice; and Class B, which is redeemable on five 

years’ notice. The rule also incorporates the requirements that each FHLBank maintain a minimum 

ratio of total capital to total assets of at least 5 percent 

and that a FHLBank may not redeem stock if it 

would fail to meet any of its minimum capital 

requirements. Each FHLBank may weight its permanent capital at 1.5 times paid-in value to meet the 

5-percent test, as long as its total capital, excluding 

such weighting, is not less than 4 percent of its total 

assets. Each FHLBank also must have enough permanent capital to meet the rule’s risk-based capital 

requirements for credit risk, market risk, and operations risk. GLBA requires each of the FHLBanks to 

submit a capital structure plan to the Finance Board 

for approval within 270 days of the publication of the 

final rule and provides for a transition period to the 

new capital structure of up to three years from the 

effective date of each FHLBank’s capital structure 

plan. FHFB 00-38, FHFB, 12/20/00. 

Amendment to Affordable Housing Program 

On May 4, 2001, the Federal Housing Finance 

Board approved a rule amending its Affordable 

Housing Program (AHP) regulations to improve the 

program’s effectiveness and efficiency. The most significant rule change increases the maximum amount 

of money that can be set aside annually under a 

Federal Home Loan Bank’s homeownership setaside program to the greater of $3 million or 25 percent of a FHLBank’s annual AHP contribution. 

Those limits previously were the greater of $1.5 million or 15 percent of the FHLBank’s annual AHP 

contribution. Each FHLBank independently operates an Affordable Housing Program in accordance 

with the FHLBank Act. Funding for each program 

varies by FHLBank, but banks must set aside a minimum of 10 percent of their funding for affordable 

housing initiatives. FHFB 01-10, FHFB, 5/4/01; BBR, 5/14/01, p. 

858. 

National Credit Union Administration 

Acting Chairman Appointed 

On February 8, 2001, President Bush named 

Dennis Dollar Acting Chairman of the NCUA Board 

of Directors. Mr. Dollar has been a member of the 

Board since October 1997. His current term expires 

on August 2, 2001. Before joining the NCUA, Mr. 

Dollar served as CEO of the Gulfport VA Federal 

Credit Union from 1992 to 1997. Mr. Dollar also 

served two terms in the Mississippi House of 

Representatives from 1975 to 1983. PR020901, NCUA, 

02/09/01. 

44 
Recent Developments 

Board Member Appointed 

President Clinton named Geoff Bacino to the 

NCUA Board of Directors in a recess appointment 

effective December 29, 2000. Mr. Bacino, who was 

originally nominated for a seat on the Board on July 

24, 2000, fills the seat held by Chairman Norman E. 

D’Amours whose term expired August 2, 1999. Mr. 

Bacino was president of Bacino and Associates, a lobbying and public-relations firm in Alexandria, 

Virginia. He previously served as a lobbyist for the 

Credit Union National Association, co-founded the 

National Association of State-Chartered Credit 

Unions, and served as executive director of the 

National Association of Share Insurance Corporations. PR010201, NCUA, 01/02/01. 

Credit Unions Receive Dividend 

On March 8, 2001, the NCUA voted to waive an 

insurance premium for 2001 and pay a dividend of 

$99.5 million to the nation’s federally insured credit 

unions. The average size $48-million credit union 

will receive a dividend of approximately $11,000. 

The dividend returns the National Credit Union 

Share Insurance Fund (NCUSIF) to the normal 

operating level of 1.3 percent of deposits of federally 

insured credit unions. Since the NCUSIF was recapitalized in 1985, approximately $552 million has been 

returned to federally insured credit unions in the 

form of dividends. PR030801, NCUA, 3/8/01. 

STATE LEGISLATION AND REGULATION
 

Illinois 

Chicago became the first city to take local legislative action against predatory lending by passing an 

ordinance on August 30, 2000, that prohibits financial 

institutions engaged in predatory practices from acting as city depositories or contractors. The “AntiPredatory Lending Ordinance” defines “predatory” 

as any loan with an annual percentage rate that 

exceeds the U.S. Treasury rate by more than six percentage points. The ordinance requires all city 

depositories and financial-services vendors to pledge 

that neither they nor their affiliates will engage in 

predatory lending. Institutions that fail to sign the 

pledge will be barred from city contracts. Mayor 

Richard Daley introduced the ordinance in an effort 

to curb lending practices that have contributed to 

unprecedented rates of foreclosures and abandonment of single-family residences in the city. BBR, 

9/11/00, p. 319–320. 

On April 17, 2001, the Illinois Joint Committee on 

Administrative Rules adopted regulations aimed at 

preventing predatory lending in Illinois. The regulations apply to high-risk loans, which are defined as: 

first-mortgage loans with an annual percentage rate 

of at least 6 percent more than the U.S. Treasury 

securities rate, and second-mortgage loans with an 

annual percentage rate of at least 8 percent greater 

than the U.S. Treasury securities rate. The regulations also apply to loans with total points and fees 

exceeding $800 or 5 percent of the total loan, 

whichever is greater. When such high-risk loans are 

issued, lenders are required to verify the borrower’s 

ability to repay and are restricted from tacking single-premium credit life insurance onto the loan. The 

regulations impose several other restrictions on 

Illinois-licensed lenders, including: a prohibition on 

deceptive marketing and sales techniques; a ban on 

loan flipping; a ban on negative amortization of loans; 

limits on the financing of points and fees; limitations 

on balloon payments; and prohibitions on loans in 

which payments are made solely to a contractor. BBR, 

4/9/01, p. 631. 

New York 

Governor George E. Pataki (R) signed a bill on 

September 8, 2000, that extends New York state’s 

“wild card” banking law for another three years. The 

law will now expire September 10, 2003. The “wild 

card” legislation gives the New York State Banking 

Department the ability to grant state-chartered 

banks powers matching those powers enjoyed by 

federally chartered banks. The legislation is necessary to protect the viability of New York state’s banking charter and New York’s banking consumers. In 

addition to extending the expiration date, the new 

law strengthens consumer protection provisions by 

prohibiting banks from charging customers certain 

fees solely because the customer purchases insurance from an insurer other than the bank or one of its 

affiliates. BBR, 9/25/00, p. 389. 

On November 9, 2000, the New York State 

Insurance Department issued a rule for safeguarding 

45 
FDIC Banking Review 

consumers’ confidential personal information. All 

licensed insurers are required to provide initial notice 

to consumers of how they share nonpublic personal 

financial information with unaffiliated parties, and 

they must provide an annual opportunity for consumers to “opt out” of having their information 

shared with third parties. The rule brings New York 

insurers into compliance with the privacy requirements of the Gramm-Leach-Bliley Act. AB, 11/13/00. 

Pennsylvania 

The Philadelphia City Council passed an ordinance on April 5, 2001, banning predatory lending in 

the city and requiring loan counseling for borrowers 

who were charged high interest rates. The city is targeting nonbank lenders, however, and the ordinance 

exempts state and national banks and thrifts and trust 

companies. The ordinance prohibits lenders from 

making high-cost loans. A high-cost loan is defined 

as one with an interest rate more than 6.5 percentage 

points above the U.S. Treasury securities rate, and 

with total points and fees financed equal to four percentage points of the loan amount. Lenders found to 

be predatory will be fined and will lose all contracts 

with the city or city agencies. The ordinance also 

establishes a Predatory Lending Review Committee 

to investigate allegations of abusive lending and to 

help the victims of predatory lenders. AB, 4/6/01. 

BANK AND THRIFT PERFORMANCE
 

Fourth-Quarter 2000 Results for 

Commercial Banks and Savings 

Institutions 

FDIC-insured commercial banks earned $17.8 billion during the fourth quarter of 2000, which is $1.5 

billion less than third-quarter earnings, but $91 million more than earnings in the fourth quarter of 1999. 

Banks’ annualized return on assets (ROA) was 1.16 

percent in the fourth quarter, down from 1.28 percent in the third quarter and 1.27 percent one year 

earlier. The number of commercial banks on the 

FDIC’s “Problem List” increased from 75 to 76 

banks during the quarter, while assets of problem 

banks increased from $14 billion to $17 billion. 

There were two commercial bank failures in the 

fourth quarter of 2000. 

FDIC BIF-insured mutual savings institutions 

reported earnings of $2.6 billion in the fourth quarter 

of 2000, up $49 million from the third quarter, but 

$90 million less than earnings one year earlier. The 

industry’s ROA for the fourth quarter held steady 

from the third quarter at 0.86 percent, but was down 

from 0.95 percent in the fourth quarter of 1999. The 

number of problem thrifts increased to 18 thrifts 

from 15 in the third quarter, but assets of problem 

thrifts decreased from $7.3 billion in the third quarter to $7.1 billion at year-end 2000. There were no 

thrift failures during the fourth quarter of 2000. FDIC 

Quarterly Banking Profile, Fourth Quarter 2000. 

First-Quarter 2001 Results for Commercial 

Banks and Savings Institutions 

FDIC-insured commercial bank earnings 

rebounded in the first quarter of 2001—net income 

totaled $19.9 billion in the quarter, up $2.1 billion 

from the previous quarter and $400 million higher 

than earnings in the first quarter of 2000. 

Commercial banks’ average ROA was 1.27 percent in 

the first quarter of 2001, up from 1.16 percent in the 

fourth quarter of 2000, but down from 1.35 percent in 

the first quarter of 2000. The number of commercial 

banks on the FDIC’s “Problem List” increased from 

76 to 78 banks during the quarter, but assets of problem banks remained unchanged at $17 billion. 

There was one bank failure during the first quarter. 

FDIC BIF-insured mutual savings institutions 

reported earnings of $2.9 billion in the three months 

from January through March 2001, which is $300 million higher than the previous quarter but $35 million 

lower than one year earlier. The industry’s ROA for 

the first quarter was 0.95 percent, up from 0.86 percent in the fourth quarter of 2000, but down from 

1.03 percent one year earlier. The number of problem thrifts declined from 18 to 17 during the quarter, 

and problem assets decreased from $7.1 billion to 

$6.1 billion. There were no thrift failures during the 

first quarter of 2001. FDIC Quarterly Banking Profile, First Quarter 

2001. 

RECENT ARTICLES AND STUDIES
 

A report released by the OCC on October 27, by 52 percent from September 1999 to July 2000. 

2000, says that the number of national banks offering The percentage of national banks allowing cusonline financial services on Internet sites increased tomers to transact business on their Web sites 

46 
Recent Developments 

increased from 21 percent in September 1999 to 32 

percent in July 2000. In addition, although smaller 

national banks (banks with less than $100 million in 

assets) still lag behind larger banks, the percentage of 

small banks offering transactional Internet services 

increased from 7 percent to 17 percent during the 

period studied. BBR, 11/6/00, p. 587. 

An October 2000 report by the Federal Reserve 

Bank of Cleveland suggests a merger of the two federal deposit insurance funds would reduce costs to 

taxpayers and would not present a risk to the financial-services industry. James B. Thompson, an economist at the Federal Reserve, reports that financial 

market integration has effectively removed economic distinctions between depository institutions and 

the risks they face, making it difficult to argue that 

banks and savings associations operate in distinct 

markets with widely different types of risk exposure. 

The author points out that nearly one-half of bank 

loans are related to real estate and that more than 12 

percent of loans made by thrifts are consumer loans 

or commercial and industrial loans. In addition, 

almost 40 percent of SAIF-insured deposits originate 

with commercial banks, while savings association 

deposits make up 9 percent of BIF accounts. The 

report, entitled “Two Deposit Insurance Funds Are 

Not Necessarily Better Than One,” was published in 

the Federal Reserve Bank of Cleveland’s Economic 

Commentary. BBR, 1/16/01, p. 57–58. 

On April 25, 2001, the Bank for International 

Settlements issued a report on the role of stress testing in financial institutions’ risk-management activities. The report, entitled A Survey of Stress Tests and 

Current Practice at Major Financial Institutions, was 

prepared by a task force formed under the 

Committee on the Global Financial System (CGFS) 

of the central banks of the Group of Ten countries. 

In early 2000, the CGFS conducted a survey of 

stress-testing scenarios used at 43 major financial 

institutions, including both commercial and investment banks, in ten countries. The survey results 

implied that stress testing has become an integral 

part of banks’ risk-management practices. BBR, 4/30/01, 

p. 768–769. 

INTERNATIONAL DEVELOPMENTS
 

Basel Committee 

The Basel Committee on Banking Supervision 

on September 14, 2000, issued revised guidelines 

on credit risk in banking. The guidelines were 

introduced by the Basel Committee initially in 

July 1999, but have been slightly altered in order 

to reflect comments made from industry representatives. The guidelines set out 17 principles for 

assessing banks’ management of credit risk, covering areas such as: establishing an appropriate credit-risk environment, operating under a sound 

credit-granting process, maintaining an appropriate credit administration, ensuring adequate controls over credit risk, and spelling out the role of 

supervisors in overseeing bank credit-risk-management efforts. The guidelines are contained in 

two papers, entitled Principles for the Management of 

Credit Risk and Best Practices for Credit Risk 

Disclosure. PR-FRB, 9/14/00; BBR, 9/18/00, p. 375. 

Wolfsberg Anti-Money Laundering
 

Principles
 

On October 30, 2000, a multinational coalition of 

11 private banks announced a set of voluntary guidelines aimed at curbing money laundering. The 

guidelines call for bank officials to exercise due diligence when opening accounts or performing transactions for customers by collecting and recording 

specific information regarding the identities of 

account-holders and the sources of their funds. 

Specifically, the guidelines state that the banks 

should collect hard data on the following: the purpose and reasons for opening a bank account; anticipated account activity; the source of wealth; the 

source of funds; the estimated account net worth; 

and references or other sources to corroborate reputation information. The banks agreeing to the guidelines are ABN AMRO Bank, Barclays Bank, Banco 

Santander Central Hispano, S.A., Chase Manhattan 

Private Bank, Citibank, N.A., Credit Suisse Group, 

Deutsche Bank AG, HSBC, J.P. Morgan, Societe 

Generale, and UBS AG. BBR, 11/6/00, p. 581. 

47