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FDIC 

Bankin; 

Review 

Spring/Summer 1993 

Vol. 6, No. 1 

Table of Contents 

Risk-Based Capital Standards for Commercial Banks: 

Improved Capital-Adequacy Standards? 

byJohnP.O'Keefe Page 1 

At year-end 1990, risk-based capital standards were implemented for U.S. commercial banks. The 

new standards substantially changed U.S. regulatory standards for assessing bank capital adequacy, 

by replacing simple flat-rate standards with standards that explicitly incorporated risk. This study 

investigates whether the risk-based capital standards are improved measures of capital adequacy. 

The relative merits of both the risk-based and former flat-rate capital standards are discussed. In 

addition, brief histories of banks' regulatory capital ratios are used to compare the effectiveness 

of the standards. The study concludes that the risk-based capital standards are an improvement 

over the flat-rate capital standards they replaced. 

The Bank and Thrift Crises A Retrospective 

by David S. Holland Page 16 

The years since 1980 have been a tumultuous period for the U.S. banking and thrift industries 

and their regulators. Recent improvements in profitability and declines in the number of bank 

and thrift failures, however, give reason to beiieve that the worst may be over. The author uses 

this respite to review what has transpired and to look ahead. 

Commercial Real-Estate Problems: A Note on Changes in Collateral Values 

Backing Real-Estate Loans Being Managed by the Federal Deposit Insurance 

Corporation 

by James L. Freundand Steven A. Seelig Page 26 

The most recent economic dislocation to affect the banking industry is the major downturn of 

commercial real-estate markets in many areas of the country. In this article the authors report the 

results of a survey estimating the decline in collateral values for individual real-estate assets under 

FDIC management. 

Recent Developments Affecting Depository Institutions 

by Benjamin B. Christopher Page31 

This regular feature of the FD/CBanting Review con tains informarion on regulatory agency actions, 

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

issues. 
Risk-Based Capital Standards 

Risk-Based Capital Standards 

for Commercial Banks: 

Improved Capital-Adequacy Standards? 

by John P. O'Keefe' 

In August 1988, the Board of Gov 

ernors of the Federal Reserve 

System agreed to adopt riskbased capital standards for U.S. com 

mercial and savings banks and bank 

holding companies. The new stan 

dards, which substantially changed 

U.S. regulatory standards for assessing 

bank capital adequacy, replaced 

simple flat-rate standards with stan 

dards thatexplicitly incorporated risk. 

While well-run banks had their own 

"risk-based" systems for allocating 

capital, business plans had to be 

revised to incorporate the new 

regulatory standards. Interim mini 

mum risk-based capital standards, 

which allowed for a transitional 

period, became effective at year-end 

1990. The new standards became 

fully effective at year-end 1992. 

The primary purpose of this paper 

is to assess the risk-based capital 

standards as measures of capital ade 

quacy. The paper concludes that the 

risk-based capital standards are an im 

provement over the former primary 

and secondary capital constraints they 

replaced. This paper first reviews the 

reasons for bank capital requirements 

and discusses the flaws inherent in 

the previous primary and secondary 

capital standards which were estab 

lished in 1985. The next section ex 

amines the motivation behind riskbased capital standards and briefly 

describes the new standards. Sub 

sequently, factual information is 

added to the theoretical discussions. 

Brief histories of banks' risk-based 

capitalization, as well as other capitaladequacy measures, are used to assess 

the standards as measures of bank 

capital adequacy. Conclusions and 

recommendations are presented in 

the final section. 

Bank Capital Adequacy 

The subject of bank capital ade 

quacy has received extensive treat 

ment in the academic literature. ' 

One reason for this is that the topic is 

intrinsically multifaceted: adequate 

capital for what purposes and from 

whose petspective? Once the relevant 

functions of capital are established, 

one can select those types of financial 

instruments that best serve these 

functions and define an appropriate 

capital measure." 

The primary function of bank capi 

tal is to provide a cushion against los 

ses, enabling banks to survive in 

difficult economic times. This func 

tion is served by equity capital, which 

represents owners' investment in the 

bank. In addition, general loan- and 

lease-loss reserves, which banks have 

"John P. O'Keefe is a financial economist in 

the FDIC's Division of Research and Statistics. 

The author would like to thank Gary Fissel of 

the FDIC's Division of Research and Statistics 

and Stephen Pfeifer of the Division of Super 

vision for the useful information and comments 

they provided. 

The interim risk-based capital standards 

established a minimum total risk-based capital 

ratio of 7.25 percent. The final standards in 

creased this minimum to 8 percent. 

The same risk-based standards apply to 

both commercial and savings banks. Historical 

differences between commercial and savings 

banks' financial reports make direct com 

parisons difficult. For this reason, savings banks 

were excluded from the analysis. In addition, 

risk-based capital standards for savings associa 

tions {thrifts! were adopted by the Office of 

Thrift Supervision in 1989. A thorough discus 

sion of thrift capital requirements is provided in 

Elmer (1990). 

' Regulators' use of the term "adequate" 

versus "optimal" capital levels reflects the fact 

that bank regulators seek to set minimallyacceptable capital requirements for banks. 

These minimums have historically been well 

below those levels that the vast majority of 

banks have found to be optimal. 

In this discussion, the term capital is used 

in its broadest sense to refer to all forms of 

long-term corporate finance, debt and equity. 

This broad definition is based upon the stand 

ard delineation used in corporate finance litera 

ture between "capital markets" and "money 

markets." Financial instruments with long 

original maturities (usually over one year) are 

traded in capital markets, while instruments 

with shorter original maturities arc traded in 

money markets. 

" Vojta (1973| contains a useful discussion of 

the functions of bank capital. 
FDIG Banking Review 

provided for anticipated but as of yet 

unidentified future losses, can be 

used to absorb losses. After account 

ing equity capital (net worth) plus loss 

reserves have been exhausted the 

bank cannot absorb further losses. 

Capital also can play a role in min 

imizing the costs of resolving bank 

failures. The most obvious way is to 

minimize the number of bank 

failures. After a bank fails, however, 

there are additional means of lowering 

these costs. The most direct means is 

to share bank failure resolution costs 

with bank creditors. Although the 

FDIC must compensate insured 

depositors in full, any losses present 

in the bank (due to the fact that bank 

liabilities exceed assets) may be 

shared with uninsured depositors and 

other noninsured creditors. Some 

forms of noninsured liabilities are 

high-cost or volatile sources of fund 

ing. Therefore, in selecting capital in 

struments to fulfill this second role, 

regulators prefer that capital require 

ments include long-term, stable sour 

ces of finance, such as limited-life 

preferred stock, convertible debt, and 

subordinated debt. 

One should also note that capital 

instruments that serve one function of 

capital may not serve other functions. 

Subordinated debtholders share bank 

failure losses with the FDIC. How 

ever, periodic interest and principal 

repayments on outstanding debt must 

be made regardless of the bank's earn 

ings. Therefore, debt instruments do 

not fulfill the first proposed function 

of capital, i.e., aiding firms' survival 

during periods of losses. 

Bank regulators are concerned 

with both functions of capital. In order 

to incorporate both functions, bank 

regulators historically used two 

regulatory capital measures, primary 

capital and secondary capital. Primary 

capital is composed of common and 

perpetual preferred stock (equity cap 

ital), a limited amount of mandatory 

convertible debt, minority interests in 

consolidated subsidiaries, and loanand lease-loss reserves, minus all 

intangible assets other than purchased 

mortgage servicing rights. Secondary 

capital includes any mandatory con 

vertible debt that was excluded from 

primary capital, plus limited-life 

preferred stock and subordinated 

debentures. 

While the primary and secondary 

capital measures incorporate the two 

functions of capital described above, 

the capital requirements based upon 

these measures had several serious 

shortcomings. The most serious flaw 

was that the statutory minimum capi 

talization rates did not vary with the 

portfolio composition of the bank. 

The same flat-rate minimum standards 

of 5.5 percent primary capital and 6 

percent primary plus secondary capi 

tal applied to all well-managed, sound 

banks. Bank supervisors were given 

the ability to set higher minimums for 

banks that were not considered wellrun or in sound condition. No formal 

guidelines, however, were estab 

lished on how these minimums would 

be adjusted with increased risks. The 

fact that the same capital require 

ments applied to both safe, low-yield 

assets, and risky assets with high ex 

pected yields was a serious shortcom 

ing. The flat-rate standards allowed 

bankers to partially circumvent the 

leverage constraints by increasing 

concentrations of risky assets. More 

over, there were no capital require 

ments set against the off-balance-sheet 

activities of banks. As a result, bank 

regulators sought ways to adjust the 

capital standards to explicitly incor 

porate risk considerations. 

The New Capital Requirements 

If banking markets operated with 

out deposit insurance, depositors 

would require a combination ofhigher 

interest rates and reduced bank debt 

(more equity) to offset increases in 

business risks. Bankers would accept 

additional risk only as long as invest 

ments yielded adequate, risk-compen 

sating returns. Depositor pressures to 

limit risk-taking by bank managers 

are substantially reduced under a sys 

tem of deposit insurance. Indeed, when 

a bank fails, insured depositors only 

face the inconvenience of transferring 

business to another depository and the 

possibility of receiving lower rates of 

interest. Risk-based capital standards 

seek to replace depositor pressures to 

limit bank risk-taking with regulatorrequired increases in equity capital 

ization as a bank's operations become 

more risky. 

Risk-based capital standards require 

a determination of the types of risk 

that will be considered, as wel I as how 

to measure those risks. There are sev 

eral categories of risks banks face that, 

if serious enough, could lead to insol 

vency. Credit risk refers to the risk of 

an individual borrower defaulting on 

obligations to the bank. Concentration 

risk refers to risks associated with loan 

concentrations, typically geographic 

and product concentrations. Interestrate risk refers to potential decreases 

in the value of fixed-income assets 

due to rising interest rates. Additional 

ly, interest-rate fluctuations may cause 

adverse changes in banks' net interest 

income if there is a significant mis 

match in the maturities of assets and 

liabilities. Liquidity risk refers to poten 

tial difficulties in meetingcurrent liabil 

ities out of current assets. Operating 

risk refers to losses resulting from mis 

takes and inefficiencies in bank oper 

ations. Country-transfer risk refers to 

potential difficulties in receiving pay 

ment from foreign borrowers due to 

economic and political events in 

those countries. Fluctuations in for 

eign-exchange rates may add addi 

tional risks to loans to foreigners when 

such loans are denominated in local 

For a detailed description of the 1985 capi 

tal requirements, see Federal Deposit Insur 

ance Corporation, 12 CFR Part 325, Capital 

Maintenance, Federal Register, Vol. 50, No. 53, 

March 19, 1985. 

The FDIC recently adopted a risk-related 

insurance assessment system to replace the tra

dicional flat-rate premium structure. The riskbased premium and capital systems should 

complement each other, inducing bankers to 

reduce risk. Fora discussion of che complemen 

tarity issue, see Hirschhorn (1987). 

The discussion of banking risks presented 

here draws upon that given in Vojta (1973). 
Risk-Based Capital Standards 

currencies. Finally, fraud has been a 

factor in a substantial number of bank 

and thrift failures. Because many of 

these risks are interrelated, bank fail 

ures are usually attributed to a combi 

nation of risks. In recent years, high 

concentrations of loans in tradition 

ally risky areas such as commercial 

real estate and land development 

have been a leading cause of bank 

failures. 

The risk-based capital standards 

address credit risk in a limited fashion 

and make crude adjustments for 

country-transfer risk. This is accom 

plished by assigning assets to risk cat 

egories, based upon the type of 

collateral, guarantees, and the iden 

tity of the obligor. Off-balance-sheet 

commitments are first converted to 

credit-equivalent amounts, then as 

signed to risk categories on the same 

basis as bank assets. Capital require 

ments are set against the value of riskweighted assets, which are computed 

as the sum of risk-weighted balancesheet assets and off-balance-sheet 

commitments. Assets and creditequivalent amounts of off-balance

sheet commitments considered to 

possess little or no credit risk are given 

risk-weights of zero percent and thus 

require no capital backing. Riskier 

assets and off-balance-sheet commit 

ments are assigned higher riskweights of either 20, 50, or 100 

percent. The risk-weights of various 

bank assets and off-balance-sheet com 

mitments are given in Appendix B. 

A bank's capital requirements are 

determined by total risk-weighted as 

sets. After a phase-in period which 

ended at year-end 1992, banks must 

have at least 4 percent Tier 1 capital 

and 8 percent total risk-based capital, 

where both capital ratios are mea 

sured as a percent of risk-weighted 

assets. Tier 1 capital is composed of 

common equity capital, noncumula

tive preferred stock, and minority in 

terests in consolidated subsidiaries, 

minus intangible assets other than 

purchased mortgage servicing rights 

and credit-card receivables. Total 

risk-based capital is composed of Tier 

1 capital, plus Tier 2 capital, where 

the qualifying amount of Tier 2 capi 

tal cannot exceed the level of Tier 1 

capital. Tier 2 capital is composed of 

cumulative perpetual and long-term 

and intermediate-term preferred 

stock, qualifying subordinated debt 

and mandatory convertible debt, and 

general loan- and lease-loss allow 

ances in amounts up to 1.25 percent 

of risk-weighted assets. As with the 

former primary and secondary capital 

constraints, bank supervisors were 

given the ability to set higher mini 

mum risk-based capital requirements 

for banks that were not considered 

well-run or in sound condition. Again, 

however, no formal guidelines were 

established on how these minimums 

would be adjusted with increased 

risks.10 

The risk-weightings of assets and 

off-balance-sheet commitments con 

tain several important distinctions, 

many of which did not appear in early 

proposals for risk-based capital stan 

dards. First, in order to account for 

country risk, all assets and credit-equi 

valent amounts of off-balance-sheet 

commitments are classified according 

to whether they are obligations of in 

stitutions within member nations of 

the Organization for Economic Coop 

eration and Development (OECD), 

of which the United States is a mem 

ber. Obligations of institutions (gov 

ernment and private) located in OECD 

member nations are given the same 

risk-weights, within asset groups. 

Claims on institutions located within 

an OECD member nation were con 

sidered less-risky than those in nonOECD countries, and therefore, 

receive lower risk-weightings. Long

term credit extended to non-OECD

based borrowers generally receives a 

100 percent risk-weight. Second, all 

obligations of OECD nations' central 

governments, including governmentbacked agency obligations, are given 

zero risk-weights. Third, first mort 

gages on l-to-4 family residential pro 

perties require half the capital backing 

that commercial, consumer, and most 

other loan categories require. Each of 

these risk-weightings is based upon 

credit-risk or country-risk considera 

tions. The lack of consideration ofmost 

other risks in banking, as well as the 

apparent arbitrariness of the riskweight categories themselves, resulted 

in much criticism of the new stan 

dards. Federal bank regulators, how 

ever, continue to work toward 

improving the risk-based capital 

standards by refining and broadening 

risk coverage. Important future addi 

tions to the standards will be explicit 

adjustments for interest-rate risk, as 

well as adjustments for credit-con 

centration risk, which regulators are 

12

required to have in place by 1993. 

In addition to the risk-based capi 

tal standards, banks also must meet 

leverage constraints. Upon adoption 

of the risk-based standards, the Fed 

eral Reserve Board stated that supple 

mentary leverage constraints may be 

needed due to gaps in the risk-based 

standards. Specifically, the lack of an 

interest-rate risk adjustment, as well 

as exclusion of several other types of 

risk, could result in some institutions 

having low required risk-based capital 

levels despite the presence of sub 

stantial risks. Institutions were, there 

fore, still required to meet the primary 

and secondary capital leverage con 

straints in 1990. To avoid confusion, 

as well as to address shortcomings in 

these leverage constraints, all three 

federal bank regulators subsequently 

revised the leverage constraints, 

basing them upon Tier 1 capital. The 

new leverage constraints, effective 

For example, substantial increases in inter 

est rates can increase the costs associated with 

liquidity risk when banks are forced to liquidate 

long-term assets at new lower market prices in 

order to meet current obligations. 

See Federal Deposit Insurance Corpora 

tion, 12 CFR Part 325, Capital Maintenance; 

Final Statement of Policy on Risk-Based Capi 

tal, Federal Register, Vol. 54, No. 53, March 21, 

1989. 

Added to the group of OECD nations are 

nations that have established special lending 

arrangements associated with the International 

Monetary Fund's (IMF) General Arrangements 

to Borrow. 

i\\c Federal Deposit Insurance Corpora 

tion Improvement Act of 1991 requires regula 

tors to amend the risk-based capital standards 

to incorporate interest-rate risk, concentration 

risk, and "the risks of nontraditional activities" 

by June 1993. See Federal Deposit Insurance 

Corporation Improvement Act of 1991, Public 

Law 102-242, (December 19,1991), 105 STAT. 

2355. 
FDIC Banking Review 

beginning 1991, also increase with the 

riskiness of the bank. 

To measure risk, regu lators use bank 

examiners' composite ratings of banks' 

capital adequacy, asset quality, man 

agement, earnings, and liquidity, 

known as CAMEL ratings (an acro 

nym derived from the five areas re 

viewed). Composite CAMEL ratings 

range in integer values from 1 to 5. 

with "1" being the best rating and "5" 

[he worst rating. Under the new le 

verage constraints, banks that have a 

CAMEL rating of "1" must have a 

minimum Tier 1 capital-to-assets (le 

verage) ratio of at least 3 percent. 

Banks that have CAMEL ratings 

poorer than "1" will have their mini 

mum Tier 1 leverage ratios increased 

by 100 to 200 basis points (and per 

haps more for banks with the worst 

ratings). The new leverage standards 

do not explicitly spell out how the 

leverage ratio changes for CAMEL 

ratings poorer than "I." The rules 

imply that the majority of banks will 

have minimum leverage ratios of at 

least 4 to 5 percent (with an absolute 

minimum of 4 percent). Indeed, since 

it is very rare for a bank with under 4 

percent leverage capital to receive a 

CAMEL rating of "1," the effective 

minimum leverage ratio for the indus 

try is 4 percent. The importance of 

the leverage constraints is discussed 

at the end of the next section. 

Have Capital-Adequacy 

Standards Improved? 

If capital standards are to be suc 

cessful they must prevent banks from 

operating on too thin a level of equity 

capital. Unfortunately, it is difficult to 

evaluate what constitutes adequate 

capital for a particular bank. The cap 

ital-adequacy measures should, at a 

minimum, fluctuate with the likeli 

hood of insolvency and indicate capi 

tal deficiencies. Further, the minimum 

capitalization rates should not be so 

low as to allow banks to move quickly 

from compliance with the standards to 

insolvency. These last two statements 

provide the basis for the tests of the 

new standards used in this section. 

Figure 1 

Median Total Risk-Based Capital Ratios 

Comparison of 119 Failed and Peer Banks 

Percent 

20 

15 

Nonfalled Banks 

10 

Failed Banks 

-5 J L _L _L _L _L J L 

-16 -15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 

Quarters Prior to Failure 

Discussions of data sources and limi 

tations are contained in Appendix A. 

Capital-Adequacy 

Measurement 

One way to assess the performance 

of capital-adequacy measures is to 

compare the trends in failing banks' 

regulatory capital ratios. The several 

regulatory capital ratios used in recent 

years vary in definition, which may 

result in some measures responding to 

a broader set of factors affecting the 

underlying adequacy of capital than 

others. Strong evidence in support of 

this supposition is presented below. 

Therefore, in order to gauge the rela 

tive degree of responsiveness of the 

capital-adequacy measures, this study 

uses the fates of change in the mea 

sures as banks approach failure. 

Figure 1 presents the median total 

risk-based capital ratios for a sample 

of 119 commercial banks that failed or 

received open-bank assistance (hence 

forth referred to as failed banks) be 

tween January 1991 and September 

1992. In order to control for general 

trends in industry capitalization, a peer 

group of 119 nonfailed banks was se 

lected for comparison. The peer group 

was composed of nonfailed banks of 

similar asset size, location, as well as 

timing of Financial data, as the 119 

failing banks. 

Figure 1 shows that the median 

total risk-based capital ratios for the 

group of 119 failed banks declined 

continuously over the four-year pe 

riod prior to failure. The failed banks' 

median total risk-based capital ratio 

declined from 11.4 to -1.18 percent 

over the period. The median total 

risk-based capitalization rate for the 

peer group remained fairly stable, 

varying between 17.8 and 16.4 per 

cent. The peer group capitalization 

rates were fairly stable for all the capi 

tal measures presented below. 

Figure 2 compares three median 

capitalization races for the same group 

'For information on the assignment of 

CAMEL ratings, see Manual of Examination 

Policies (1986) Federal Deposit Insurance Cor 

poration, Division of Supervision, 

More precisely, the new leverage sran

dards are based upon the ratio of a bank's Tier 

I capital to average assets for the calendar quar 

ter. In addition, any intangible asser deducted 

from Tier 1 capiral is deducted also from aver 

age assets. 

15As of September 1992, there were 136 commercial and savings banks whose Tier 1 

leverage ratio was less than 4 percent. None of 

these institutions had composite CAMEL rat 

ings of "1," two banks were rated "2," four 

banks were rated "3," 31 banks were rated "4," 

and 99 banks were rated "5." 

Between January 1991 and September 

1992, 204 banks failed and 3 banks received 

FDIC open-bank assistance. The 35 mutual 

savings bank failures were excluded from the 

analysis in order to ensure comparability of the 

data. An additional 53 commercial hank failures 

were excluded due to incomplete data. 
Ilisk-Based Capital Standards 

Percent 

14 

Figure 2 

Median Capital Ratios 

for 119 Failed Banks in 1991 and 1992 

Total Risk-Based Capital 

Primary + Secondary Capital 

-16 -15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 

Quarters Prior to Failure 

Figure 3 

Composition of Primary Capital 

for 119 Failed Banks in 1991 and 1992 

Millions 

4.000 

Loan-Loss Reserve 

3.000 -\ 

2.000 

1.000 

0.000 

-1.000 i i i i i ; i i t i i i i i 

-16 -15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 

Quarters Prior to Failure 

of 119 failed banks: total risk-based ital standards, however, it was possi 

capital, primary plus secondary capital, ble for banks to have 6 percent pri 

and primary capital alone. To check mary plus secondary capital, yet not 

compliance with the risk-based stan meet the minimum 5.5 percent pri 

dards one need only look at total risk- mary capital requirement. Figure 2 

based capitalization. Because Tier 2 indicates that the primary and secon 

capital may comprise no more than dary capital measures were less respon 

half of total risk-based capital, any bank sive to the declining condition of the 

with 8 percent or higher total risk- failing banks than was total risk-based 

based capital must have at least 4 capitalization. Both the median pri 

percent or higherTierl capital. Under mary and primary plus secondary cap 

the former primary and secondary cap ital ratios declined 75 percent over the 

four years prior to failure, compared to 

the 110 percent decline in total riskbased capital. In addition, the median 

primary and primary plus secondary 

capital ratios did not fall below their 

respective 5.5 percent and 6 percent 

minimums until four quarters before 

failure, compared to six quarters for 

median total risk-based capital. This 

does not mean many failing banks were 

necessarily meeting their capital re 

quirements shortly before failure be 

cause regulators may well have raised 

the standards of these weakened 

banks. 

The reasons for the differences in 

the rates of change in the various cap 

ital measures can be found by compar 

ing the composition of the ratios. To 

help focus the analysis, first consider 

the differences between the former 

primary capital standard and the cur 

rent Tier 1 capital standard. While 

primary capital is composed of many 

of the same elements as Tier 1 capital, 

an important difference, particularly 

among failing banks, is that primary 

capital includes all of the loan- and 

lease-loss reserves, while Tier 1 capital 

excludes the loss reserves. As a result, 

when failing banks increase their loanloss reserves, as is typically needed for 

growing expected losses, the resultant 

reduction in equity capital is offset by 

the inclusion of the increased loss 

reserves in primary capital. This change 

in the composition of failing banks' 

primary capital is shown clearly in 

Figure 3. Figure 3 partitions the 

combined primary capital of the 

119 failing banks into three com 

ponents: loan-loss reserves, tangible 

equity capital, and "all other" compo 

nents. As shown in Figure 3, as this 

group of banks approached failure, 

the composition of primary capital 

shifted from tangible capital toward 

loss reserves. 

For simplicity, this discussion employs 

the final risk-based capital standards that be 

came effective at year-end 1992. When these 

119 banks failed in 199). they were actually 

subject to the lower, interim risk-based stan 

dards tjf 7 25 percent total risk-based capiiiil 

and 3.6 percent Tier 1 capital. 

This occurs because the amount of sec 

ondary capital components banks were permit 

ted to count toward total leverage capital (primary 

plus secondary capital) could be as much as 50 

percent of available primary capital. As a result, 

a bank with on!y 4 percent primary capital could 

still have 6 percent total I eve rage capital if it had 

sufficient secondary capital. 
FDtC Banking Review 

This offset does not occur with Tier 

1 capital due to its exclusion of loanloss reserves. Therefore, one finds a 

larger proportionate decline in failing 

banks' Tier 1 capital levels than in 

their primary capital levels. There is 

the potential for this offset to occur in 

Tier 2 capital (and hence, total riskbased capital) because banks may in 

clude a portion of the loan-loss reserve 

in Tier 2 capital. The amount of loss 

reserves that may be included in Tier 

2 capital is limited, however, to 1.25 

percent of risk-weighted assets. 

Fluctuations in the level of riskweighted assets will affect also failing 

banks' risk-based capital ratios. Riskweighted assets can change either due 

to changes in overall asset levels or 

due to changes in the composition of 

bank assets and off-balance-sheet 

commitments. Failingbanks typically 

experience some decrease in total as 

sets due to loan losses, as well as 

deliberate attempts to consolidate 

operations. In addition, risk-weighted 

assets have the potential to fluctuate 

without changes in total book assets. 

Troubled banks have, at times, sold 

off certain assets in order to generate 

income from capital gains, as well as 

to downsize the bank. Among the 

assets most easily sold are a bank's 

security portfolio and other liquid, highquality assets. If these types of sales 

occur, risk-weighted assets should rise 

relative to book assets. 

In order to investigate whether this 

occurred, one can use the ratio of riskweighted assets to book assets. Over 

the four-year period prior to failure, 

the median ratio of risk-weighted as 

sets to book assets exhibited a slight 

upward trend, rising from an average 

of 71 percent in the fourth year prior 

to failure to 74 percent in the last year 

before failure. Based upon these aver 

ages, a bank whose dollar Tier 1 (or 

total) risk-based capital and book as 

sets remained unchanged would still 

incur a 4.1 percent decline in its Tier 

1 risk-based capital ratio, due to the 19 change in its risk-weighted assets. 

For the 119 failed banks studied, there 

fore, changes in portfolio composition 

appear to be a factor, albeit a small 

one, in explaining movement in risk- measures of capital adequacy by sim 

based capital ratios. ply incorporating information on bank 

asset quality. Marino computed an While the evidence from failing 

"adjusted-capital ratio" by deducting banks indicates that the risk-based 

capital standards are an improvement To see this, consider a bank with $8 in 

over the former primary and secondary total lisk-based capita] and $100 in total assets. 

Further assume no changes in either capital or capital standards, additional improve asset levels. If this bank's ratioof risk-weighted 

ment in regulatory capital-adequacy assets to book assets rose from 71 percent to 74 

measures may be possible. Marino percent, then its total risk-based capital ratio 

would decline from 11.27 percent to 10.81 per (1984) showed that it is possible to cent. The rise in the risk-weighted assets reduced 

greatly improve the responsiveness of total risk-based capitalization 4.1 percent. 

Figure 4 

Median Capital Levels 

for 119 Failed Banks in 1991 and 1992 

Millions of Dollars 

-16 -15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 

Quarters Prior to Failure 

Figure 5 

Median Asset Levels 

for 119 Failed Banks in 1991 and 1992 

Millions of Dollars 

55 

50 

Adjusted Average 

Assets T ... 45 

40 Risk-Weighted Assets 

T 

35 

30 

25 

-16 -15 -14 -13 -12 -11 -10 -9-8-7-6-5-4-3-2 -1 

Quarters Prior to Failure 
■ 

■ 

■ 

■ 

■ ■ ■ 

■ 

■ 

■■ 

■ 

■ 

■ ■ 

■ 

■ 

R ,k liii^d L:p-: ml Sri ml. i-.h: 

>] cdiiui U 

Inr I VJ Faik-J Hunk* m I'l^l and 

-16 -15 -14 -13 -1? -II -10 -9 -B -7-6-5-4 -3 -3 -I 

Qusrig ra Pr.or lo Failure 

_L Jia^C-C ^e Ul'l n.iri<it|il].il. u-ri^-il 

Icjic tro-rn prlmm1 capiral b1 i^urc '■

prejenU trend; in. in <Kijusrcd -tapi ta.L 

ruin r.hd[ i: -inmc^ lui mn.rc b.'nadl>. 

Jf fj.td tlmri\fnnii(j Ail u-I ill .i|n 

a\ i1;1. defined ai equity ..apLcal plus 

I'l.lii Iij"j"j <!-:■ i" s iinfl jllili ;II.O;I IIIii'

fer-riik rejsr^e-i, ':.nnui rhc jum uf 

Mini" i liriiiiiio. ;l:.i'i-|■ d'd ndlCi rc.il 

Bicare owned Non performing -ijji <. 

mclnrlc ,.lI Icxjjh jr.d. Ica^e: pa=E-due 

90diiyiOr:.".OTC, pluSEIUni:n.'r|is|llui.n'. 

_nd lc_'Cff OiIicj real estcre 

inv -.-.il .-m.i'l

by t.c bank ±: Loan 

'IJlC 

IliL if ml-mi hi^ijisiir IcifiV ndi

jjec :hj[ ihc acljusieij-tdpical m^urne 

n :-.n-c rcipi.n;i^c [f. chc ccclLinnr; 

^cntliiion. of fulling barik^ ili-:iii in^ ul 

nc lii^iLljcn^1 cap.ral-jdeiujc; mci

Tr|i.li;l :].. I l rnri'i.iii .1111■ ---1■. :I 

icf' rjni'oeo'Ln.;:d iB2 pen em over 

iIil In .i-ycar |.l:i i..i1 prim lc IjiIuil, 

i■ ii 111.ir-: 11 I" 7i |" 11 lit. I'" i'iiiii -rlr 

nd ] ] U pef.f n I for T» r ] i-.ip

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ad fQuaty [recids. 11 miy be nlilVicu 11 n. 

lc.s fcn 1 iiiniirriu:^ i^nihirnf c-ipirjl

i'ii"l'in t lie l"ivi"|l u[""i mil 11 nil .i\ij-' 

Thi' xh-L- ulnmdH. lust? 

ji . i.ih. il I'1, 1111 np£ 1 liir 111 ill]-; ,i 

\ir-- due co a number of factor*, 

iH [Ik :.■:.:< 11111 <::<■-. 1111111 nl 1 •::• r■ 11 :-1 Iiiiiiiiiim 

LH^icii. [■ c; r example lojie-i frurn lo^n: 

..-1 nri.1 hy ifiidtnual |.i..pciLiC' s.

penence rr.uLli Iu'ict Ilijs r■l^^ ih^n 

uii'^iurcii^^niumer Iojjii. \i j re

*Lilt, vhtc* it*hv Lm" -&i 1 lit r.i 1111.11 >. ,iti .11111 

iev .11 Ehc pmejida] Ini^es aisoLiawd 

It ill .1 |T| 1-1 II llj.'Ol I'l il'.'il |I'L-| I 111 III 111 I1, 

a^iCE^ Morcj-ei, le" re^uh 

i.-ii.il.-ii.]■; im;i[■ I-,',L:i1 11||i:.li drl I. 

japjcl me?iUKb. rl^cre ihjliJJ be 

inOLn:ivc: Inr nidn^prcmenei i.l woik 

I.l.in k ji 1i:- - n 1 I -" -, I.: I jv.il iniilil . 

pjoiiems 

RIt ah-1'a ilu ffi /' rr 'I if! iim 

I he prcLcdin^ rrenc i-al^1..1. in

..IlL .Ik I ll-.nl.1 I 111 lll|ff \: IK I ^ III (llT 

rc^pun;ivene^i at ^everil capitjl

.oiLl •: 11 j. 11 v iiiij..'; li■lti:, lii 'IiC l Ii;Iiimiii|£ 

.undiELon uf feilinj" jmlu One mipiE 

mzci iir.ifi r.u"( Eicnd1. rluL clit 

P.i^JLC- ;llC rC'piin'i^til^" 'if J 1 Li 111 

liil 111I'iin>i''I iiiLiHiir' lij rl" 'I." 1111

^a DlIrIi. rh.e b^aenc^LibLliEy cr 

ifL oi^.k lailnfci I hi* 

it.3 JuppojLrion bv 

eIic predictive alii 111\- ,il 

■.. 11 :■ 11.11 .-j . ] i_ : 111. l 1" -r HjLi^iiics hi ni"il'-|L; 

of Uank-fn 11iiTL- pudn'ion. Il jliunki 

".n 11li ''ill 11.ill 11" ill i' 111 [:■ rr 1 -. 111 

irsd model i Fut predicri^p 

1; beyond rhc I.cii|.c ..I 

lln' 'I ui1v Nt1 1II11 k --^ lh" nit .hi mi 

power uf i.iip.ciil-.iclecinaL> 

.in It com pa red \-,< 1 nempm 111 n^. i 

niM-ri|.l.-iii.y|. I...fI-a 11nii. prz||itrion 

".- 0-LL.-11■ r-lj I1I.O1JI ui' nil I'U'IlI". -,-, 

I j 11111" iZ: ("OIL". I mi £.|5li 1.II11 ii||^ J .■.J 1 

I v ill l"i>ji 11 irrii-- 1111 kIi K 'nil -I'll i*in :i 

I li II rl 11| 1 "i-\ I In'; \\ u.ly w-i: .in .111 

1 r-::■.-11 h miiiiI.ii In iliil uyil !■!■ Bij'ri-.TI'l. 

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, 'ii 11 ii l 

.11 ly uf a Diink ia 

in si £ivi' it u «anJ 10 be lac^el^ 

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m j pin" pcr:m' Ihc key flu .in \*< 

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ItuI fin I 1. Inr; -|J. -■,- <•> ui 

l ind to 

in dice^planfojry pee: it die capi 

tal-ad ecu acu me^-.u::z J^hefinaacitl 

considered included nca

ni -iiiCE i|U3licv arid hiiujciEy 

.|IJjlllV "'^ IllCJ'ulill I., IliL 

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11 .j-,r .lin Qlh .Livs ni i.ini.-, lii.ni.i' r 1.1,11 

kill 113 ni'l k<i$^{i, .ii"i ol'n T — 1.—ill Lt 

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fruiyi udicj dcpcii-iuEy injiiniE.UEi^. plua 

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^i-i'i 11 1^1 ii'nii.l' i' iri

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1- 1 in "•'■"- iioi^^i-lih^li'il ];• !i^ 11 L-i

i:. Pi.Iim 11-H-: .. k ... I. 1. ..Ill Kh|.! ' 

L'L.ir.| o.ll i 

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l" | 

j| luj-it ! ii- Li. *-.' b\ i-inip^r n; ih< i;l 1 ol 

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I il^J hh I I ItMH'S'ij-fi-lU^ W.lhVL -II.I"".- '.'III. 

nonjL'.niul I■-.■ j —1 . 
FDIC Banking Review 

securities. All financial variables were 

measured as percentages of bank as 

sets. While similar measures of finan 

cial condition have been included in 

other studies of bank-failure prediction, 

none of these studies has compared 

the predictive power of the risk-based 

capital measures with the previous pri 22 mary and secondary capita! standards. 

Because denovo banks tend to have 

higher rates of failure than established 

banks, de novo banks were excluded 

from the sample of failed and nonfailed 

banks. Specifically, all banks that 

were chartered after March 31, 1984, 

were excluded from the sample. 

Banks included in the sample, there 

fore, had been in existence for at least 

four and three-fourths years prior to 

the date of the financial data used. 

Models 1 through 3 present esti 

mates of alternative models of failure 

prediction using logit analysis. Logit 

estimation allows one to relate the 

observed failure or survival of banks 

to a set of exogenously determined 

explanatory variables. For the mod 

els presented in Models 1 through 3, 

positive (negative) coefficient esti- A 

mates, p\t, indicate that an increase in 

that factor will increase (decrease) the 

likelihood of failure.26 

The models shown in Models 1 

through 3 were designed to help ex 

plain any differences in the informa 

tional content of the regulatory capital 

ratios, both past and present. To this 

end, four capital ratios were used: eq 

uity capital to assets; Tier 1 plus Tier 2 

capital to risk-weighted assets; primary 

plus secondary capital to adjusted av 

erage assets; and Tier I plus Tier 2 

capital to assets. 

The four capital-adequacy mea 

sures tested use varying definitions of 

"capital" as well as assets (numerators 

and denominators, respectively). Eq 

uity capital is the narrowest measure 

of capital, excluding the debt instru 

ments and loan-loss reserves included 

in the regulatory capital measures. 

Total risk-based capital is more nat

rowly defined than the primary plus 

secondary capital measute, primarily 

due to the limited amount of loan-loss 

reserves that may be included in the 

risk-based measure. Because the eq 

uity capital ratio and primary plus sec 

ondary capital ratio employ similar 

asset measures, comparisons of these 

two ratios indicate the importance of 

using narrower capital measures in 

failure prediction. Finally, the ratio of 

total risk-based capital to assets was 

included in order to learn the extent 

to which risk-weighted assets are im 

portant in failure predictions. 

Models 1 through 3 present results 

of logit estimations based upon a sam 

ple of bank failures that occurred be 

tween June 30, 1991 and June 30, 

1992; the explanatory variables were 

measured as of December 31,1990.In 

all instances the capitalization mea 

sures were significantly negatively re 

lated to the probability of failure. 

Model 1 shows that the Tier 1 plus 

Tier 2 capital-to-risk-weighted assets 

ratio (total risk-based capitalization) 

provided more explanatory power 

than all other capital measures tested. 

This is seen by comparing the pseudo 

R statistics for the alternative mod

els. The pseudo R statistic takes on 

a value of 1 when the model is a per 

fect predictor of bank failures, and 

zero when the explanatory variables 

impart no useful information. Be 

tween these two extremes, the pseu 

do R statistic can be thought of as 

measuring "the percent of uncertain 

ty in the data explained by the em

pirical results." The pseudo R 

Statistic for the model that employed 

total risk-based capitalization was 

.4163, while the corresponding values 

for the equity capital and primary plus 

secondary capital ratios were 0.4063 

and 0.3421, respectively. These re 

sults indicate that capital-adequacy 

measures that are more narrowly de 

fined, particularly those excluding 

loan-loss reserves, had greater explan 

atory power in failure-prediction 

models. In addition, Model 1 shows 

that much of the greater explanatory 

power of the risk-based capital ratios 

is due to the use of risk-weighted as 

sets, not merely the narrower capital 

measures. This is seen with the decline 

in the pseudo R that occurred when 

Tier 1 plus Tier 2 capital is expressed 

as a percent of book assets (Tier 1 plus 

Tier 2 leverage ratio) rather than riskweighted assets. 

Models I through 3 also present 

information on the accuracy with which 

the alternative models predicted bank 

failures. Specifically, estimated failure 

probabilities were obtained for each 

sample period using the logit estima 

tions. Banks whose estimated probabil 

ities of failure were above the specified 

criteria were designated as likely 

failures or "in-sample" failure fore 

casts. Between January 1987 and June 

1992, the average bank-failure rate 

was 1.35 percent. Therefore, banks 

with estimated failure probabilities 

above 1.35 percentwere predicted tc 

Gary Fissel of the FDlC's Division of 

Reseaich and Statistics has made such compar 

isons as pan of an internal FDIG analysis (un 

published) of the FDlC's risk-related deposit 

insurance system. 

To see this, define recently-established 

[de novo) banks as banks that have been in 

existence for 5 years or less as of a point in time. 

The failure rate for these banks can be defined 

as [he number oidtnovo bank failures in a year, 

divided by the number of de novo banks in 

existence at yea [-end. Between 1984 and 1991, 

the average failure tate among de novo banks 

was approximately 1.80 percenr, compared to 

1.14 percent for all other banks. For banks in 

existence 10 years or less, [he average failure 

rate for this period was 2.34 percent, compared 

to 0.98 percent for all other banks. 

Other studies of bank-failure ptediction 

have also excluded denovo banks. The 4.75 year 

period used here was somewhat arbitrarily cho 

sen, but is nor dissimilar from approaches used 

in other studies. 

more complete description of logit anal 

ysis can be found in Maddala (1983). 

T*he precise interpretation is that an esii

mated coefficient, pj, indicates how a change 

in the factor it is associated with, i,, changes 

the natural logarithm of the ratio of the prob 

ability of failing, to the probability of not failing, 

i.e., „ 

The pseudo R statistic is defined here as 

1 minus the ratio of the log of the likelihood 

function maximized with all the explanatory 

factors included in the model, to the log of the 

likelihood function maximized in the model 

with none of the explanatory factors included 

(only the intercept term). See Maddala (1983). 

ZSSee Judge, G. G., W. E. Griffiths, R. C. Hill, H. Lutkepohl, and T. Lee (1985), p. 767. 
■ 

■ 

Risk-Based Capital Standards 

fail. Model 1 shows that the highest 

proportion of actual failures was cor 

rectly predicted when total risk-based 

capitalization was employed in the 

models. Approximately 89.2 percent 

of actual failures were predicted when 

total risk-based capitalization was used, 

compared to the 75.4 percent accuracy 

achieved with the primary plus secon 

dary capital ratio. The model using 

total risk-based capitalization was less 

precise in forecasting nonfailures than 

the model based upon the primary plus 

secondary capital ratio; the predictive 

accuracies were 93.8 percent and 94.5 

percent, respectively. Seated different 

ly, the risk-based capitalization model 

incorrectly predicted 80 more nonfailed 

banks to fail than did the model using 

the primary plus secondary capital ratio. 

Model 2 shows that the likelihood of 

failure rises with the proportion of non

performing assets. Moreover, the in 

clusion of information on asset quality 

substantially increased the explanatory 

power of the models. The model using 

total risk-based capitalization as the 

measure of capital adequacy, however, 

still provided more explanatory power 

than all other capital-adequacy mea 

sures tested. In addition, the model 

using total risk-based capitalization 

continued to predict bank failures more 

accurately than any of the comparison 

models, although it less accurately fore 

casted nonfailures. 

Model 3 shows chat when informa 

tion on bank liquidity was added to 

the models, the pseudo R obtained 

when total risk-based capitalization is 

used was equal to that obtained with 

the primary plus secondary capital ratio 

and less than that obtained with sim 

ple equity capitalization. One possible 

reason for this is that the proportion of 

liquid assets held is already measured, 

to some extent, by risk-weighted assets. 

Banks that are more liquid will have 

lower risk-weighted asset levels and 

The choice of the failure criteria (critical 

probability) was somewhat arbitrary. The arith 

metic average failure rate was used because of 

its intuitive appeal. The criteria designate a 

bank as a likely failure if its estimated probabil 

ity of failure is greater than the overall average 

failure rate. 

Table 1 

Logit Estimation of Failure-Prediction Models 

(June 1991 June 1992 Failures Predicted with December 1990 Data) 

MODEL 1 

Intercept 0,910 ns 0.160 ns 2.407 0,789 ns 

(0.583) (0.551) (0.698) (0.572) 

Note: Unless seated otherwise, all estimated ccieffieienis were signi the 1 perccni l 

denotes significant at the 5 percent level, 

ns denufti not li^hlniSilL, i.e.. significance level ibovc 10 percent. 

These esiiniaiionsiverc hHisetl upon 10,8.10 observations. 
FD1C Banking Review 

hence higher risk-based capitalization, respectively), indicates the contribu 

ocher things being equal. Therefore, tion of the narrower capital measure. It 

while the measure of liquidity added should be pointed out, however, that a 

information to the models not em higher proportion of failures was cor 

ploying risk-weighted assets, little rectly predicted in Model 3 when total 

was added to the model using risk risk-based capitalization was used 

weighted assets. The higher pseudo R than was achieved with primary plus 

obtained in the model using equity secondary capital ratios. 

capitalization in Model 3, relative to 

that obtained with total risk-based In order to test the robustness of 

capitalization (0.4679 and 0.4579, these results, the tests were repeated 

Figure 7 

Proportion of Banks in Compliance 

with Capital Rules, 119 Failed Banks 

Percent 

100 

80 

60 

Old Leverage 

40 

Risk-Based 

20 

New Leverage 

l i i i i 

-16 -15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 

Quarters Prior to Failure 

Figure 8 

Proportion of Banks in Compliance 

with Capital Rules, 119 Failed Banks 

Percent 

100 

80 Risk-Based 

60 

40 

New Leverage and Risk-Based

20 

J I I L _L J I L 

-16 -15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 

Quarters Prior to Failure 

using different sample periods and 

prediction intervals. In general, those 

results support the conclusions con 

cerning the explanatory power of riskbased capitalization versus the former 

primary plus secondary capital lever 

age ratios, 

In sum, the results in Models 1 

through 3 are consistent with the earlier 

graphical analysis. When considered 

in isolation, the risk-based capitaliza 

tion measures appear to be more re 

sponsive to the changing condition of 

failing banks than the former primary 

and secondary capital standards/This 

reflects additional information em 

bodied in the risk-based measures, as 

demonstrated by the fact that the su 

perior predictive ability of the model 

using risk-based capitalization is largely 

eliminated as more information is 

added to the alternative models. 

Compliance with Minimum 

Capitalization Requirements: 

Are Supplementary leverage 

Constraints Necessary? 

As stated previously, failure to com 

ply with minimum capitalization re 

quirements is perhaps the most obvious 

indication of capital inadequacy, as 

defined by bank regulators. The trends 

in median capitalization rates present 

ed above provided partial information 

on compliance. This section looks at 

compliance in greater detail, begin 

ning with the same group of 119 failed 

banks. 

As a group of banks approaches fail 

ure, one can reasonably expect that an 

increasing proportion of the group will 

fail to comply with minimum regulatory 

capitalization requirements.' This was 

indeed the case for the regulatory 

standards tested. Figure 7 presents 

data on compliance for three regula 

tory capital standards: the former 5.5 

percent primary capital and 6 percent 

This section used [he statutory minimum 

capitalization rales to lest compliance. It is ex 

pected that some banks may have had higher 

individual standards set by bank supervisors; 

however, compliance rates with statutory mini

mums are still instructive. 

Ill 
Risk-Based Capital Standards 

primary plus secondary capital stan 

dards (old leverage constraints); the 8 

percent risk-based standards; and the 

new Tier 1 capital leverage constraints 

(new leverage constraints).' Figure 7 

indicates that the group of 119 failing 

banks generally found it more diffi 

cult to comply with the new leverage 

standards than with either the riskbased or old leverage requirements. 

Five quarters prior to failure, only 44 

(37 percent) of the 119 failing banks 

met the new T,ier 1 leverage stan 

dards, compared to 63 (53 percent) for 

old leverage standards and 49 (4! per 

cent) for the risk-based standards.' 

The new leverage standards sup 

plement the risk-based standards, i.e., 

banks are expected to meet both sets 

of standards. Figure 8 shows that when 

used jointly, the new leverage and 

risk-based capital standards are better 

at identifying failures than either of 

the standards alone. Five quarters 

prior to failure, only 35 (29 percent) of 

the 119 failing banks met both riskbased and new leverage capital stan 

dards. These results offer support for 

[he idea that the leverage constraints 

provide a useful supplement to the 

present risk-based capital require 

ments. 

Figure 9 looks at compliance rates 

for all banks, failing and nonfailing. 

Figure 9 shows that the vast majority 

of banks are in compliance with the 

new capital standards." Moreover, 

the trend has been toward increased 

compliance in recent years. Finally, as 

was the case for the sample of failing 

banks, one finds that the joint riskbased and new leverage standards are 

more stringent than either of the stan 

dards alone. 

Compliance with the capital stan 

dards has varied across bank size 

groups. In order to give an indica 

tion of the differences in compli 

ance across banks' asset size groups. 

The new leverage ton strain ts vary a bank's 

minimum Tier 1 capitul-to-asscts ratio with its 

most recent composite CAMEL rating (see 

Federal Deposit Insurance Corporation, 12 

CFR Part 325, Capital Maintenance, Federal 

Register, Vol. 56, No. 47, March II. 1991). 

Because rhe published standards only provide 

a general framework foi how the standards vary 

Figure 9 

Proportion of Banks in Compliance 

with Capital Rules, (All Banks) 

387 1287 1288 1269 1290 1291 1292 

Calendar Quarter-Ends 

Figure 10 

Proportion of Banks in Compliance 

Banks with Assets of $100 Million or More 

Percent 

100 

Old Leverage 

98 

New Leverage 

96 

94 

Risk-Based ' "- /<r~ O'" ''"'. 92 

^ y New Leverage and Risk-Based

90 i i i i i i i i i i i i i i i i i i i i 

387 1287 1288 1289 1290 1291 1292 

Calendar Quarter-Ends 

with banks' CAMRL ratings, an approxima most recent composite CAMK1, ratings. While 

tion, based upon the published standards and most banks are examined annually, there may 

discussions wiih I-TJIC bank supervisory staff, be longer intervals between examinations, par 

was used here. Specifically, for those banks ticularly for the most highly-rated banks. FDIO 

whose most recent composite CAMEL rating policy in the late 1180s permitted examination 

was " 1" or "2," the minimum Tier I capital-to- intervals of up to three years for the most 

assets ratio was 4 percent. Banks wiih CAMEL highly-rared banks. Therefore, this study used 

ratings of "3" were required to have a minimum banks' most recent exam ratings lor intervals up 

Tier 1 ratio of 4.5 percent. Banks rated "4" were to, but not exceeding, three years. 

required to have a minimum of S percent Tier 1 Figure 9 includesal I commercial banks fitr I capital, while banks rated "5" were rc<|uired which data on compliance were available. A to have Tier 1 capital ratios of at leasl 6 percent. small number of banks (less than one percent! 

1 Banks'Tiet I leverage requirements were were deleted due to incomplete information on 

estimated each calendar quarter, using their capitalisation and/or examination ratings. 

11 
■ 

97 

Tla il. ir ° R" 

more EcrinEini- ig*l if eapnal ad.c

nuae> 'I hi; Icvl-ii^^ sinn'lirJi Jo 

lice nh.iaLe Lh^ nik-l.iitd. sLinrlairl' 

Cor all hanki, hnwevcr. I3aia rm coi\<

pliancc wlih. L\i|iiial stu.11tlu-rj.l3 fur 

hank sue giii\\j* showed 

.Liii^ii^ ljjnk* wLth. assets of 

mil 11 (in i-T muH;, rhe risk-bRied 

were, in average, a more 

resrh a^ rncaEured 

pliRnce rare^, chan [he new 

araudardi. UnjivenelVj anic-ng 

i*1 Lh aiscts of less 1 han tl flfl 

ctie nciv levcjsfc sLanriafds pro 

vided amrhjc scringpiu 

adequacv rhan rhe 

hRvc eigucd chai 

.1 f- rr iln; n*k-l?aicd measujcE hive 

Iiclii miLiiLLlb-il [ij iTiuorporate inier

ink, j^ v/<ll , 

risk, rhn? leverage 

IV111 hccninc NililtH-^ssiLry 

^= amendmeinE'j'ill 

rhe ji^k-hascd capiLal 

^. leverape curLErranus mav 

useful purprric 'I hec itt 11 

lease iwo facinjs Lhai. ngw: Fur rlie 

:nnrinnjed use of supp-lenieiuaftf le 

verage cnnsTrainrs. 1'ir^i. Lrii ven1 dif

niulr <u nbiaiii aDrujBie meaaurcn rif 

lin-h m|. ri^.i-TBte n^k Riid (■nncenaa

'.i.jn risk 111 Ijauking. The faCE ih'r in 

cion of [he rlik-hascii siandird s I 

Lriicrc^i-mc risk and i?j[KencrHtLun 

:i-k .ifljus'irif nts ure tu be Rdded ia 

LllC sVs"Clrl is siLffln-" ill fviilenLt nf 

the a foie c ii ti n ii l l| .11IT11, nl rm j. 

Shccnnd. a1, shown ahmvt, i|r.iii[iesi nf 

capnal ancrjLLi'y is more cTf'cnv^ in 

idencLf.11 n k I allures ihan th* r^kv 

based siandards alone ^lsr\ 1 Liz l>ur

3cn OIL Llie lildllSlls1 i>f CU:nn|^||lg 

«!ch ihc curieiLLjnliiLstand.irrls Mi's 

nui appeRr unduly severe, because 

iiLrmnl yf lhc indlistrv "-Kb Ln 

Lhc Ji>lilL s'^iirlJrdi d.1 

ParaBrrT 

1C0 

I-'j^uit- 11 

li"n ill'ftiirtl'5 in ("Jump I mm1* 

AbecIei Under $10" Million 

Haw Lava rane 

Npwl_evtreg> and Hltk-Bt&ed 

LJ 

387 1267 1268 1263 1390 1291 1292 

Calarnda/ Quanar-Enda 

Il JilCC U[es ri rn ^,i ,i| rb-d fi.r 

I Inn k si'egruLip, Faibreviiv, 

Figures 10 and 11 pjticn: results <c-\ 

ivo liaik si/.. gn'Lipi-. b.mks ivith as

ol"I11)U mil I inn cu more ind hml.' 

^^ii^ innkillOOmiLhoci Among 

'viih ai^:a cA $[<\l> ^iillmn ^i 

more, com|ilurii-? riir: ^'l^l^c higher 

ten the n=w lcv:repc nandardi than 

for cheri?k-hated si.niO:r,li Theip

(jnii'.t »ji ini.. frji t>iink^ nirh assets 

rff]L33 UmnSlOU mi I IioHl h:rc 

pliancci'ich the rkk-biitd. 

v/n .iLg/.ci ibian forihe nci1 

S1.niJ.,iriLs. 

Tim JtuJy i.it pcrfcu

ill mcHiures uf bar.kcapital adequacy, 

nf dJiii^jf^L^^. Tht 

is thar [tic ji^k

>r<mdards are ar. im p ruvemen [ 

he pjimaiy jndiccnndjr.ifi|iLul 

lIil y ri'jil.iia111 T1 I, im

|itijil mi in 15 .lue iu t" u factors Tirsi. 

tiL? "qual i cv" ot" ih ; rcpu I a enry c-j pJia I 

; is hTlDfOVCd uhUl: lIil risk 

based scandard^. This la 

due io Lhc ckflusion nF Ii.jm- iml 

k^si 'lusa tpsbtv e* frum Tier 1 capical 

iand ii: limited niflnsinn m '\"il< 2 

fj the use of riskpear '-fi (iffi,T .iO

jnnplc bcuk a^aetE 

ivticr assessijip, [lie adcciuaey nl cn|ii

i.il levels Thi'se tyntlu'smns *crc 

fjom icac^ itiai itiowed clianhc 

LU*a.1 UJC1! 

[|> Lhi i 

Ili.iil uf fin I nig bunks 

Ln the fijitncf pniuiry jml 

zapira I standard1: Mnrcovej, 

: .ipn.il niHi> L-^lnl.ir^.l gTrHtrr explan

acory powej in madeli ol bank-fal'me 

liiL-'li: ci|iii ih.in lliL fi'niitr 

standards. 

While: I liL ii■sk-l.i.im:lI sl^jtij.1 ri|^ ire

ini|irHivLiuL-:L| uv^r rhe furmer pnHud seton.d 

5Li|iplemeniary 

L cnpi:nl> miy 

mi h> flllliy in11 

I links l ii.n I Ll lanii. it i ill i.irirjus L.iniI _lI -ClJ IIeEiI Ll S \ll"'.VL[1 I III I |h' !l I I.I 11 JNli 

->< the 'I LCI 1 lcVCld£C riiiisTL.nl-. l.i 

Ll.C lisk-liSsifl sliinl.iiils (lr'.'vI[[|!l.i |i 
Risk-Based Capital Standards 

REFERENCES 

Bovenzi, John F., James A. Marino, and Frank E. McFadden. "Commercial Bank Failure Prediction 

Models." Federal Reserve Bank of Atlanta Economic Review (November 1983): 14-26. 

Bovenzi, John F. and Arthur J. Murton. "Resolution Costs of Bank Failures." FDIC Banking Review 

(Falll988):l-13. 

Chessen, James. "Risk-Based Capital Comes to the Fore." FDIC Regulatory Review (January 1987):1

19. 

Elmer, Peter J. "Risk-Based Capital Requirements: Reshaping the Thrift Industry." FDIC Banking 

Review (Fa\\ 1990):Z7-35. 

Gajewski, Gregory R. "Assessing the Risk of Bank Failure." In Federal Reserve Bank of Chicago 

Proceedings of the 25th Annual Conference on Bank Structure and Competition^ pp. 432-56. Chicago: 

n.p., 1989. 

Hempel, George H. "Bank Capital: Determining and Meeting Your Bank's Capital Needs." Bank 

Study Series. Boston, MA: Bankers Publishing Co., 1976. 

Hirschhorn, Eric. "Risk-Related Capital Requirements and Deposit Insurance Premiums: The Whole 

May Be GreaterThan the Sum of Its Parts." FDIC Regulatory Review (July 1987): 1-10. 

Judge, G. G., W. E. Griffiths, R. C. Hill, H. Lutkepohl, and T. Lee. The Theory and Practice of 

Econometrics. Second Edition. New York: John Wiley and Sons, 1985. 

Maddala G. S. Limited-Dependent and Qualitative Variables in Econometrics. Cambridge, England: 

Cambridge University Press, 1983. 

Marino, James A. "Comparisons of Failed and Healthy Banks'Capital Ratios." FDIC Economic Outlook 

(November 1984 ):2-5. 

Office of the Comptroller of the Currency. Bank Failure: An Evaluation ofthe Factors Contributing to the 

Failure of National Banks. Washington, DC: Office of the Comptroller of the Currency, June 

1988. 

O'Keefe, John. "The Texas Banking Crisis: Causes and Consequences, 1980- 1989." FDIC Banking 

Review (Winter 1990): 1-34. 

Santomero, Anthony M. Current Views of the Bank Capital Issue. The Wharton School of Business. A 

Study Prepared for the Trustees of the Banking Research Fund, Association of the Reserve City 

Bankers, January 1983. 

Vojta, George J. Bank Capital Adequacy. New York: First National City Bank, 1973. 

13 
Data Limitations 

Data on commercial banks' riskbased capitalization were obtained 

from quarterly Reports of Income and 

Condition which banks are required 

to file with federal bank regulators. 

Data on banks' risk-based capital 

ratios are limited in two ways. First, 

not all banks are required to report 

their actual risk-based capitalization. 

In order to reduce the reporting bur 

den of computing risk-weighted as 

sets, only those banks with assets of 

$1 billion or more (as of the reporting 

period), as well as those banks that fail 

a simpler 8 percent total risk-based 

capital-tn-adjusted assets test, must re 

port actual risk-based capitalization." 

FDIC Banking Review 

APPENDIXA 

The result is that as of year-end 1991, 

only 20 percent of commercial banks, 

with 79.6 percent of industry assets, 

reported their risk-based capitaliza 

tion. Estimated risk-weighted asset 

values and estimated risk-based capi 

tal ratios for the remaining banks 

were, however, made available by the 

Federal Financial Institutions Ex 

amination Council (FFIEC). The 

FFIEC has developed an algorithm 

for estimating risk-weighted assets, 

using available financial data, for 

those banks that do not report riskweighted assets. 

A second limitation arises from 

the fact that banks only began report 

ing risk-based capital ratios in March 

1990. In order to obtain somewhat 

longer histories of banks1 risk-based 

capitalization, the FFIEC algorithm 

was modified to obtain estimated riskbased capital ratios from 1987 to 1989. 

Modifications to the FFIEC algo 

rithm were necessary due to differen 

ces in the detail of banks' financial 

reports in the prior periods. Addition 

al reporting deficiencies in periods 

prior to 1987 prevented estimation of 

risk-based capitalization for periods 

before 1987. Comparisons of es 

timated risk-based capital ratios for 

the 1987 to 1989 and 1990 to 1992 

periods indicated a close agreement 

between estimates obtained under 

the two algorithms. 

The adjusted asset definition used for this test is defined as total assets minus the sum of cash, U.S. Treasury securities, U.S. Government agency 

obligations, and 80 percent of U.S. Government-sponsored agency obligations, plus the loan-loss allowance and certain off-balance-sheet commitments. 

14 
Risk-Based Capital Standards 

APPENDIXB 

FDIG Risk-Weightings of Assets and Off-Balance-Sheet Commitments 

Balance-Sheet Items 

Risk- Risk-Asset 

Weight Variable 

0% Cash and balances due from Federal Reserve Banks and other OEGD central banks. 

0% Direct claims on, and portions of claims unconditionally guaranteed by, the U.S. Government and its agencies 

or other OECD central governments. 

0% Direct local currency claims on, or guaranteed by, non-OECD central governments. 

0% Gold bullion and Federal Reserve Bank stock. 

20% Cash items in the process of collection. 

20% All claims on U.S depository institutions and other OECD depository institutions and short-term (remaining 

maturity one year or less) claims on non-OECD banks and non-OECD central banks. 

20% Portions of loans and other claims conditionally guaranteed by the U.S. and other OECD countries' central 

governments. 

20% Securities and other claims on U.S. Government-sponsored agencies (i.e., not explicitly U.S.-backed). 

20% Portions of loans and other claims collateralized by securities issued or guaranteed by the U.S. Government, or 

by U.S, Government agencies or Government-sponsored agencies or other OECD central governments. 

20% Portions of loans and other claims collateralized by cash on deposit in the lending bank. 

20% General obligations backed by the full faith and credit of U.S. state and local governments and political sub 

divisions of other OECD governments. 

20% Claims on official multilateral lending institutions or development institutions. 

20% Privately-issued mortgage-backed securities representing indirect ownership of a U.S. Government agency or 

U.S. Government-sponsored agency. 

20% Investments in the shares of mutual funds whose portfolios contain assets qualifying for 0% or 20% risk-weight. 

50% Loans fully secured by first mortgages on l-to-4 family residential properties (if made in accordance with 

prudent lending practices). 

50% Certain privately-issued mortgage-backed securities representing indirect ownership of a pool of residential 

mortgages which meet the criteria for the 50% risk-weight. 

50% Revenue bonds and similar obligations, including loans and leases, that are obligations of U.S. and other OECD 

municipal governments. 

50% Credit-equivalent amounts of interest-rate swaps and foreign-exchange rate contracts. 

100% All remaining assets or portions of assets not falling into above categories. 

Off-Balance-Sheet Items 

Note: Off-balance-sheet obligations are first converted to credit-equivalent amounts, then assigned to risk-weight 

classes based upon the identity of obligor or guarantor or collateral used. 

Credit 

Convrsn. Off-Balance-Sheet 

Factor Variable 

100% Direct credit substitutes backing financial claims. 

100% Participants in bankers' acceptances. 

100% Forward agreements (excluding those involving foreign-exchange rate contracts). 

100% Securities lent (where the lending bank faces some risk of loss). 

50% Transaction-related contingencies. 

50% Unused commitments with an original maturity exceeding one year. 

20% Short-term, self-liquidating, trade-related contingencies. 

15 
FDIC Banking Review 

The Bank and Thrift Crises 

Retrospective ! 

by David S. Holland* 

Theyearssince 1980 have been 

a tumultuous period for the 

U.S. banking and thrift indus 

tries and their regulators. Indeed, not 

since the Depression of the 1930s 

have the nation's depository institu 

tions been so severely buffeted. The 

overlapping and interacting causes of 

the turmoil have been many and var 

ied, as have been the responses of the 

industries and of government author 

ities in both the legislative and execu 

tive branches. 

Recent improvements in bank and 

thrift industry profitability and declines 

in the number of bank and thrift fail 

ures, however, give reason to believe 

that the worst may be over. Whether 

the more favorable outlook will last or 

will prove to be only temporary is, of 

course, impossible to know before 

hand. But the recovery does provide a 

respite in which to review what has 

transpired and to cogitate a bit on the 

future. Those tasks are what this arti 

cle strives to do. 

The almost decade and a half of 

turmoil can be summarized as follows: 

• High and volatile interest rates in 

the late 1970s and early 1980s 

undermined the decades-old ap 

proach to profitability in thrift in 

stitutions, which was: borrow for 

short terms at low rates, lend for 

longer terms at higher rates. 

In the late 1970s and throughout 

the 1980s, both banks and thrifts 

experienced increasing levels of 

competition from nonbanks. For 

example, growing use of commer 

cial paper as a funding source for 

nonfinancial corporations eroded 

banks' traditional commercial lend 

ing niche. And money-market 

mutual funds attracted substantial 

amounts of liquid funds that for 

merly would have been deposits in 

banks and thrifts. 

To aid the thrift industry, Congress 

and federal and state regulatory au 

thorities in the early 1980s relaxed 

restrictions on activities. The thrifts' 

enthusiastic embrace of the new 

powers was not constrained by ade 

quate supervisory oversight. 

The thrift industry suffered mas 

sive losses and eventually required 

a huge taxpayer bailout. The fed 

eral regulator and the federal in 

surer of S&Ls— the Federal Home 

Loan Bank Board and the Federal 

Savings and Loan Insurance Cor 

poration -— were legislated out of 

existence. The FHLBB was re 

placed by the Office of Thrift Su 

pervision. The insurance function 

was given to the FDIC. 

As the thrift industry was experi 

encing its explosive expansion and 

implosive contraction, the banking 

industry and its regulators were hit 

by a rolling series of difficulties. 

Troubles in less-developed coun 

tries and in the energy, agricultural, 

and real-estate sectors of the U.S. 

economy all had negative impacts 

on the health and profitability of 

banks. 

• The real-estate-related difficulties 

were the most widespread. The dif 

ficulties began in Texas and the 

Southwest and spread to the 

Northeast, the Southeast, and finally 

the West Coast. 

• The banking industry's difficulties 

severely tested the FDIC and the 

bank deposit insurance system. 

Congress responded by signifi 

cantly buttressing the bank super 

visory system and by providing 

taxpayer backing for the Bank In

surance Fund. 

• Not all of the trends and events 

concerni ng the banking system were 

negative. One significant develop 

ment was the partial relaxation of 

the longstanding interstate bank and 

thrift restrictions that were increas 

ingly confining the industries. This 

relaxation contributed to a consol 

idation trend in which the numbers 

•David S. Holland is a senior financial ana 

lyst in the FDIC's Division of Research and 

Statistics. 

16 
The Bank and Thrift Crises A Retrospective 

of bank and thrift organizations 

declined. 

• Congress'efforts since 1980 to deal 

with the turmoil in the bank and 

thrift industries have resulted in 

five major, occasionally contradic 

tory, laws: the Depository Institu 

tions Deregulation and Monetary 

Control Act of 1980 (DIDMCA); 

the Garn-St Germain Act of 1982; 

the Competitive Equality Banking 

Act of 1987 (CEBA); the Financial 

Institutions Reform, Recovery, 

and Enforcement Act of 1989 

(FIRREA); and the Federal De 

posit Insurance Corporation Im 

provement Act of 1991 (FDICIA). 

This summary is expanded upon in 

the remainder of this article. The dis 

cussion begins with a brief review of 

pre-1980 developments. Next, the 

thrift industry's expansion and con 

traction are described. Then, the 

banking industry's difficulties are ex 

amined. Finally, some thoughts on fu 

ture prospects are presented. 

Background 

Any attempt to understand the fi 

nancial turmoil of the last dozen years 

should begin with a look at the struc 

ture of the bank and thrift industries 

at the inception of the period. Two 

limitations with roots deep in Ameri 

can history determined to a great ex 

tent what that structure was. The 

first limitation was geographic. The 

second pertained to products and 

services. 

Regarding the geographic limita 

tion, banks and thrifts were largely 

prevented from conducting banking 

operations in more than one state. For 

banks, the 1927 McFadden Act and 

state laws and attitudes prevented the 

establishment of branches across state 

lines. And the 1956 Bank Holding 

Company Act prohibited the creation 

of interstate banking organizations 

consisting of separately chartered 

banks in more than one state, al 

though there were a few grand

fathered exceptions. For savings and 

loan associations, the policies of state 

and federal regulators prevented 

interstate branching, and interstate 

S&L holding companies were prohib 

ited by the 1967 Savings and Loan 

Holding Company Act. 

Concerning products and services, 

a variety of state and federal laws, 

including the 1864 National Bank 

Act, the 1933 Glass-Steagall Act, the 

1933 Home Owners' Loan Act, the 

1934 National Housing Act, and the 

1956 Bank Holding Company Act — 

and their many amendments large 

ly confined bank and thrift organ 

izations to the taking of deposits and 

the making of loans. Lending was 

usually further circumscribed. Most 

S&L loans, as a leading example, had 

to be for residential real-estate pur 

poses. And interest rates on bank and 

thrift deposits were subjected to reg 

ulatory caps, or in the case of demand 

deposits, prohibited altogether. 

Depending on its structure and the 

applicable law, a bank or thrift organi 

zation could engage in some financial 

activities beyond just the taking of 

deposits and the making of loans, but 

the scope of the activities was nar 

rowly drawn. And importantly, two 

significant financial businesses were 

for the most part off-limits: the secu 

rities business and the insurance 

business. 

As a result of the geographic and 

product limitations on banks and 

thrifts, the U.S. depository institutions 

industry was, in comparison to the in 

dustry in other nations, unconcentrated 

and segmented. Thousands of institu 

tions existed in semi-protected mar 

kets, enjoying only minimal compe 

tition from similar institutions. The 

activities restrictions hindered inno 

vation by banks and thrifts regarding 

products and services. Meanwhile, 

non-depository institutions not con 

strained by the pervasive geographi 

cal and product limitations applicable 

to banks and thrifts were impinging 

more and more on the latters' areas of 

business. 

Technology was contributing to the 

assault on the competitive barriers — 

the statutory geographic and product 

restraints. Computers and computer 

ized communications were making 

credit, market, and product informa 

tion much more accessible, and the 

delivery of financial services much less 

dependent on customer or institution 

location. 

Capacity is a difficult thing to mea 

sure in the banking world, where the 

ultimate product is an intangible — 

money. Nevertheless, one could argue 

that the U.S. bank and thrift indus 

tries had by the 1970s become bur 

dened by a large measure of 

overcapacity. The overcapacity was 

due to the restraints on competition 

the geographic and product limita 

tions that had been controlling the 

development of industry structure for 

well over a century. The difficult-to

quantify overcapacity was evidenced 

by the large numbers of depository 

and non-depository financial institu 

tions competing in regard to both 

sources and uses of funds. 

Economically and financially, the 

1970s were a decade of increasing in 

stability. Early in the decade, the 

Bretton Woods fixed exchange-rate 

regime, which had been a foundation 

of international economic and finan 

cial activity since the end of World 

War II, came to an end. The fixed-rate 

system was dependent on interna 

tional faith in an unchanging value for 

the U.S. dollar. That faith was under 

mined by economic growth outside 

the United States, by persistent U.S. 

balance of payments deficits, and by 

inflationary fiscal policies in the 

United States during the Vietnam 

conflict. The fixed-rate system was 

replaced with a floating-rate system. 

One consequence was a substantial 

increase in currency trading activities. 

International banks were significant 

participants in the increase. 

An economic shock with far-reach 

ing ramifications occurred in 1973. 

The major oil-exporting countries im 

posed a fourfold increase in the price 

of a fundamental component of 20th 

One might also argue that overcapacity in 

the U.S. financial industry is, in 1993, still a 

17 
FDIC Banking Review 

Century economic activity oil. Fur 

ther increases came as the decade pro 

gressed. 

One almost immediate result of the 

oil-price increase was an enormous in 

crease in the wealth of oil-exporting 

countries, far too much to be absorbed 

internally. A large amount of it was 

recycled, to use the term that became 

common, through international banks 

to less-developed countries. The 

competition among banks to partici 

pate in this recycling process led to lax 

lending standards and eventually the 

less-developed-country debt crisis of 

the 1980s. 

Another consequence of the oilprice increases was a contribution to 

increases in inflation rates and inter 

est rates, which were under upward 

pressure during these years because of 

expansionary monetary policies. The 

largest annual increase in the consumer 

price index in the 1960s had been 5.5 

percent, in 1969, During 1974, the 

first full year after the initial oil-price 

boost by the oil-exporting countries, 

the CPI rose 11 percent. The annual 

increase fell to 5.8 percent in 1976 but 

returned to double digits by the end 

of the decade. For 1979, 1980, and 

1981, the CPI increases were 11.3, 

13.5, and 10.3 percent, respectively. 

Interesc-rate statistics show a sim 

ilar trend. The annual rate on new 

issues of3-month U.S. Treasury secu 

rities reached 10.0 percent in 1979, its 

first foray into double digits. The yield 

on new-home mortgages went from 

7.7 percent in 1971 to 10.8 percent in 

1979, 14.7 percent in 1981, and 15.1 

percent in 1982. The prime rate 

charged by banks hit 18.9 percent in 

1981; in 1971 it had been 5.7 percent.3 

The flexible currency exchangerate system that followed the demise 

of the Bretton Woods fixed-rate 

scheme aided and abetted the rise in 

inflation and interest rates by making 

it easier for governments to avoid 

adopting tough, restrictive monetary 

and fiscal policies. Inflation under a 

fixed-rate regime often leads quickly 

to pressure on a currency that in turn 

spurs the government to adopt non

inflationary policies. Inflation under a 

flexible-rate regime, on the other 

hand, can merely result, at least ini 

tially, in the depreciation of the cur 

rency, which a government is often 

willing to tolerate as the lesser ofevils. 

Thus the 1970s were a decade of 

considerable change and flux in the 

environment within which banks and 

thrifts operated. The environmental 

upheavals added to the pressures on 

the government-created barriers to 

competitive adjustment. Two finan 

cial phenomena can serve to highlight 

the changing marketplace and the de 

teriorating position of depository 

institutions in the 1970s. For a signifi 

cant proportion of larger corporations, 

the issuance of commercial paper was 

becoming an alternative to borrowing 

funds from banks. And money-market 

mutual funds, which were not subject 

to the interest-rate caps restraining 

banks and thrifts, were attracting 

large amounts of funds that previously 

would have resided in those deposi 

tory institutions. 

The Thrift Industry 

The story of the thrift industry 

since 1980 is a story of crisis, and the 

crisis was a two-step affair. The first 

step was relatively straightforward, its 

immediate cause relatively easy to 

pinpoint. That cause was high inter 

est rates. The second step was signif 

icantly more complex and eventually 

much more severe. It concerned the 

sometimes contradictory responses of 

the industry, the industry's regulators, 

and Congress to those high interest 

rates and the various difficulties that 

ensued. 

As institutions whose principal 

mode of operation was to fund long

term loans with short-term deposits, 

thrift institutions were detrimentally 

affected by the prolonged period of 

high interest rates that occurred in the 

late 1970s and early 1980s. Thrifts 

sustained losses by having to pay 

higher rates on the short-term depos 

its than they were earning on the long

term loans. And the interest-rate caps 

then in existence made keeping old 

deposits and acquiring new ones ex 

ceedingly difficult. In 1981, for exam 

ple, the profits for the thrift industry 

were a negative $4.6 billion, and 

FSLIC-insured institutions suffered 

net deposit withdrawals of $25.4 

billion.5 

Congress' initial answer to the 

problems created by the high interest 

rates was to provide for the phasing 

out of interest-rate controls. This was 

done in the Depository Institutions 

Deregulation and Monetary Control 

Act of 1980. The relaxation and even 

tual elimination of the controls en 

abled both thrifts and banks to stem 

the loss of deposits due to the inability 

to pay market rates of interest. Paying 

market rates of interest, however, 

only exacerbated the major difficulty 

facing a large proportion of thrifts: 

supporting low-rate, long-term loans 

with high-rate, short-term liabilities. 

Parenthetically, DIDMCA con 

tained another provision, little no 

ticed at the time, that in hindsight 

exemplifies the attitude with which 

much of the financial industry and its 

regulators entered the 1980s. With 

very little analysis or debate, Con 

gress raised the federal deposit insur 

ance limit for both banks and thrifts 

from $40,000 to $100,000. This action 

itself may not have contributed much 

to the problems that were to come. 

But the almost carefree more-than

doubling of the federal deposit guar 

antee indicated a certain optimism 

and lack of apprehension regarding 

the prospects of the depository insti 

tutions industry. 

To help the thrift industry both 

overcome the interest rate-caused 

threat to its viability and meet other 

difficulties arising from changes in the 

Economic Report of the President (Washing 

ton, DC: U.S. Government Printing Office, 

February 1992), Table B-59, p. 365. 

3/awfo»., Table B-69, p. 378. 

Office of Thrift Supervision, Supervising 

Today's Thrift Industry, December 1992, p. 1. 

Federal Home Loan Bank Board, Anniiaf 

Report, 1986, p. 6. 

18 
The Bank and Thrift Crises A Retrospective 

financial marketplace, Congress and 

the Federal Home Loan Bank Board 

the federal regulator of S&Ls — 

cook a number of steps. In total, the 

actions came to be referred to as "de 

regulation." To generalize, deregula 

tion consisted of (1) the relaxation of 

capital and accounting standards and 

(2) the expansion of lending and in 

vestment powers. Of great significance, 

the increased flexibility and freedom 

granted to the thrifts were not matched 

by increased supervisory efforts or re 

sources. Indeed, a major cause of the 

subsequent troubles was inadequate 

supervision. 

The relaxation of capital and ac 

counting standards occurred in a vari 

ety of ways. One of the first major 

steps was the FHLBB's reduction in 

1980 of the statutory reserve require 

ment one of several measures of 

thrift capital from 5 percent to 4 

percent of insured deposits. The re 

quirement was further reduced in 1982 

to 3 percent. In 1981, the FHLBB 

authorized thrifts to defer and amortize 

losses on the sale or other disposition 

of mortgage loans, mortgage-related 

securities, and debt securities. Pre 

viously, such losses had to be recog 

nized immediately. Also in 1981, the 

FHLBB permitted troubled institu 

tions to issue income capital certifi 

cates to bolster their capital positions. 

The certificates were purchased by 

the FSLIC with either cash or inter 

est-bearing notes. 

In the Garn-St Germain Act of 1982, 

Congress appropriated the income 

capital certificate concept by author 

izing a net worth certificate program 

for both banks and thrifts. The pro 

gram improved the financial appear 

ance of banks and thrifts with low net 

worth by permitting the institutions 

to count promissory notes from the 

appropriate federal regulator as capi 

tal. Among the FHLBB's actions in 

1982 was an increase from ten to 40 

years of the period during which 

goodwill in merger transactions could 

be amortized. The effect was to sig 

nificantly increase the reported, but 

not the real, income and capital of the 

thrift industry. 

A retreat from the standards relax 

ation trend began the following year, 

1983, but several major capital-dilut 

ing steps still lay ahead. In 1985, the 

FSLIC began a Management Con 

signment Program to reorganize and 

recapitalize troubled institutions. The 

recapitalizations were largely paper 

transactions, being accomplished 

through the issuance of capital certifi 

cates. And in the Competitive Equality 

Banking Act of 1987, Congress insti 

tuted supervisory forbearance for "well

managed" undercapitalized thrifts. 

Regarding the expansion of thrift 

lending and investment powers, 

DIDMCA in 1980 was an important 

early step. In that Act, Congress re 

moved a geographic limit on thrift 

lending, allowed thrifts to buy corpo 

rate debt and commercial paper up to 

20 percent of assets and to invest up 

to 3 percent of assets in service corpo 

rations, and expanded thrift authority 

to make acquisition, development, 

and construction (ADC) loans. Mean 

while, several states, notably California, 

Texas, and Florida were aggressively 

broadening the powers of state-char 

tered institutions. 

In 1980 and 1981, the FHLBB al 

lowed thrifts to lend with loan-to

value ratios greater than 90 percent, to 

accept less than a first lien on mort 

gage loans, and to hedge with finan 

cial futures. In addition, thrift service 

corporation powers were expanded. 

In 1982, and on the liabilities side of 

the ledger, the FHLBB removed re 

strictions on brokered deposits. 

Congress also made significant lib 

eralizing contributions in 1982, in the 

Garn-St Germain Act. Prohibitions 

or limitations on nonresidential realestate lending, consumer lending, 

commercial lend ing, and personal prop 

erty leasing activities were relaxed. 

It should be emphasized that these 

many steps to expand the powers of 

thrift institutions were not in them 

selves, and considered individually, 

necessarily "bad." Indeed, in view of 

the changes taking place in the finan 

cial marketplace, some of them may 

have been unavoidable, even desir 

able. The liberalizing steps, however, 

were not accompanied by adequate 

oversight. Many thrift executives re 

acted to the freer environment like 

small children turned loose without 

parental oversight in the Halloween 

candy. The unrestrained gorging was 

unsurprising, and the unpleasant con 

sequences were not unforeseeable. 

The resources and efforts of gov 

ernment supervisors were insufficient 

to halt a rapid growth in imprudent 

lending and investing. Moreover, fraud 

and insider abuse began surfacing with 

unsettling frequency. Attempts by su 

pervisors to handle troubled institu 

tions with a minimum initial outlay of 

government funds compounded the 

difficulties. Acquisitions of such insti 

tutions were permitted in which ac 

quirers put little or no capital at risk. 

Unhindered by either government su 

pervision or fear of losing their invest 

ments, more than a few such acquirers 

treated their acquisitions as spigots on 

the pipelines of the nation's financial 

flows. 

One further major ingredient inter 

acted with the loosened capital and 

accounting standards, expanded lend 

ing and investment powers, and inade 

quate supervision to produce the thrift 

debacle of the latter half of the 1980s. 

That ingredient was an exaggerated 

swing of the real-estate cycle. Real-es 

tate markets expanded rapidly in the 

early and mid-1980s and contracted 

precipitously as the decade neared its 

end. A portion of the expansion and 

contraction was undoubtedly the nat 

ural workings of the marketplace. The 

pent-up demand that the high interest 

rates of the early 1980s had produced 

led to overbuilding, which in turn 

caused retrenchment. Just as impor 

tant in the swing, however, were gov 

ernment actions and policies that first 

encouraged and then discouraged flows 

of funds to real estate. 

For some time, the quasi-govern

ment mortgage agencies the Fed 

eral National Mortgage Association, 

19 
FDIC Banking Review 

the Government National Mortgage 

Association, and the Federal Home 

Loan Mortgage Corporation — had 

been bringing forth, in conjunction 

with private-sector participants in the 

capital markets, a variety of innova 

tive mortgage packaging techniques 

and products. The innovations wid 

ened the circle of potential real-estate 

investors. 

Congress contributed to the up 

swing in the real-estate cycle by tax 

cuts in 1981 and through the Second 

ary Mortgage Market Enhancement 

Act in 1984. The tax cuts in 1981 con 

tained accelerated depreciation pro 

visions and investment tax credits 

that made real-estate investments ex 

tremely attractive. The 1984 law re 

duced state barriers to investment in 

mortgage-related securities. 

On the other hand, as many real-es 

tate sectors were probably getting 

ready to cool of their own accord, Con 

gress, inadvertently, accelerated the 

downturns with the Tax Reform Act 

of 1986. That law reduced deprecia 

tion benefits, restricted passive loss 

deductions, and eliminated favorable 

treatment for capital gains. The re 

duction in the attractiveness of real 

estate as an investment was both sub 

stantial and abrupt. Over the next few 

years, real- estate values in many areas 

declined significantly. Commercial 

properties were particularly hard hie. 

Thrifts that had helped fuel the spec 

ulative binges of the early 1980s 

found themselves burdened with de 

faulting borrowers and falling collat 

eral values. Although many of the 

post-1986 thrift failures were un 

doubtedly already foreordained, the 

Tax Reform Act of 1986, by sudden 

ly altering the real-estate investment 

climate, did the industry no favors. 

By the middle of the decade, thrift 

executives were making extensive use 

of the increased powers they had been 

given by Congress, state legislatures, 

and the regulators. Assets ofFSLIC

insured institutions grew from $600 

billion in 1980 to over $1 trillion in 

1985. The share of the nonresiden

tial morcgagc Joan market controlled 

by thrifts in 1980 was 11 percent. By 

1985, the thrifts' proportion had risen 

lo 30 percent. Home mortgage loans 

the traditional mainstay of thrifts 

fell from 67 percent of thrift assets 

in 1980 to 42 percent in 1985.8 One 

hundred thirty-three new thrift char 

ters were issued in 1984; the number 

the following year was 173. 

Also by mid-decade, signs of the 

coming disaster were surfacing, rapidly. 

In 1978, the mortgage delinquency 

rate for FSLIC-insured institutions had 

been under 1.5 percent. In 1986, it 

was 5 percent. Thrift industry prof 

its for 1986 were an anemic $131 mil 

lion. The previous year they had 

been $3.7 billion. By one count, 46 

FSLIC-insured thrifts with assets to 

taling $12 billion failed in 1986.12 At 

an estimated cost of $3.1 billion, these 

failures rendered the FSLIC fund in 

solvent. In 1987, the thrift industry 

suffered a loss of $7.8 billion. Fortyseven institutions with assets of $11 

billion failed, at an estimated cost of 

$3.7 billion. 

Reaction to the developing crisis 

was increasing, but the taking of ef 

fective corrective steps was severely 

hindered by a number of factors. 

There was a general disbelief that the 

problems were really as bad as they 

seemed. The complexity and esoteric 

nature of the difficulties discouraged 

examination by the media. A politi 

cally powerful thrift industry lobby 

vehemently fought any reexamina

tion of the liberalizing moves of the 

early 1980s and even the smallest at 

tempt at increased supervision. In 

volvement of both political parties in 

industry problems at the policy as 

well as individual levels discour 

aged Congressional and Executive 

Branch action, particularly during the 

1986 and 1988 election years. 

Congress' first effort to deal with 

the snowballing situation was tentative. 

The Competitive Equality Banking 

Act of 1987 authorized a $10.8 billion 

recapitalization of the FSLIC and 

called for supervisory forbearance 

for "well-managed" undercapitalized 

institutions. The Act did little to 

stanch the hemorrhaging that was tak 

ing place in the thrift industry, and the 

$10.8 billion was quickly perceived as 

inadequate. In 1988, 205 thrifts with 

assets of $100 billion failed. The esti 

mated cost of the failures was $31.2 

billion. The FSLIC reported a def 

icit of $75 billion.17 

Tentative was not how the next 

Congressional effort could be charac 

terized. Shortly after taking office in 

1989, President Bush sent a massive, 

complex thrift industry restructuring 

bill to Capitol Hill. The resulting leg 

islation was the Financial Institutions 

Reform, Recovery, and Enforcement 

Act of 1989 (FIRREA). The FHLBB 

and the FSLIC were abolished. 

Thrift industry oversight was moved 

to the Department of the Treasury, 

being placed in the newly created Of 

fice ofThrift Supervision (OTS). The 

FSLIC's insurance functions were 

transferred to the FDIC. Responsibil 

ity for dealing with failed thrifts was 

given to another newly created organ 

ization, the Resolution Trust Corpo 

ration, which was to accomplish its 

task and go out of existence by 1996. 

few of FIRREA's provisions may 

have gone too far, thus compounding 

the difficulties. For example, thrifts 

were required to dispose quickly of 

their junk-bond inventories. In com 

plying, some thrifts sustained what 

might have been unnecessary losses, 

James R. Barth, The Great Savings and Loan 

/>A7c/.?(Washington,DC: The AEI Press, 1991), 

p. 25. 

Prudential-Bache Capical Funding, Finan 

cial Strategies Group, A 1980s Retrospective ofthe 

Savings andLoan Crisis, Wall Chart (PrudentialBache Capical Funding, 1990). 

fiBarth, p. 25. 

Prudential-Bache. 

10Prudencial-Bache. 

"Barth, p. 25. 

^Ibidem., p. 32. 

1 Federal Home Loan Bank Board, Annual Report, 1986, p. 25. 

1 Federal Home Loan Bank Board, Annual 

Report, 1987, p. 5. 

lsBarch, p. 32. 

Ibidem. 

Federal Home Loan Bank Board, Annual 

Report, 1988, p. 36. 

20 
The Bank and Thrift Crises A Retrospective 

and the already weakened junk-bond 

market may have received an addi 

tional unnecessary jolt. 

From the perspective of midyear 

1993, the S&L crisis appeared to have 

moved past its peak. Most of the thrift 

institutions destined for the RTC had 

found their way there, and the agency 

had disposed of almost three-fourths 

of the failed-thrift assets in its inven 

tory. The agency, however, was still 

awaiting an additional amount of ap 

proximately $25 billion from Con 

gress to complete its work. The total 

cost to the taxpayer of the S&L crisis 

was expected to be close to $200 

billion. 

The portion of the thrift industry 

remaining in private-sector hands 

consisted of, at year-end 1992, 1,855 

OTS-supervised institutions with as 

sets of $795 billion, down from 3,092 

institutions with assets of $1,284 bil 

lion in June of 1988. In 1991, the pri 

vate-sector portion of the industry had 

earned its first annual profit since 

1986, $1.83 billion. Primarily because 

of declining interest rates, privatesector industry profits for 1992 were a 

record $5.14 billion. 

What the future held for the indus 

try survivors was impossible to fore 

tell, however. Over a period of little 

more than a decade, the industry had 

first been severely threatened, had 

then enjoyed enormous growth, and 

had next been virtually decimated. In 

light of this recent history and the 

fallibility of government policymak 

ers, government regulators, and in 

dustry executives, cautious optimism 

appeared to be the most favorable 

view that an observer should be 

willing to entertain. 

The Banking Industry 

The difficulties that have beset the 

banking industry in the years since 

1980 have differed in several important 

respects from the problems of the thrift 

industry. First and foremost, the rise 

in interest rates in the late 1970s and 

early 1980s was much less a problem 

for banks than it was for thrifts. 

Although banks were subject to the 

interest-rate caps on deposits and con 

sequently experienced some outflow 

of funds, they were not burdened with 

large proportions of long-term, fixedrate assets. Bank assets generally had 

much shorter maturities than did the 

mortgage loans of the thrifts. Conse 

quently, banks could adjust upward 

the price of loans and other assets as 

the cost of funds the rates paid on 

deposits increased in response to 

market forces. 

Second, the credit-related prob 

lems that beset banking were regional 

or sectorial in scope. Thus, the en 

tire industry was not hit by difficul 

ties at once. The industry and its 

regulators were able to deal with trou 

bles in more manageable portions 

than were the thrift industry and its 

regulators. 

Finally, the supervisory system for 

banks was generally superior to the 

system for thrifts. The primary federal 

thrift regulator, the FHLBB, was 

charged with being both a supervisor 

of S&Ls and a promoter of the homefinancing industry. This dual focus 

probably increased the thrift supervi 

sory system's susceptibility to the 

badgering and entreaties of what was 

at the time one of Washington's most 

powerful and myopic lobbies. 

In the years since 1980, four major 

sets of difficulties have challenged 

the banking industry and its regula 

tors. These four sets of difficulties 

concerned less-developcd-country, 

agricultural, energy, and real-estate 

lending, with the last being the most 

damaging. The four areas have a sim 

ilarity. Bank involvement in each was 

characterized by an exuberance fu 

eled in part by the enthusiasm of 

other banks the bandwagon effect. 

The exuberance and enthusiasm 

clouded the reality that there can be 

too much of a good thing. After the 

initial burst of bank lending in each 

area, further funds were chasing fewer 

viable projects and were advanced 

with inadequate attention to chang 

ing macroeconomic conditions. 

The less-developed-country debt 

crisis was the outcome of massive 

flows of funds to the LDCs in the 

1970s. Fueled in large measure by the 

"petrodollars" that the oil-exporting 

countries placed in international 

banks following the oil-price rises 

during the decade, the lending was 

based on increasingly tenuous as 

sumptions about LDC growth. The 

LDCs simply could not make bona 

fide economic use of the financial lar 

gess coming their way. The lending 

resulted in large increases in LDC 

external debt. 

Mexico's announcement in August 

1982 that it would be unable to meet 

its debt payments to foreign creditors 

brought an abrupt end to unrestrained 

lending and an abrupt start to the 

LDC debt crisis. Within the U.S. 

banking industry, the largest banks 

were the ones with the greatest LDC 

exposure and consequently the most 

affected. Asa percent of equity capital 

and reserves, the non-trade exposure 

of the average U.S. money-center 

bank to LDCs was 227 percent in 

1982.19 

The announcement by Mexico 

began a multi-year workout effort in 

volving banks, governments in both 

debtor and creditor countries, and 

international organizations during 

which much of the LDC debt was 

restructured. The crisis' impact on 

U.S. banks was slow to be acknowl 

edged in financial statements. Even 

tually, however, the piper had to be 

paid. In 1987 and again in 1989, U.S. 

money-center banks added substan 

tially to reserves to provide for LDC 

debt losses. The effect in 1987 was 

especially noticeable, the increase in 

reserves being largely responsible for 

a decline in the return on assets for the 

banking industry from 0.61 percent in 20 1986 to 0.09 percent in 1987." 

Office of Thrift Supervision: (1) Press 

Release, March 11,1993; (2) SupervmngTodays 

Thrift Industry, December 1992, p. 35. 

GaryS. Fissel, "The Anatomy of the LDC 

Debt Crisis," FD1C Banting Review, Vol. 4, No. 

1, Spring/Summer 1991, p. 10. 

Calculated from Federal Deposit Insur 

ance Corporation, Historical Statistics on Bank 

ing, 1934-1991, Tables GB-7, CB-12. 

21 
FDIG Banking Review 

By the early 1990s, the LDC debt 

crisis appeared to have abated. The 

external debt burden for many of the 

LDCs had been eased through vari 

ous forms of debt restructurings. The 

economies of the countries had gener

ally stabilized, and for most the Inter 

national Monetary Fund was 

projecting healthy growth. As for 

banks, their exposure to LDC debt 

problems had been reduced. For ex 

ample, the ratio of LDC non-trade 

exposure to equity capital and re 

serves for the average U.S. moneycenter bank had fallen from 227 

percent in 1982 to 91 percent in 

1989.21 

Regarding agricultural lending, 

difficulties had surfaced by 1984 and 

were to be a concern for the next sev 

eral years. The difficulties had their 

immediate origins in the previous de 

cade. Led by export growth and rising 

commodity prices, the farming sector 

of the economy in the 1970s enjoyed 

one of its more expansive periods. 

The boom had a substantial effect on 

Che price of farm land, causing it to rise 

significantly. Expecting the good 

times to continue, many farmers bor 

rowed heavily to expand operations, 

using the inflating real-estate values 

to support the increases in debt. 

As booms are wont to do, however, 

the agricultural boom of the 1970s 

came to an end. The particular macro

economic forces that had helped pro 

duce it strong growth in demand in 

the industrial economies, a cheap dol 

lar, high inflation, and low real inter 

est rates suffered reversals as the 

new decade began. The value of 

farmers1 main asset, land, plunged. 

Farmers who had used rising real-es 

tate values to finance operations were 

forced to rely on cash flow from oper 

ations. In many instances, the cash 

flow, which was reduced because of 

the general fall in demand, was not 

sufficient to enable debt service obli 

gations to be met. 

In consequence, farm lenders ex 

perienced large loan losses, and many 

of them failed. Agricultural banks, 

defined as banks in which agricultural 

loans amount to 25 percent or more of 

total loans, accounted for 32 percent 

of bank failures in 1984 (25 of 79), 54 

percent in 1985 (65 of 120), 41 percent 

in 1986 (57 of 138), 30 percent in 1987 

(56 of 184), and 14 percent in 1988 (28 

of 200). Fortunately from the stand 

point of the banking system and its 

regulators, most of the failed agricul 

tural banks were relatively small. 

Thus, considered in isolation, the 

problems in agricultural lending, 

though significant, were not systemthreatening. 

Energy-related lending difficul 

ties, centered in the Southwest but 

reverberating nationwide, were to 

pose a more formidable challenge to 

banking and its overseers. As was the 

case with agriculture, the energy-re 

lated lending difficulties of the 1980s 

had their origins in boom conditions 

in the 1970s. The boom was due to the 

huge increase in energy prices. The 

real price of domestic crude oil more 

than tripled during the decade, from 

$8 to $28 per barrel in constant (1982) 

dollars. Assuming that the OPEC 

cartel's ability to set world oil prices 

would continue, many forecasters en 

visioned a barrel's cost at $50 or more 

before too long. 

Such projections colored the lend 

ing decisions at many Southwest 

banks and thrifts. The oil-price out 

look implied strong economic growth 

and in-migration for the region. Bank 

ing institutions responded by lending 

aggressively to businesses that stood 

to benefit from these trends, princi 

pally oil and gas producers, construc 

tion firms, and real-estate developers. 

sizeable oil-price hike in 1981, from 

$24 to $34 per barrel in current dollars, 

appeared to confirm the prevailing 

outlook for ever-increasing energy 

prices. 

But 1981 was the oil-price apogee. 

Prices began falling in the latter half 

of the year and did not find a bottom 

until past mid-decade. The 1986 price 

per barrel was $15. The prog

nosticators had failed to foresee the 

increase in supply from non-OPEC 

producers and the significant reduc 

tion in demand due to conservation 

measures. They also had failed to dis 

cern the fragility of OPEC's own pro 

duction agreements. As oil prices 

began falling, OPEC members sought 

to maintain their revenues by ignoring 

production quotas and raising output. 

This further increased supply and 

accelerated the downward movement 

of prices. 

Economic growth in the Southwest 

slowed, stopped, and turned negative. 

Real-estate values collapsed, and 

lenders of all types began feeling the 

effects. From 1980 through 1989,535 

banks failed in Texas, Oklahoma, and 

Louisiana, a total that was 50 percent 

of all U.S. bank failures during the 

period. Some of the failures were of 

agricultural banks, but the majority 

succumbed to energy-related difficul 

ties. By the end of the decade, nine of 

the ten largest banking organizations 

in Texas had been recapitalized with 

FDIC or other outside assistance. 

Factors that combined with the en 

ergy boom-bust to produce the South

west banking debacle included 

inadequate portfolio diversification, 

poor underwriting standards, weak in 

ternal controls on lending decisions, 

infrequent supervisory examinations, 

and unrealistic real-estate valuations. 

21Fissel. 

See John Rosine and Nicholas Walraven, 

"Drought, Agriculture, and the Economy," 

Federal Reserve Bulletin, January 1989, p. 7. 

"T"ocal bank failures for each year are from 

FDIC Annual Report, 1991, Table A, p. 127. 

Agricultural bank failures are from the follow 

ing FDIC Annual Reports: 1986, p. 8; 1987, p. 

xvi; 1988, p. xvi. 

John O'Keefe, "The Texas Banking Cri 

sis: Causes and Consequences, 1980-1989," 

FDIC Banking Review, Vol. 3, No. 2, Winter 

1990, Table 5, p. 17. 

** Ibidem. 

lhlbidem. 

Gregory K.Gibbs, "Distribution of Failed 

Banks by State and by Type of Transaction," 

unpublished paper prepared in the Banking 

Statistics Section, Division of Research and 

Statistics, Federal Deposit Insurance Coipora

tion, March 16, 1990. 

Z8O'Keefe, p. 1. 

22 
■ 

The Bank and Thrift Crises —A Retrospective 

The effects of the energy-related 

lending difficulties were not confined 

to the Southwest. Indeed, the largest 

U.S. bank failure, that of Continental 

Illinois National Bank and Trust 

Company in 1984, with assets of $33.6 

billion, can be traced to troubles in the 

Oil Patch. Continental had purchased 

hundreds of millions of dollars of en 

ergy loans from Penn Square Bank, 

N.A., Oklahoma City, which failed in 

1982. The large losses on these loans 

led in May of 1984 to a massive run on 

Continental, sparked by withdrawals 

of several billion dollars in deposits by 

European and Japanese depositors. 

Quick action by the FDIC and the 

other bank regulators stanched the 

run. A permanent reorganization and 

recapitalization, involving significant 

monetary assistance by the FDIC, 

29 was accomplished later in the year. 

Energy-related lending and the 

difficulties it encountered also con 

tributed to the most recent assault on 

the banking industry's well-being — 

the collapse of the nationwide real-es 

tate boom. An important part of the 

Southwest's energy euphoria in the 

early years of the decade was a surge 

in construction and real-estate devel 

opment. That surge outlived the en 

ergy boom itself and spread to much 

of the rest of the nation. The surge 

continued long after economic indica 

tors should have persuaded percep 

tive real-estate lenders and investors 

that a degree of caution was in order. 

For example, the vacancy rate for 

office buildings in 31 major markets 

rose from 4.9 percent in 1980 to 13.5 

percent in 1983 to 16.5 percent in 

1985. Yet, the funds continued to 

flow. By 1991 the vacancy rate was 

18.8 percent. 

Banks and thrifts were important 

providers of funds for the real-estate 

boom. Thrift involvement was dis 

cussed earlier. For banks, real-estate 

loans rose from 14.5 percent of their 

assets in 1980 to 24.5 percenta decade 

later." And as was the case with thrift 

real-estate activity, the composition of 

bank real-estate lending shifted toward 

riskier endeavors. The safer home 

mortgage lending became relatively 

less important, displaced by more 

volatile construction and commercial 

real-estate lending. Furthermore, 

the underwriting standards for con 

struction and commercial real-estate 

lending were relaxed. High loan-to

value ratios, no take-out commitments, 

and reduced recourse to corporate 

strength became common. 

In hindsight, discerning what hap 

pened regarding the real-estate 

boom-bust of the 1980s as well as 

the boom-busts regarding LDC, agri 

cultural, and energy lending is rela 

tively easy. Determining why it 

happened is more difficult and not 

susceptible to much in the way of 

quantifiable answers. The ultimate 

"why" raises issues of human psychol 

ogy, specifically the mind-sets that 

produce economtcbooms and busts. 

Charles Kindleberger discussed the 

human propensity for economic folly 

in his classic Manias, Panics, and 

Crashes; A History ofFinancial Crises. 

More recently, James Grant described 

the 1980s in his book, Money of the 

Mind, in terms that give rise to visions 

of credit run amuck. 

Certainly there was a reduction in 

caution and an increase in risk-taking 

in the financial world of the 1980s. 

Being part of the financial world, 

banks were infected by these atti 

tudes. Banks also were influenced by 

the changing nature of their busi 

ness. For example, many corporate 

customers found cheaper financing 

elsewhere, such as in the commercial 

paper market. As they lost customers 

and saw more competition in some of 

their traditional areas of activity, 

banks turned to other fields, such as 

the risky world of real-estate develop 

ment. 

Bank troubles grew throughout the 

decade. Insured bank failures from 

1934 through 1981 totalled 586, an 

average of 12 a year. On a decade 

basis, 358 banks failed from 1934 

through 1940, 61 banks in the 1940s, 

28 in the 1950s, 50 in the 1960s, and 

79 in the 1970s. The 1980s started 

normally enough, with 10 banks fail 

ing in 1981. In 1982, however, the 

figure jumped to 42. From 1982 

through 1992, 1,480 banks failed, an 

average of over 130 a year and more 

than two and one-half times the num 

ber of failures in the previous 48 

years. In 1984, Federal Deposit In 

surance Corporation insurance assess 

ments on banks were, for the first time 

since the agency's founding, less than 

insurance outlays. 

Still, the banking system, includ 

ing the industry's deposit insurance 

fund, appeared to be in reasonably 

good shape through the end of the 

decade, particularly when compared 

to the S&L industry and its defunct 

insurance fund. Despite insurance as 

sessments not keeping pace with in 

surance costs after 1984, the bank 

insurance fund continued to increase, 

reaching its apogee, $18.3 billion, in 

1987. The increases were due to 

interest on the fund's investments in 

U.S. Treasury securities. There were 

declines to $14.1 billion in 1988 and 

$13.2 billion in 1989, but attention at 

the time was focused on the thrift 

industry and its problems. The FDIC 

was still respected enough in Con 

gress to be given responsibility for 

overseeing the organization and oper 

ation of the RTC, the S&L cleanup 

agency. That mandate came in 

the Financial Institutions Reform, 

See Federal Deposit Insurance Corpora 

tion, Annual Report, 1984. 

CB Commercial/Toito Wheaton Research. 

Vacancy rates are reprinted in various issues of 

The Real Estate Report, Division of Research 

and Statistics, Federal Deposit Insurance 

Corporation. 

Calculated from Federal Deposit Insur 

ance Corporation, Historical Statistics on 

Charles P. Kindleberger, Manias, Panics, 

and Crashes: A History of Financial Crises (New 

York: Basic Books. 1978). 

" James Grant, Money afthe Mind{New York: 

Farrar Straus Giroux, 1992). 

Calculated from Federal Deposit Insur 

ance Corporal ion,,Annual Report, 1991, Table A, 

p- 127. 

Ibidem, Table D, p. 133. 

,5ft 

Ibidem. 
FDIC Banking Review 

Recovery, and Enforcement Act of 

1989(FIRREA).37 

Within a very short time, however, 

the possibility of an S&L-type disas 

ter in the banking industry moved to 

center stage. The reason for the con 

cern was increasing awareness of the 

enormity of the real-estate problems. 

The Southwest's difficulties had been 

known for some time. But as the 1990s 

dawned, the abysmal state of New 

England real-estate markets became 

apparent. And it soon became obvious 

that conditions in the Southeast and 

on the West Coast were also poor. 

Lenders, including banks, suffered 

heavy losses. The FDIC fund declined 

to $4.0 billion in 1990, and expecta 

tions of further massive declines rap 

idly became widespread. 

Fears that the banking industry was 

going the way of the thrift industry 

quickly grew. Also attracting adherents 

was a belief that the bank regulatory 

agencies1 performance in controlling 

bank risk-taking had been inadequate. 

This was reflected in the Federal De 

posit Insurance Corporation Improve 

ment Act of 1991 (FDICIA). general 

thrust of that law was to curtail super 

visory discretion. One important way 

this was done was to require that cer 

tain corrective actions be taken as an 

institution's capital ratios decline. The 

Act also, among other things, (1) pro 

vided a Treasury line of credit for the 

deposit insurance system, (2) mandated 

annual examinations for banks and 

thrifts, (3) established a least-cost stan 

dard to be followed by the FDIC in • 38 resolving failing institutions, (4) re 

quired the adoption of a risk-related 

deposit insurance assessment system, 

and (5) restricted the activities of state 

banks. 

For 1991, the FDIC reported a bal 

ance for the bank deposit insurance 

fund of a negative $7.0 billion, which 

included a large General Accounting 

Office-mandated reserve for future fail 

ures. The negative result confirmed 

for a number of observers the severity 

of the situation. Predictions of contin 

ued troubles and further declines in 

the fund were heard throughout 1992 

and even surfaced prominently as an 

issue in the presidential election cam 

paign in the Fall. 

The Future 

Nineteen ninety-one was the lowpoint, however. Due in part to low 

interest rates, 1992 turned out to be a 

year of record profits for the industry. 

The number of bank failures was con 

siderably less than what had been pre 

dicted. By midyear 1993, the banking 

industry appeared to be well out of 

the real-estate crisis that had engulfed 

it in 1990-91, that had led to the dev 

astation of the bank deposit insurance 

fund, and that had provided the im 

petus for the enactment of FDICIA. 

Preliminary data indicated that the 

bank fund had a positive balance ac 

the end of 1993's first quarter. The 

question was whether the upturn was 

the start of a long-term trend, or whe 

ther it was merely a brief respite be 

fore the reappearance of problems 

emanating from deep-seated structural 

difficulties and, perhaps, industry 

overcapacity. 

One key to answering the question 

may be the considerable consolida 

tion that both the bank and thrift in 

dustries have undergone over the last 

dozen years or so. The number of banks 

dropped from 14,758 atyear-end 1980 

to 11,875 at year-end 1992, a decline 

of 20 percent. During almost the 

same period, year-end 1980 to Sep 

tember 1992, the number of banking 

organizations—bank holdingcompa

nies and independent banks de 

clined 28 percent, from 12,572 to 

9,095. For thrifts, the decline from 

year-end 1980 to year-end 1992 was 

54 percent, from 4,005 to 1,855.41 

An important reason for this con 

solidation has been the growth of in 

terstate operations. In 1980, interstate 

bank and thrift organizations were 

largely prohibited by law. The various 

marketplace changes and crises, how 

ever, prompted efforts to overcome or 

reduce the legal hurdles. Although not 

completely successful in removing the 

barriers to interstate organizations, 

the efforts have had a significant 

impact. 

The OTS now permits nationwide 

branching by healthy thrift associa 

tions. Federal and state laws still for 

the most part prevent banks from 

branching across state lines, but inter 

state bank holding companies are 

commonplace and have reshaped the 

rankings of banking organizations. 

For example, of the 25 largest U.S. 

bank holding companies at year-end 

1980, only 14 were still in the group at 

year-end 1992. The 11 newcomers all 

had substantial presences in more 

than one state. In 1980, no bank hold 

ing company headquartered in the 

Southeast was in the top 25; in 1992, 

5 were. 

Interstate acquisitions accounted 

for a sizeable number of failed thrift 

and bank resolutions. Without the ex 

istence of interstate acquirers, the 

thrift and bank cleanups might have 

been even more costly. Over the long 

term, interstate operations should in 

crease competition and help to reduce 

any overcapacity that the industries 

may have. And by making institutions 

less vulnerable to economic declines 

in a single state or region, interstate 

J7The FDIC's oversight of the RTC was 

removed by the Federal Deposit Insurance 

Corporation Improvement Act of 1991. 

38Section 141 of FDICIA, 12 U.S.C. 

§1823(c)(4), requires the FDIC to use the "least 

costly" method of resolving failed or failing 

banks. There is a systemic-risk exception for 

large institutions. The least-cost standard re 

placed the cost test that the FDIC had been 

nsing since 1951 and that had been codified in 

the 1982 Garn-St Germain Act. Under the cost 

test, financial assistance provided by the FDIC 

to aid in the acquisition of a troubled bank by 

another institution could not exceed the cost of 

liquidating the bank and paying off only its 

insured deposits. 

1980 number: Federal Deposit Insurance 

Corporation, Historical Statistics on Banking, 

1934-1991, Tables CB-1, SB-1. 1992 number: 

Federal Deposit Insurance Corporation, 

Quarterly Banking Profile, Fourth Quarter 1992. 

Numbers include both commercial and savings 

banks insured by the FDIC. 

Division of Banking Supervision and 

Regulation, Federal Reserve Board. 

1980 number: Savings Institution 

Sourcebook, 1990, p. 43. 1992 number: Office of 

Thrift Supervision, Press Release, March 11, 

1993. 

American Banker, April 21,1981, and Febru 

ary 3, 1993. 

24 
The Bank and Thrift Crises A Retrospective 

operations should enhance industry 

safety and soundness. 

Nevertheless, the thus far partial 

removal of barriers to interstate opera 

tions is only a portion of what is 

needed to increase the chances that 

banking's current favorable perfor 

mance will be lasting. In the years 

ahead, the health of the banking in 

dustry, on which the health of the 

supervisory system ultimately 

depends, will be affected by continu 

ing marketplace and technological 

changes and the ability to adapt to 

them. Public policymakers responsi 

ble for the banking system must deal 

with two imperatives and one fact. 

The first imperative is that, as 

profit-seeking risk-taking entities 

in a free-market economy, banking 

organizations require the freedom to 

respond to a changing world. The 

necessary freedom has both product 

and geographic aspects. Banking or 

ganizations must have flexibility 

regarding the types of products and 

services they offer. And banking organ 

izations must not be unduly con 

strained by economically inefficient 

geographic restrictions. 

Imperative number two concerns 

those entrusted with the responsibil 

ity both to protect insured depositors 

and to maintain the viability of a sig 

nificant portion of the financial inter 

mediation process. These bank 

supervisors need the tools, the judg 

ment, and the discretion to ensure 

that bankers' exercise of their neces 

sary freedom does not become sys 

tem-threatening. 

And as for the fact that public pol 

icymakers should be cognizant of, the 

achievement of social goals by placing 

responsibilities on private-sector enti 

ties is not cost-free. Profit-making 

lending institutions that must accom 

plish such legislatively imposed tasks 

as injecting funds into low-income 

areas can have their profits detrimen 

tally affected, which in turn can re 

duce overall financial strength. 

Striking the proper balance among 

these three often conflicting consider 

ations — the imperatives regarding 

bank freedom and adequate super 

vision and the fact of social goals en 

tailing costs is no mean task. The 

degree of success attained by 

policymakers in the effort to reconcile 

the conflicts will be a significant 

determinant regarding the future 

health of the banking industry. 

25 
FDIC Banking Review 

Commercial Real-Estate Problems: 

Note on Changes in Collateral Values 

Backing Real-Estate Loans Being Managed by 

the Federal Deposit Insurance Corporation 

by James L. Freund and Steven A. Seelig* 

Many of the failed-bank assets 

passed in recent years to the 

Bank Insurance Fund of the 

Federal Deposit Insurance Corporation 

have been loans that were secured by 

real assets or foreclosed collateral it 

self. In fact, many of the bank failures 

resulted from lending based on un 

derwriting criteria that gave undue 

weight to anticipated inflation in col 

lateral values rather than current cash 

flow and debt coverage analysis. When 

deflation replaced inflation in several 

key sectors of the economy, many loans 

fell into nonperforming status and were 

inadequately collateralized. 

This was the case in the early 1980s 

when oil prices plunged after a period 

of rapid increases. In the mid-1980s, 

declining land prices and weakening 

agricultural earnings caused numerous 

farm loans to sour. The most recent 

economic dislocation to affect the 

banking system, and consequently the 

FDIC, is the major downturn of com 

mercial real-estate markets in many 

areas of the country. This note reports 

on the effect that the collapse of com 

mercial real-estate markets has had on 

some typical FDIC assets. 

Origins of the Commercial 

Real-Estate Problems Facing 

the FDIC 

The commercial real-estate prob 

lems currently facing the FDIC are 

the culmination of more than a decade 

of changes in the financial and regu 

latory environment affecting banks' 

commercial real-estate lending ac 

tivities. FDIC-insured commercial 

banks traditionally devoted a relative 

ly small part of their portfolios to realestate lending. In 1950, real-estate 

loans accounted for only 8 percent of 

commercial bank assets. Real-estate 

lending increased slowly during the 

subsequent three decades, rising to 

14.5 percent by 1980. Thereafter, 

growth in real-estate lending accel 

erated at commercial banks (Chart 1). 

By 1992, real-estate loans had risen to 

almost 25 percent of total assets, 

thereby replacing commercial and in 

dustrial loans as the largest com 

ponent of bank lending activity. 

Commercial banks held $269 billion 

in real-estate loans in 1980; by 1992, 

the total had increased to almost 

$870 billion. 

The composition of real-estate 

lending also changed during the 

1980s. Traditionally, the most impor 

tant type of commercial bank realestate loan has been permanent 

mortgages on l-to-4 family residen 

ces. Such lending grew from $148 bil 

lion in 1980 to $390 billion at the end 

of the first quarter of 1993. However, 

during the early 1980s, commercial 

banks also were aggressive lenders for 

other types of real estate. For instance, 

construction lending by banks surged 

from $37 billion in 1980 to$107 billion 

by 1986. Construction lending peaked 

in 1989 at $136 billion. Permanent 

financing for commercial real-estate 

projects also grew rapidly throughout 

the 1980s, climbing from $64 billion 

in 1980 to $238 billion a decade later. 

Unlike construction lending, per 

manent commercial mortgage loans 

on the books ofbanks have continued 

to rise, totaling more than $260 billion 

in March 1993. 

James L Freund is Chief of the Financial 

and Industry Analysis Section in the FDIC's 

Division of Research and Statistics .Steven A. 

Seelig is Chief Financial Officer of the FDIC. 
Commercial Keal-Kslate Problems 

Chart 1 Chart 2 

Real-Estate Lending at Insured Commercial Banks: Nonperforming Real-Estate Loans 

Real-Estate Loans Outstanding at BIF-Insured Institutions 

$ Billions 

1,000 

1M2 ieeo 

Nonperforming Real-Estate Loans as a Percentage 

Real-Estate Loans as a Percent of Total Assets of Total Nonperforming Loans and Leases 

1960 1056 1960 1866 1070 1078 1880 

The problems of the commercial 

real-estate market are well-known. In 

both industrial and retail commercial 

real-estate markets new supply out 

paced demand in the 1980s. However, 

office-building markets suffered the 

most from overbuilding. According 

to data gathered by CB Commer

cial/Torto Wheaton Research, the 

office-building vacancy rate in major 

U.S. markets averaged just under five 

percent at the end of 1980.' After a 

decade in which new construction far 

exceeded demand, che office-build 

ing vacancy rate climbed to nearly 20 

percent in the early 1990s. In Texas, 

for instance, office-building vacancy 

rates rose to almost 28 percent in Dal 

las during the mid-1980s. In Houston 

and Austin, vacancy rates soared to 32 

percent and 40 percent, respectively. 

As one would expect, prices of com 

Percent 

1085 1000 1802 1082 1083 1S64 1BSS 1B8B IBM 1838 1BSS 1BB0 1M1 1SSZ 

mercial real estate in many areas fell 

sharply in response to the overbuilding. 

The combination of aggressive 

lending and subsequent overbuilding 

caused severe asset-quality problems 

at commercial banks (Chart 2). Prob 

lem real-estate loans (loans 90 days or 

more past due, plus those no longer 

accruing interest for accounting pur 

poses) rose from $9.4 billion in 1982 to 

$16.7 billion in 1987. By the end of 

1990, this figure totaled $39 billion. 

Problem real-estate loans as a propor 

tion of total nonperforming loans rose 

from 19 percent in 1983 to almost 

65 percent, in 1992. Moreover, repos 

sessed real estate resulting from loan 

foreclosures (OREO) doubled from 

$4.4 billion in 1982 to $8.8 billion in 

1986. OREO continued to increase 

sharply, peaking at over $27 billion at 

che end of 1991. 

Many of these problem real-estate 

assets were passed to the FDIC when 

banks failed. As of late 1992, approx 

imately one-half of the $40 billion in 

assets being liquidated by the FDIC 

were either mortgages, loans backed 

by real-estate collateral, or owned 

real estate. 

How Much Did Falling 

Commercial Real-Estate 

Prices Affect the Insurance 

Fund? 

The risk of a real-estate loan to a 

bank and ultimately to the FDIC 

largely depends on the terms on 

which the original loan was underwrit 

ten. Loans can have provisions that 

reduce their overall riskiness: pre-lease 

CRCommefciairr<ir[oWhearon Research, 

Boston, MA. 

27 
FDIC Banking Review 

or pre-sale requirements, "take-out" 

commitments for construction loans, 

or prohibitions on adding interest to 

loan balances. Other provisions are 

aimed at ensuring that, if the bor 

rower is garnering all the positive 

returns, he or she also assumes the 

bulk of the risk. For instance, lenders 

can — and often do — insist on 

recourse to a borrower's otherassets in 

the event of problems. In addition, by 

diversifying loan portfolios an institu 

tion can avoid the risk of severe losses 

if economic problems develop that 

disproportionately threaten particular 

types of credit. 

Perhaps the most universal way 

that lenders seek to avoid losses, how 

ever, is by requiring collateral that can 

be sold to satisfy any outstanding loan 

balance and interest obligation. To 

provide effective protection, the ini 

tial valuation of the collateral must 

be realistic. Moreover, the size of 

the initial loan relative to the value 

of the collateral must be low enough 

to accommodate declines in the col 

lateral's value due to external economic 

forces or to problems associated with 

the specific property. 

While systematic data are not avail 

able, it is generally agreed that under 

writing standards for commercial 

real-estate loans were loosened con 

siderably in the 1980s. In 1982, the 

Congress released national banks from 

the regulations that governed the basic 

terms under which commercial real-es 

tate credits could be written. Moreover, 

many thrift institutions, faced with 

serious profitability and capital prob 

lems, lent aggressively on terms favor 

able to many borrowers. 

As the real-estate "boom" turned 

to a "bust," many loans soured and 

property values declined. Loans that 

were made with high loan-to-valuc 

ratios and those where lenders as 

sumed earlier collateral price inflation 

would continue unabated —were the 

First to experience difficulty. How 

ever, even conservatively underwrit 

ten loans experienced difficulties in 

markets in which commercial price 

declines were substantial. 

While it is widely thought that 

commercial property values have fal 

len as much as 30 to 40 percent in the 

past several years, limited data exist to 

document that decline. The most 

often used source of information — 

the Russell-NCREIF data on un

leveraged, income-producing proper 

ties owned by pension funds and 

trusts shows that property values 

fell by just over 26 percent during the 

past six years. These data are not 

likely to reflect the FDIC's experi 

ence, however, because pension funds 

and trusts typically hold better-than

average quality properties. 

To obtain evidence on declines in 

collateral values that would be typical 

in failed banks, commercial real-es 

tate-backed loans held by the FDIC 

were studied. By quantifying the 

decline in value of collateral backing 

commercial real-estate loans the 

FDIC holds, this study attempts to 

measure the degree of the exposure 

that the Bank Insurance Fund can 

face when commercial real-estate 

markets sour. The data source is uni 

que in that it brings together two 

pieces of hard-to-obtain information: 

the reported value of the collateral 

when the loan was originated and the 

current value of the collateral. 

Data 

Because the FDIC's Division of 

Liquidation maintains information on 

individual assets, changes in collateral 

values on a loan-by-loan basis can be 

analyzed. Bank records (where they 

were adequately kept) can be used to 

identify the estimated collateral value 

at the time a commercial real-estate 

loan was originated. To document 

changes in collateral value, these es 

timates must be matched with either 

the sales prices the FDIC received or 

with current appraised values. The 

use of sales proceeds has the advantage 

of employing actual market-deter 

mined prices. However, reconstruction 

of the original bank records for assets 

sold in liquidation is often quite dif 

ficult. In contrast, historical records 

are readily available for nonperform 

ing loans currently being held, and 

such loans are required by FDIC 

policy (by virtue of their nonperforming 

status) to have current appraisals on 

file. For that reason, this study focused 

on such loans. 

When this study commenced in 

the Summer of 1992, the FDIC held 

approximately 6,000 nonperforming 

commercial real-estate loans in 

herited from failed banks and thrift 

institutions. A random sample of ap 

proximately 400 loans was selected, 

with the only constraint that they be 

evenly distributed regionally. The 

FDIC liquidation specialist in charge 

of monitoring each loan at the ap 

propriate field office obtained the ap 

praised value of the collateral and 

related information at the time of loan 

origination. 

In addition, the liquidators were 

asked to provide the most current in 

formation available on each loan: cur 

rent loan balance, type of collateral, 

and current appraised value. Ap 

praised values were provided by inde 

pendent fee appraisers, who were 

asked to value the properties in accor 

dance with industry market-value 

appraisal standards. That is, value 

was defined as the price that was 

estimated to hold in functioning 

markets under normal sale conditions 

— rather than in the case of forced 

liquidation or distressed sale. Com 

plete information on 224 commercial 

real-estate loans was received. 

Study Results 

The loss of collateral value was 

measured by the ratio of current ap 

praised value to the original value es 

timated by the bank at the time of 

loan origination. If the current valua 

tion is accurate, this ratio could be 

less than one for either (or both) of 

two reasons. First, economic condi 

tions may have caused the value of the 

commercial properties to decline. Al 

ternatively, valuations at the time of 

loan origination may have been too 

high. On average for the 224 loans 

reviewed, the current value of the col 

lateral was just over one-half (54 per 

cent) of the valuation at the time the 

zSee7fo Rt/sseft-NCREIFRealEstate Perfor 

mance Report, published by the National Coun 

cil of Real Estate Fiduciaries and the Frank 

Russell Co., Tacoma, WA, various issues. 

28 
Commercial Real-Estate Problems 

Chart 3 

Loss of Collateral Value on FDIG-Managed 

Real-Estate Loans 

Percent of Sample 

35 

30 

25 

20 

15 

10 

5 

0 

0-.a5 .E6-.50 .51-.75 .78-1,0 Greater Irian 1.0 

Ratio of Current Value to Original Value 

Table 1 

Loss of Collateral Value on 

FDIC-Managed Real-Estate Loans 

Users1 Note: Results are from a sample of nonperforming loans managed by ihe FDIC's Division of Liquida 

tion. Permanent financing includes loans with a term to maturity greater than 5 years. "Mini-Perm" includes 

loans with maturities of lets than 5 years. Both categories refer to loans noi specifically designated for ihe pur 

pose of constructing, teal estate. 

Table 2 

Loss of Collateral Value on 

FDIC-Managed Real-Estate Loans 

Users' Note; Results are from a sample ofnonpciforaiing loans managed by Ihe FDlC's Division of Liquida 

tion. Commetcial/Industrial calcgory includes hotels and motels. Retail category includes "mini-warehouse" 

self-storage facilities. 

loan was originated. As shown in 

Chart 3, the current collateral value 

was at least 25 percent below the 

original evaluation for three-quarters 

of the loans. In almost one-half of the 

cases, the collateral lost at least 50 

percent of its assigned value. In con 

trast, only 7 percent of the collateral 

appreciated in value after the loan 

was originated. 

The study also examined whether 

any loan types resulted in greater los 

ses than others. Loans were divided 

into three basic categories. Construc 

tion loans were identified separately. 

Other loans were divided between 

mini-perms (defined in this study as 

having maturities of five years or less) 

and permanent (longer-term maturity) 

loans. The average loss of collateral 

value did not differ significantly among 

categories (see Table 1). On average, 

permanent loans experienced more loss 

of value than other types of loans. 

However, many construction loans 

suffered severe loss of value, with the 

current collateral values of one-fourth 

of the loans being less than 22 percent 

of the original estimated value. This 

result is not unexpected because col 

lateral values for construction loans 

typically are projected values of the 

finished project rather than the valua 

tion of an existing structure under con 

temporaneous market conditions. 

As shown in Table 2, the real-es 

tate collateral that secured the loans 

ranged from office buildings to unim 

proved land. The differences in loss of 

collateral value among different types 

of real estate were not striking. Land 

loans, which were the most common 

type examined, experienced an average 

loss of 47 percent somewhat more 

than the average for the total sample. 

Land loans also had the largest con 

centration of catastrophic losses, with 

one-fourth of the properties currently 

valued at less than 19 percent of the 

comparable figure at time of origina 

tion. Mixed-use projects held their 

value the best, on average losing only 

32 percent of value. 
FDIC Banking Review 

Regional Differences 

A question often posed is whether 

losses to the FDIC on real-estate 

loans are worse in real-estate markers 

that are highly depressed. A poorly 

underwritten loan can lose money 

under any circumstance, but prosper 

ous real-estate markets can at least 

partially mask bad decisions. Eighty 

percent of the loans in the sample 

financed real-estate ventures in seven 

stares; statistics describing their change 

in value are shown in Table 3. 

In states that have experienced 

serious commercial real-estate prob 

lems, collateral values generally have 

sustained the largest losses. Looking 

at the median loss, one-half of the 

loans in Connecticut lost 63 percent or 

more of their original valuation. Like 

wise, one-half of the properties in 

Texas and Louisiana lost at least 58 

percent of their value since loan origin 

ation; in Oklahoma the median loss of 

value was .S3 percent. In contrast, for 

California and Florida — %vhere 

downturns in commercial real estate 

during the sample period were not as 

severe and extended the median 

loss in value was 30 percent and 34 

percent of original appraised value, 

respectively. 

Cost to the Bank Insurance 

Fund 

One measure of the FDIC's loss 

exposure on such loans is the differ 

ence between the current loan balance 

and the current value of the collateral. 

In more than 60 percent of the loans 

studied, the current balance exceeded 

Table 3 

Loss of Collateral Value on 

FDIC-Managed Real-Estate Loans 

Texas 

Massachusetts 

Louisiana 

Oklahoma 

Florida 

Connecticut 

California 

the value of the collateral. In aggregate, 

the current value of the collateral only 

covered $49.8 million of the $125.3 

million in loan balances, a loss rate of 

60 percent before foreclosure costs. If 

the cost of collection were considered, 

or if uncollected but accrued interest 

were added to the loan balance, the 

proportion of loans imposing losses on 

the FDIC — and the cost of such 

losses would be even higher. 

Conclusions 

A randomly drawn sample taken 

from almost 6,000 nonperforming 

commercial real-estate loans being 

resolved by the FDIC shows that 

most of the collateral backing such 

loans currently is valued far below the 

original value assigned to them when 

the loans were made. In fact, the 

sample suggests that collateral values 

are commonly less than current loan 

Ratio of Current Value 

balances by a substantial amount in 

the aggregate, completely mitigating 

the protection that the collateral was 

designed to provide. 

On the one hand, the fact that the 

FDIC inherited these assets suggests 

they were of poor quality, poorly un 

derwritten, or both. This implies that 

the declines in collateral value that 

occurred were not necessarily typical 

of bank real-estate loans. On the other 

hand, they illustrate the risk that in a 

severe real-estate downturn many real

sstate assets can, and do, lose substan 

tial value. When a bank fails, the Bank 

Insurance Fund looks toward the 

market value of the failed bank's as 

sets to offset the deposit insurance 

claims it has paid. Declining col lateral 

values of the magnitude suggested by 

the sample in this study therefore 

contribute substantially to the FDIC's 

insurance losses. 

3C 
Recent Developments 

Recent Developments 

Affecting Depository 

Institutions 

by Benjamin B. Christopher* 

Regulatory Agency Actions 

Inter-Agency Actions 

Federal Bank and Thrift 

Regulatory Agencies' 

Joint Actions 

The federal bank and thrift regula 

tory agencies are engaging in joint or 

coordinated efforts in a number of 

regulatory areas that are mentioned 

specifically in this issue of the Review, 

among which are: "prompt corrective 

action," real-estate lending standards, 

real-estate appraisals, enforccmenr of 

fair lending laws, enforcement of 

money-laundering laws, programs for 

increasing credit availability, "fair 

value" disclosures, and reducing reg 

ulatory burden. 

See the discussions under the 

headings of the individual agencies 

and the Federal Financial Institutions 

Examination Council (FFIEC). 

Federal Deposit Insurance 

Corporation 

Recapitalization Schedule 

for the BIF; Adequacy of 

Assessment Rates 

The KDIC is revising its existing 

schedule for increasing the reserve ratio 

of the Bank Insurance Fund (BIF) to 

the designated reserve ratio of 1.25 

percent. Under Section 7{b) of the 

FDI Act, the Board must set semian 

nual assessment rates for BIF mem 

bers in accordance with the BIF 

recapitalization schedule promulgat 

ed by the FDIC. The FDIC is retain 

ing the current assessment tates 

applicable to members of the BIF and 

members of the Savings Association 

Insurance Fund (SAIF) for the semi 

annual period beginning July 1, 1993. 

The current assessment rates range 

from 23 cents to 31 cents per $100 of 

domestic deposits, depending on the 

institution's risk classification. 

When the FDIC adopted the orig 

inal BIF recapitalization schedule and 

set assessment rates for BIF and SAIF 

members in September 1992, the 

Board agreed to monitor the schedule 

and the adequacy of assessment rates 

over six-month intervals. Since then 

the condition of the banking and thrift 

industries has continued to improve, 

although ateas of concern remain. 

The FDIC's assumptions affecting 

each fund's projected balance have 

been revised accordingly. In particu 

lar, the short-term projected annual 

level of failed-bank and -thrift assets 

has been lowered. Also, the loss rate 

relative to failed-bank and -thrift as 

sets has been lowered. By main 

taining current deposit insurance 

assessment rates, the FDIC projects 

that the BIF will be recapitalized 

by the year 2002, rathet than 2006 as 

projected last September. Although a 

lower average assessment rate would 

recapitalize the BIF over the original 

15-year period {i.e., by 2006), the 

Board believes that even at current 

assessment rates the BIF's ratio of 

reserves to insured deposits would 

remain below the statutorily required 

1.25 percent target for nine years. The 

Board also believes that if it is possible 

to recapitalize the BIF sooner than 15 

years without placing an undue bur 

den on the industry, it is in the public 

interest to do SO. FIL-Z6-93,FD1C,4/I3i93; 

FR, 4/5, p. 17533; 6/1, p. 31150. 

BIF First Quarter 1993 

Financial Results 

As of March 31, 1993, the BIF 

amounted to $1.2 billion, up from a 

negative $101 million at year-end 

1992 (preliminary figures), and a neg 

ative $7.0 billion at year-end 1991. 

The increases reflected net income to 

the Fund of $1.3 billion in the first 

quarter and $6.9 billion in the year 

1992. 

Reporting fot 1992, the FDIC said 

that a favorable interest-rate environ 

ment for banks, and other economic 

conditions, were the primary reasons 

for the BIF's improved results. These 

conditions resulted in a lower project 

ed loss from future bank failures and 

a reduction in the estimated loss from 

past bank failures. The Fund's losses 

from banks that failed in 1992 totaled 

$4.7 billion and teserves previously 

established for specific failures ex 

ceeded the losses the FDIC expects 

"Benjamin 8. Christopher is a financial 

economise in ihe FOIC's Division of Rescaich and 

Starisiics. 

Reference sources: American Banter(Mi); Wall 

Slrcet Journal{WHD; UNAS Banting Report (BBR); 

and Federal Register (FR). 

31 
FDIC Banking Review 

CO incur. These and other factors re 

sulted in a net reduction of $5.5 billion 

in the amount set aside at year-end 

1992 to absorb the costs of banks that 

are expected to fail, to $10.8 billion 

from the $16.3 billion at year-end 

1991. Loss reserves were further re 

duced to $10.6 billion as of March 31, 

1993. 

Failures of insured banks in the 

first quarter of 1993 totaled only 

seven, compared to 122 in the year 

1992 and 127 in 1991. Assets of the 

institutions that failed in 1992 were 

$44.2 billion, and in the first quarter 

of 1993 were $731 million. Summary 

FinancialManagement Report, FirstQuarter 1993, 

FDIC; PR-43-93,514193. 

Risk-Related Assessments 

The FDIC is required to establish 

a system, effective January 1, 1994, 

wherein insured institutions will pay 

deposit insurance assessments ac 

cording to the risks to the insurance 

fund from the institution. The FDIC 

proposed to amend its assessments 

regulation to establish a new riskrelated premium assessment system. 

Under the proposed system, as under 

the transitional assessment system 

(see this Review, Fall/Winter 1992, p. 

34), depository institutions would be 

assigned to one of nine assess 

ment classifications. The assessment 

rate applicable to each classification 

would remain unchanged from the 

rate in effect under the transitional 

system. FIL-1-93, FDIC, f/lf/93; FR, 

12131192, p. 62503. 

The FDIC approved revisions to 

the "transitional" risk-related pre 

mium system adopted in September 

1992 to provide a transition between 

the previous flat-rate system and the 

risk-related system that must be im 

plemented in accordance with the 

FDIC Improvement Act of 1991 

(FDICIA). The revisions arc effec 

tive October 1, 1993, for the assess 

ment period beginning January 1, 

1994, and are those proposed in 

December 1992, with minor modi 

fications. FIL-48-93, FDIC, 7/2/93; FR, 6/25, 

p. 34357, 

Assistance to Operating 

Insured Depository 

Institutions 

The FDIC adopted a revised pol 

icy, largely reflecting changes man 

dated by FDICIA, on the criteria the 

agency will follow in considering re 

quests for financial assistance from in 

stitutions in danger of failing. These 

include a possibility of "early resolu 

tion" of institutions that are troubled 

and the requirement that failing insti 

tutions generally be resolved in the 

manner that is the least costly to the 

deposit insurance fund. The latter 

means that the FDIC Board can grant 

open assistance only if that option 

would be more cost-effective than re 

solving the institution if and when it 

closes. The revised policy statement 

also addresses provisions of FDICIA 

that require the FDIC to make certain 

findings with respect to the ongoing 

management of the institution. 

The revised policy statement 

stresses the importance of the timing 

of requests for assistance, and the 

FDIC is encouraging an institution's 

management to submit any proposals 

for open assistance "well before 

grounds first exist for the institution's 

closure." 

The FDIC receives many requests 

for open assistance but rarely grants 

this aid, A total of 75 banks have 

received open assistance since the 

authority first was used in 1981. Open 

assistance has become more rare as a 

result of statutory and other changes 

that enhanced the FDIC's options for 

dealing with problem institutions, 

such as bridge bank authority. There 

have been no assistance transactions 

thus far in 1993. Only two were ap 

proved in 1992 and three in 1991, with 

none of the banks exceeding $30 mil 

lion in total assets. PR-no-92, FDIC 

12/8/92; FR, 12/18, p. 60203; FIL-3-93, FDIC, 

1/13/93. 

Prompt Corrective Action 

The FDIC approved a final rule, 

effective December 19, 1992, imple 

menting a requirement of FDICIA that 

the banking regulators take specified 

"prompt corrective action" when an 

insured institution's capital falls to 

certain levels. On January 26, 1993, 

additional regulations were approved 

that concern applications to conduct 

certain activities or to seek exceptions 

from certain restrictions. The Board of 

Governors of the Federal Reserve Sys 

tem (FRB), the Office of the Comp 

troller of the Currency (OCC), and the 

Office of Thrift Supervision (OTS) 

have adopted final PCA rules. 

The statute provides a framework 

of supervisory actions based on the 

capital level of an insured depository 

institution. It establishes five capital 

categories, ranging from "well-capi 

talized" to "critically undercapital 

ized." The federal banking agencies 

are required to specify, by regulation, 

the levels at which an institution 

would be within each of these five cate 

gories. The law requires an insured in 

stitution to submit a capital restoration 

plan when it becomes undercapital 

ized. Certain activities are subject to 

restrictions or prohibitions, which be 

come more severe as an institution's 

capital level declines, beginning with 

measures such as restrictions on divi 

dends and management fees (if the 

payments would result in the institu 

tion becoming undercapitalized), and 

ultimately ending in the closing of 

institutions that are critically under 

capitalized. The stated purpose of the 

PCA provisions is to resolve the prob 

lems of insured depository institutions 

at the least possible long-term loss to 

the deposit insurance fund. 

Under the FDIC's final rule, a 

"well-capitalized" institution is de 

fined as having a total risk-based capi 

tal ratio (the ratio of total capital to 

risk-weighted assets) of at least ten 

percent, a Tier 1 risk-based ratio (the 

ratio of Tier 1 or "core" capital to 

risk-weighted assets) of at least six 

percent, a leverage ratio (the ratio of 

Tier 1 capital to total assets) of at least 

five percent and is not subject to any 

written agreement, order or directive 

from the FDIC to meet and maintain 

a specific capital level. A "critically 
Recent Developments 

undercapitalized" institution has a 

"tangible equity"-to-total assets ratio 

of two percent or less. Tangible equi 

ty combines elements of core capital 

and cumulative perpetual preferred 

stock, minus all intangible assets ex 

cept for limited amounts of purchased 

mortgage servicing rights. The ratio 

for this capital category is specified in 

the statute. 

A procedure is established for an 

institution to notify the appropriate 

agency if any event occurs that would 

cause a reclassification of the institu 

tion to a lower capital category. Under 

the bank regulatory agencies'uniform 

procedures, an institution will gener 

ally be provided advance notice when 

the appropriate agency proposes that 

the institution take one or more of the 

actions committed to agency discre 

tion under Section 38. The final rules 

also implement the statutory require 

ment that officers and directors dis 

missed as a result of an agency order 

issued under Section 38 be afforded 

agency review of the dismissal, in 

cluding an opportunity for an infor 

mation hearing. FIL-70-92,10/5/92; 12-93, 

2/22/93; FR, 9/29/92, p. 44866; 2/12/93, p. 8210. 

Safety-and-Soundness Rule 

Proposed 

The FDIC proposed a rule, under 

Section 132 of FDICIA, that would 

require insured depository institutions 

to meet general safety-and-soundness 

standards in several regulatory areas. 

An insured depository institution or 

company that fails to meet any of the 

prescribed standards would have to 

submit and implement an acceptable 

plan to achieve compliance. Failure to 

submit or implement such a plan within 

the time allowed would result in an 

order to correct the deficiency. 

The FDIC and the three other fed 

eral bank and thrift regulatory agencies 

issued an advance notice of proposed 

rulemaking in July 1992 (see this Re 

view, Fall/Winter 1992, p. 35). The 

proposed standards do not represent a 

change in the agencies' policies. These 

standards instead formalize the fun 

damental standards already used by 

the FDIC when supervising institu 

tions. PR-65-93, FDIC, 6/9/93. 

Capital Standards 

The FDIC will seek comment, 

pursuant to Section 305 of FDICIA, 

on revisions to its capital rules to en 

sure that banks measure and monitor 

their interest-rate risk and maintain 

capital adequate to the risk. In August 

1992, the three bank regulatory agen 

cies issued a proposal (see this Review, 

Fall/Winter 1992, p. 36). 

An institution's exposure to inter 

est-rate risk would be measured by 

the change in its capital that occurs as 

interest rates change, using a supervi 

sory model. Internal models could be 

used for this purpose when available 

and approved during the bank exam 

ination process. For institutions that 

have high levels of interest-rate risk, 

alternative methods are proposed for 

determining what amount of additional 

capital, if any, a bank may be required 

to have for such risk. To limit paper 

work and other burdens on the indus 

try, the agencies would exempt banks 

that are potentially low-risk from addi 

tional reporting requirements. PR-66-93, 

FDIC, 6/9/93. 

The FDIC proposed revisions, 

pursuant to Section 305 of FDICIA, 

to its capital rules under which the 

concentration of credit risk and the 

risks of nontraditional activities as 

well as an institution's ability to man 

age these risks would be specifically 

cited as important factors in assessing 

an institution's overall capital ade 

quacy. No mathematical formulas or 

explicit capital requirements for these 

risks are incorporated in the proposal. 

PR-52-93, FDIC, 5111193. 

The FDIC amended its risk-based 

capital guidelines, effective Decem 

ber 31, 1992, to lower from 100 percent 

to 50 percent the risk-weight assigned 

to certain loans to builders to finance 

the construction of presold l-to-4 

family residential properties. To qualify 

for the lower risk-weight, such loans 

must be first liens, must be made in 

accordance with prudent underwrit 

ing standards, and must not be past 

due 90 days or more or carried in nonaccrual status. Among other criteria, 

the loans to builders will be consid 

ered prudently underwritten only if 

the bank has obtained sufficient doc 

umentation that the buyer of the 

home intends to purchase the home, 

and has the ability to obtain a mort 

gage loan sufficient to purchase the 

home. FR. 3/3/93, p. 12149; FIL-19-93, 

3/19/93. 

The FDIC adopted amendments, 

effective March 1, 1993, concerning 

intangible assets under its capital 

maintenance regulation. Limited 

amounts of purchased mortgage ser 

vicing rights (PMSRs) and purchased 

credit-card relationships (PCCRs) 

may be recognized for purposes of 

calculating Tier 1 capital under the 

FDIC's leverage capital and riskbased capital standards. However, all 

other intangible assets, including 

goodwill and core deposit intangibles, 

will continue to be deducted in deter 

mining the amount of Tier 1 capital. 

The aggregate amount of PMSRs and 

PCCRs that may be recognized for 

regulatory capital purposes will be 

limited to no more than 50 percent of 

Tier 1 capital. Certain other condi 

tions and restrictions will also apply. 

The FDIC's action was coordinated 

with the staffs of the other federal 

banking agencies in an effort to 

achieve convergence in the way in 

tangibles are treated by the agencies 

for regulatory capital purposes. PR-2

93, FDIC, 1/12/93; F1L-8-93, 2/4; FR, 1/28, p. 

6363. 

Guidelines for Bank 

Directors and Officers 

The FDIC issued a statement in 

tended to clarify the duties of bank 

directors and officers and to outline 

[he factors the FDIC considers before 

filing a personal liability lawsuit after 

a bank fails. The FDIC said it will not 

bring civil suits against those who ful 

fill their responsibilities "and who 

make reasonable business judgments 

on a fully informed basis and after 

proper deliberation." Lawsuits only 

follow "detailed investigations" by 

the FDIC, are approved by the 

agency's Board of Directors, and "are 

not brought lightly or in haste." 

33 
FDIC Banking Review 

The statement recognizes the im 

portance of having knowledgeable 

and responsible bank directors and 

officers, especially when an insured 

institution becomes troubled. How 

ever, the statement also stresses that 

directors and officers have numerous 

responsibilities, including "duties of 

loyalty and care," that the FDIC 

expects will be carried out. The state 

ment notes that "directors must re 

quire and management must provide 

the directors with timely and ample 

information to discharge board re 

sponsibilities." FDIC lawsuits are 

authorized only if a breach of duty is 

uncovered. The guidelines also com 

ment on the differences in the way 

the FDIC analyzes claims against in 

side directors versus those against out 

side directors, and recognizes that 

outside directors generally do not par 

ticipate in the day-to-day business 

operations of the bank. The most 

common suits brought against outside 

directors involve "insider abuse" 

(such as preferential loans or con 

tracts) and the failure to implement 

corrective measures after being warned 

of problems at the bank. PR-166-92, FDIC, 

1214192; FIL-87-92, FDIC, 12117. 

"Gross Negligence" Rejected 

as the Standard in D&O 

Liability 

The U.S. Supreme Court let stand 

a ruling by a U.S. appeals court 

(McSweeney v. FDIC, 6/1/93) which 

rejected "gross negligence" as a stan 

dard in suits involving personal liabi 

lity of bank directors and officers. The 

issue of whether simple or gross neg 

ligence is the standard centered on 

the intetpretation of Section 212(k) of 

FDICIA. BBR, 617193,p. 854. 

Real-Estate Lending 

Standards 

The FDIC, FRB, OCC, and OTS 

adopted a final uniform rule on realestate lending by insured depository 

institutions, effective March 19, 

1993, implementing Section 304 of 

FDICIA. The rule prescribes standards 

that require each insured depository 

institution to adopt and maintain 

comprehensive written real-estate 

lending policies that are consistent 

with safe-and-sound banking prac 

tices. The policies must address cer 

tain lending considerations, including 

loan-to-value limits, loan administra 

tion procedures, portfolio diversifica 

tion standards, and documentation, 

approval, and reporting requirements. 

The policies also must be appropriate 

to the size of the institution and the 

nature and scope of its operations, and 

must be reviewed and approved by 

the institution's board of directors at 

least annually. The policies adopted 

by the institution also should reflect 

consideration of the Interagency 

Guidelines for Real-Estate Lending 

Policies established by the agencies in 

conjunction with the final rule. FtL-2

93, FDIC, 1/12/93; FR, 12/31192, p. 62890. 

Affordable Housing 

The FDIC will provide assistance 

for the purchase of certain affordable 

single-family homes in its inventory 

of properties retained from failed in 

stitutions. This will implement pro 

visions of FDICIA requiring the 

FDIC to establish an affordable hous 

ing program, to operate for three 

years, in connection with the agency's 

disposition of property. Last Fall, 

Congress appropriated $5 million for 

the FDIC's affordable housing pro 

gram. These funds will be used to 

provide discounts and rebates to lowand moderate-income home buyers 

and to administer the program. The 

FDIC estimates that about 1,500 sin 

gle-family residential properties in its 

nationwide inventory are available 

under the affordable housing pro 

gram. The properties include singlefamily detached homes (including 

l-to-4 unit residential properties), 

condominiums and townhouses. 

Qualified purchasers include lowand moderate-income buyers, non-pro 

fit organizations and government 

agencies, 

Upon acquiring the property as re 

ceiver, the FDIC will restrict the sale 

of qualified properties to low- and 

moderate-income buyers for 180 days. 

After 180 days, properties can be sold 

to anyone. Rebates and discounts will 

be limited to ten percent of the pur 

chase price. FDIC assistance can be 

used in one or more of several speci 

fied ways. PR-159-92, FDIC, 11/20/92. 

Enforcement of Fair Lending 

Laws 

FDIC Acting Chairman Andrew C. 

Hove, Jr., announced two actions in 

tended to strengthen the monitoring 

and enforcement of fair lending laws 

at commercial and savings banks su 

pervised by the agency. At the di 

rection of Chairman Hove, a Fair 

Lending Working Group of seniorlevel staff from around the country 

has been appointed to analyze the 

FDIC's existing programs and proce 

dures for preventing, detecting and 

correcting discriminatory credit prac 

tices. The FDIC also has revised the 

procedures its examiners must follow 

in monitoring a bank's adherence to 

the Fair Housing Act of 1968 (FHA), 

which prohibits discrimination in 

making loans involving housing be 

cause of race, color, religion, sex, 

national origin, familial status or 

handicap. Examiners are being given 

more specific direction and guidance 

in three basic areas: collecting and 

evaluating various information; ana 

lyzing samples of approved and de 

nied loans and loan applications for 

possible signs of discrimination; and 

reaching conclusions about the in 

stitution's compliance with the fair 

housing and equal credit opportunity 

laws. 

There are now 250 field examiner 

positions plus an Assistant Regional 

Director and examination review staff 

in each of the FDIC's eight regional 

Division of Supervision offices, with 

specific responsibility for compliance. 

Also, there are staff in each regional 

office whose primary mission is to 

promote a better understandingof fair 

lending laws through outreach to 

bankers, local citizens, government 

officials and others. PR-44-93. FDIC, 

5/5193. 
Recent Developments 

Advance Notice by Banks 

of Branch Closings 

The FDIC issued a proposal to im 

plement Section 228 of FDICIA 

which, in general, requires an insured 

institution to give its federal regulator 

a90-day advance notice of a proposed 

branch closing, including a detailed 

statement: of the reasons for closing 

the branch and any supporting infor 

mation. The law also requires a mail 

ing at least 90 days before the branch 

closing, and a conspicuous notice at 

the branch at least 30 days prior to the 

proposed closing. bank that tempo 

rarily operates a branch of a failed 

bank or savings association but does 

not purchase or lease the branch 

would be excluded from the advance 

notice requirements if it closes the 

branch before the end of any contrac 

tual option with the FDIC to retain 

the branch. One reason for the pro 

posed policy is to encourage acquirers 

that are unsure about the future status 

of a branch to keep it open temporari 

ly rather than close it immediately for 

fear of triggering the 90-day advance 

notice requirements. 

The FRB, OCC, and OTS already 

have proposed similar policies for the 

institutions they regulate. The FDIC 

also is asking for public comment on 

whether the advance notice require 

ments should apply to closings of au 

tomated teller machines and certain 

branch relocations. The agency's pro 

posal on branch closings would apply 

to each state nonmember bank with 

one or more branches. If an FDIC-su

pervised bank has no branches, it 

would be required to adopt a policy 

for branch closings before establish 

ing its first branch. PR-142-92, FDIC, 

IOI13I92;FR, 10//9.p. 47657. 

Final Rule for Outside 

Audits of Insured Banks 

and Thrifts 

The FDIG adopted regulatory re 

quirements and interpretive guide 

lines, implementing provisions of 

FDICIA, to require each insured in 

stitution over the threshold set by the 

FDIC total assets of $500 million 

or more to have an annual audit of 

its financial statements by an inde 

pendent public accountant. Also, 

each institution subject to the audit 

requirements is required to establish 

an audit committee composed en 

tirely of outside directors who must 

review the annual audit findings with 

management and the outside accoun 

tant. Any change in an outside auditor 

also by law must be brought co the 

attention of the FDIC. 

The new audit and reporting re 

quirements, effective July 2, 1993, will 

apply to about 1,000 of the approxi 

mately 14,000 FDIC-insured banks 

and thrifts, with about 75 percent of 

combined industry assets. Among the 

information that the annual report 

must contain is: an assessment by the 

institution's management of the ef 

fectiveness of its internal controls for 

financial reporting and its compliance 

with safety-and-soundness laws and 

regulations. The law mandates that 

"large institutions," defined by the 

FDIC as those having $3 billion or 

more in total assets, have more strin 

gent requirements for their audit 

committees. There are an estimated 

240 of these institutions. For these 

banks and thrifts, the audit commit 

tee must include at least two mem 

bers with banking or related financial 

management expertise, "large custo 

mers" with significant credit or other 

relationships are prohibited from 

serving on the audit committee, and 

the committee must have access to its 

own outside counsel independent of 

management. 

About 96 percent of the institu 

tions with $500 million or more in 

assets are known to already engage an 

independent public accountant to 

perform annual audits, while the rest 

use independent accountants for 

more limited audit work. Therefore, 

the new rule and the use of the guide 

lines approach should not impose 

undue burdens on the affected insti 

tutions. The FDIC is urging all in 

sured institutions to voluntarily have 

audits by independent public accoun 

tants and establish audit committees. 

PR-40-03. FDIC, 5/11/93; FR, 6/2, p. 31332. 

Restrictions on StateChartered Banks 

The FDIC approved final rules, 

effective December 9, 1992, im 

plementing provisions of FDICIA re 

stricting the ability of state-chartered 

banks to own corporate stock and mu 

tual fund shares, and to have equity 

ownership in investments such as realestate development projects. FDICinsured state banks will be under the 

same restrictions on equity invest 

ments, whether they are members of 

theBIForthcSAIF. 

FDICIA prohibits insured statechartered banks from making equity 

investments of a type or amount not 

permitted for national banks, and man 

dates divestiture of these investments 

by December 19, 1996. However, the 

law provides a partial exception for 

stock and mutual fund ownership by 

an institution meeting certain condi 

tions. An institution that meets the 

conditions can retain or acquire newqualifying stock or mutual fund own 

ership if it notifies the FDIC of its 

intention and receives the agency's 

approval. FDICIA states that a bank 

receiving FDIC approval to continue 

making stock or mutual fund equity 

investments will be subject to an ag 

gregate maximum limit equal to the 

institution's capital. An institution that 

holds prohibited equity investments 

is required to submit to the FDIC a 

plan to divest such holdings as quickly 

as can be prudently done. 

Under the new regulations, a bank 

that was lawfully engaging in insur 

ance underwriting on November 21, 

1991, or a bank that had a subsidiary 

that was lawfully underwriting insur 

ance on that date is exempt from a 

general prohibition in FDICIA on in 

surance activities but must give no 

tice to the FDIC. Notice procedures 

are specified which institutions must 

follow if they wish to continue the 

insurance activities. PR-147-92, FDIC, 

10127192; FR, I'1/6, p. 53211'. 

The FDIC proposed a second 

phase of new statutory restrictions on 

the activities of insured state-chartered 

banks. The regulation, which went into 

effect Dccembcr9, 1992, primarily 

35 
FDIC Banking Review 

relates to a ban on certain equity in 

vestments. The FDIC Board now is 

proposing a rule that would establish 

procedures and criteria for state banks 

to seek approval to engage in other 

wise prohibited activities. The FDIG 

proposal would clarify that the law 

does not impose new restrictions on 

activities where the bank is not acting 

"as principal" (i.e.r, the bank is acting 

as an agent for a customer). This 

means there would be no change in a 

state bank's ability to operate insur 

ance agencies, securities brokerage 

firms, real-estate agencies, travel 

agencies, financial planning services 

or certain other agencies if authorized 

by state law, even if national banks 

cannot engage in these activities. 

FDICIA prohibits a state bank from 

engaging as principal in an activity 

either directly or through a majorityowned subsidiary that is not permissi 

ble for a national bank unless the bank 

meets its minimum capital require 

ments and the FDIC determines that 

the activity does not present a signi 

ficant risk to the insurance funds. The 

proposal includes a tentative list of 

activities that would not present a sig 

nificant risk to the funds, including 

certain guarantee activities (such as a 

credit-card program in which a bank 

guarantees the obligations of its retail 

banking customers), activities that are 

"closely related to banking" (as de 

fined by the FRB), and securities ac 

tivities conducted in a subsidiary. 

PR-1-93, FDIC, 1112193; FIL-9-93, 2/4; FR, 

1129193, p. 6448. 

The FDIC requested comment on 

whether to amend its regulations gov 

erning insurance underwriting by 

well-capitalized insured state banks 

and their subsidiaries to provide that 

excepted insurance underwriting ac 

tivities may only take place in the 

state in which the bank is chartered 

and in the state in which the bank's 

insurance underwriting subsidiary 

is incorporated. The result of this 

change would be to narrow the excep 

tion for insurance underwriting activ 

ities. FR, 4129193, p. 25953. 

Applications by Savings 

Associations 

The FDIC proposed amendments 

concerning applications and notices 

by savings associations, relating to the 

definitions of "significant risk" and 

"equity security." Insured state sav 

ings associations would be allowed to 

conduct activities and make invest 

ments without the FDIC's prior ap 

proval provided that the activities 

and/or investments were found by the 

OTS to be permissible for federal sav 

ings associations. This change would 

also place insured state savings associ 

ations on a par with the treatment 

accorded insured state banks under 

the FDIC's regulations. F/L-37-93, 

FDIC, 5114193; FR, 5/3, p. 26259. 

Insurance Rules on Employee 

Benefit Plans 

The FDIC approved final deposit 

insurance rules, implementing Sec 

tion 311 of FDICIA, affecting cer 

tain individual retirement accounts 

(IRAs), self-directed Keogh accounts 

and other self-directed employee 

benefit plan accounts. 

Among the several rule changes 

are: a) Retirement account coverage: 

As specified in FDICIA, effective 

December 19, 1993, an individual's 

deposits at the same institution in any 

combination of IRAs, self-directed 

Keogh Plan accounts, "457 Plan" 

accounts, and self-directed defined 

contribution plan accounts will be 

protected by federal insurance up to 

$100,000 in the aggregate. This is 

a reduction from the maximum of 

$400,000 in insurance coverage now 

provided for deposits in these four 

types of retirement plan accounts. 

The existing insurance coverage 

remains in effect for certain time 

deposits under grandfather provisions; 

b) "Pass-through" insurance: The new 

law also continues "pass-through" in 

surance coverage for most employee 

benefit plans (i.e., $100,000 per indi 

vidual participant, not $100,000 per 

plan). However, certain employee 

benefit plan accounts kept in under 

capitalized institutions and other in 

stitutions notauthorized by the FDIC 

to accept brokered deposits will be 

covered only up to $100,000 per plan, 

not $100,000 per participant. FDICIA 

made this provision of the law effec 

tive December 29, 1992. 

Each insured institution is re 

quired to inform customers of the new 

rules in a one-time mailing by Octo 

ber 10, 1993, using a brief notice de 

veloped by the agency. Institutions 

are being given the option of mailing 

the notice to all depositors or only 

those customers who have the types 

of accounts affected by the rule chan 

ges. PR-51-93, FDIC, 5/11193; FR, 5/25, p. 

29952. 

Excess Deposit Insurance 

General Reinsurance Corporation 

will offer insurance policies to cover 

bank deposits in excess of the 

$100,000 general limit on FDIC 

deposit insurance. The policies, to be 

sold by a subsidiary of General Rein 

surance, will cost 25 to 30 cents per 

$100 of deposits insured, or $500 to 

$600 a year for the minimum $200,000 

policy. customer wishing to know if 

the insurance is available for deposits 

in a particular institution would obtain 

this information and apply for cover 

age through a local insurance agent. 

The program could be of use particu 

larly to depositors such as professional 

persons who hold funds in escrow for 

clients, small companies that need to 

keep more than $100,000 in an ac 

count, for example, to meet payrolls, 

or to savers with money held in 

higher-yielding certificates of de 

posit. The risks to the insurer are con 

trolled by limiting the coverage to $5 

million in any one bank, a ceiling 

which may be increased as the pro 

gram grows, and limiting the term of 

policies to six-month periods, subject 

to nonrenewal if an institution gets 

into difficulty. Under state insurance 

rules the policies appear not to be 

available at present to residents of 

seven states, including New York, 

California and Florida. The New York 

Times, 3110193,p. D4;AB, 3115, p. 15. 

Deposit insurance in excess of the 

FDIC's limit of $100,000 per deposi 

tor is now available to banks in Kansas 

through Kansas Bankers Surety Co., 

which has offered banks a variety of 

36 
Recent Developments 

crime insurance policies since 1922. 

Premiums for excess deposit insur 

ance are paid by the bank, which also 

determines which large deposit ac 

counts are to be insured by the insur 

ance company. Bank News, 6193, p. 26. 

Erroneous Information About 

FDIC Insurance Coverage 

The FDIC, OCC, FRB, and OTS 

issued an advisory to insured banks 

indicating the agencies' concern that 

bank and thrift employees when 

asked by depositors may sometimes 

be providing erroneous information 

about deposit insurance coverage. The 

agencies are encouraging all institu 

tions to make certain that their em 

ployees, especially those who have 

front line contact with depositors, have 

an understanding of federal deposit 

insurance to ensure that customers are 

accurately informed about coverage. 

basic source of information is the 

FDIC's "Your Insured Deposit," a 

pamphlet that helps explain the limits 

on FDIC coverage and circumstances 

where coverage over $100,000 is pro 

vided. Institutions are reminded that 

FDICIA made certain changes in de 

posit insurance coverage, effective 

1992 and 1993, mostly in the area of 

pension and other employee benefit 

plan accounts. These changes (see 

above) were explained in the FDIC's 

letter to all insured institutions dated 

November 6, 1992 (FIL-78-92). FlL-i-93, 

FDIC, 2/3/93. 

Among other educational activities 

in this area, the FDIC is starting a 

quarterly newsletter that will address 

deposit insurance questions. 

Environmental Liability 

The agency issued guidelines to 

FDIG-supervised commercial and 

savings banks advising that the insti 

tutions should have in place appropri 

ate safeguards and controls to limit 

exposure to potential environmental 

liability associated with real property 

held as collateral. The guidelines con 

tain information and recommendations 

about implementing an environmen 

tal risk program that can be tailored to 

the needs of the lending institution. 

Among the topics discussed are train 

ing, policies, environmental risk 

analysis and assessment, loan docu 

mentation, and monitoring. 

Examiners will review an institu 

tion's environmental risk program as 

part of the examination of its lending 

and investment activities. When ana 

lyzing individual credits, examiners will 

review the institution's compliance 

with its own environmental risk pro 

gram. Failure to establish or comply 

with an appropriate environmental 

program will be criticized and correc 

tive action required. FIL-14-93, FDIC, 

2/25/93. 

Foreign Banks' Activities 

The FDIC proposed to amend its 

regulations to implement Section 202 

of FDICIA, which provides that after 

December 19, 1992, a state-licensed 

insured branch of a foreign bank may 

not engage in any activity that is not 

permissible for a federal branch of a 

foreign bank without the approval of 

both the FRB and the FDIC. In the 

event an application to engage in such 

activity is denied or the foreign bank 

elects not to continue the activity, a 

plan of divestiture or cessation must 

be submitted and such divestiture or 

cessation must be completed within 

one year, or sooner if the FDIC so 

directs. FR,3/2/93,p. 11992. 

Certain Requirements 

Waived in Disaster 

Areas 

Section 2 of the Depository Insti 

tutions Disaster Relief Act of 1992 

(DIDRA) authorizes the FDIC, 

OCC, FRB, OTS, and National 

Credit Union Administration (NCUA) 

to make exceptions to their require 

ments relating to appraisals for trans 

actions that involve real property in 

major disaster areas when the excep 

tions would facilitate recovery from 

the disaster and would not be incon 

sistent with safety and soundness. 

Any such exceptions would expire no 

later than three years after the disaster 

is declared by the President. Under 

this authority, relief was granted from 

the provisions of Title XI of FIRREA 

and the agencies appraisal regulations 

promulgated under it for any realestate-related financial transaction 

requiring an appraisal involving real 

property located in an area designated 

eligible for federal assistance by the 

Federal Emergency Management 

Agency as a result of Hurricanes An 

drew or Iniki or of the Los Angeles 

civil unrest in May 1992. For eligibil 

ity it is further required that the real 

property involved was directly af 

fected by the major disaster, or that 

the real property involved was not 

directly affected by the major disaster 

but the institution's records explain 

how the transaction would facilitate 

recovery from the disaster. FR, 11/17/92, 

p. 54173. 

The FDIC determined that recov 

ery from Hurricanes Andrew and 

Iniki and from the Los Angeles civil 

unrest in May 1992 would be facil 

itated by exempting from publication 

requirements certain transactions in 

volving establishing a branch or relo 

cating a branch or main office in the 

areas directly affected by those disas 

ters. The FDIC's publication require 

ments were suspended for a period of 

180 days beginning October 23, 1992, 

and ending April 21, 1993, with 

respect to applications filed by FDICinsured state nonmember banks 

whose principal place of business is 

within, or with respect to activities 

within, an area designated eligible for 

federal assistance by the Federal 

Emergency Management Agency as a 

result of the hurricanes or civil unrest 

indicated above. FR, 12/15/92,p. 59284. 

Survey Shows Real-Estate 

Markets Continuing 

to Improve 

Residential and commercial realestate markets continued to improve 

in the three months ending in April 

1993, according to the FDIC's most 

recent survey. The national compos 

ite index of survey responses was 66, 

the same level as in January, and up 

from 57 in October 1992. The national 

residential index rose to 74 in April 

from 73 in January and 63 in October, 

while the commercial index was the 

37 
FDIC Banking Review 

same in January and April at 57, in 

creasing from 51 last October. 

The surveys began in April 1991, 

and are based on interviews across the 

country with nearly 500 senior exam 

iners and liquidation personnel at fed 

eral bank and thrift regulatory agencies. 

Values of the index above 50 indicate 

that more respondents believed con 

ditions were improving than declin 

ing, compared to the previous quarter, 

while values below 50 indicate the 

opposite. 

The South remained the strongest 

region in the country in April for the 

seventh consecutive survey. There 

was significant continuing improve 

ment in the Midwest, particularly in 

residential real estate. Real-estate 

markets in the Northeast posted gains 

in April, matching January's, which 

were the most positive to date for this 

region. In California, nearly half of the 

respondents observed declines in both 

commercial and residential real-estate 

conditions. In contrast, in the West 

outside California, commercial and resi 

dential markets reportedly outper 

formed the national average. Among 

other indications of improvement na 

tionally, less than half of the respon 

dents reported an excess supply in 

their local housing markets for the 

second consecutive survey. Also, more 

respondents cited increasing prices of 

existing homes than in any survey to 

date. Survey ofReal Estate Trends, FD1C, October 

1992January, April 1993, 

Pilot Reinsurance Program 

The FDIC solicited public com 

ments on a Pilot Reinsurance Program 

pursuant to Section 322 of FDICIA, 

which requires the agency, in consul 

tation with the Secretary of the Trea 

sury and individuals from the private 

sector, to conduct a study of the feasi 

bility of establishing a private reinsur 

ance system. The study must include 

a demonstration project, consisting of 

a simulation, by a sample of private 

reinsurers and insured depository 

institutions, of the activities required 

for a private reinsurance system. 

These activities include: a) estab 

lishing a pricing structure for riskrelated premiums; b) formulating 

insurance or reinsurance contracts; and 

c) identifying and collecting informa 

tion necessary for evaluating and 

monitoringrisks in insured depository 

institutions. 

Section 322 authorizes the FDIC 

to engage in actual reinsurance trans 

actions as part of the demonstration 

project. As part of the new risk-related 

assessment system, the FDIC is au 

thorized to obtain private reinsurance 

covering not more than ten percent of 

any loss the FDIC incurs with respect 

to an insured depository institution 

and to base that institution's semian 

nual assessment, wholly or partially, on 

the cost of the reinsurance. 

The FDIC asked for comment on 

all aspects of a PRP, including the 

reinsurance process, the terms and 

conditions of participation by private 

reinsurers, the appropriate criteria for 

determining which insured depository 

institutions may be included in the 

PRP, and alternate methods of struc 

turing a PRP. FRl2l3I93,p.6996;FlL-ll-93, 

FDIC, 2117; FR, 4/27, p. 25644. 

Private Reinsurance Study 

The FDIC submitted a report to 

the Congress as required by Section 

322(b) of FDICIA. In order to ascer 

tain whether establishing a private re 

insurance system is feasible, the FDIC 

has initiated a Pilot Reinsurance Pro 

gram as part of the demonstration pro 

ject required under the section. While 

the demonstration project has not been 

concluded, the preliminary results of 

the study in part are: a) combining 

private reinsurance with federal de 

posit insurance requires introducing 

and establishing a financial market that 

currently does not exist; b) potential 

reinsurers have shown limited inter 

est in engaging in reinsurance con 

tracts on terms acceptable to the FDIC 

thus far; and c) further discussions are 

necessary to develop a consensus re 

gard ing the goals, limitations, and fea 

sibility of a PRP. 

The FDIC will continue to seek 

the counsel of a number of parties in 

order to arrive at a reasonable approach 

to a Pilot Reinsurance Program. The 

FDIC envisions a Pilot Program with 

three phases. After completing each 

phase, the FDIC will decide whether 

to continue on this course. First, the 

FDIC will determine the general terms 

under which it is willing to obtain 

reinsurance and will solicit participa 

tion of parties willing to provide rein 

surance. The FDIC will work with 

these parties to develop a detailed and 

final reinsurance contract. Second, the 

reinsurers will conduct their analysis 

of banks and submit bids indicating 

the prices at which they are willing ta 

reinsure banks. Third, the FDIC and 

the reinsurers will enter into reinsur 

ance contracts. The third phase will 

end when the term of the reinsurance 

contracts terminates. Private Reinsurance 

Feasibility Study, FDIC, June 1993, 

Report on Development of 

Deposit Tracking System 

Section 311 of FDICIA requires 

the FDIC to conduct a study of the 

cost and feasibility of tracking the in 

sured and uninsured deposits of any 

individual and the exposure of the 

U.S. Government with respect to all 

insured depository institutions. A de 

tailed technical analysis must be con 

ducted of the costs and benefits 

associated with the least expensive 

manner of implementing the tracking 

system. As part of the study, the FDIC 

must investigate and evaluate: a) the 

data systems that would be required 

to track deposits in all insured depos 

itory institutions; b) the reporting bur 

dens of such tracking on individual 

depository institutions; c) the system 

that exists or that would be required 

to be developed to aggregate such data 

accurately; d) the privacy implications 

of such tracking; and e) the manner in 

which systems would be administered 

and enforced. 

The FDIC sought public comment 

on the desirability, cost and feasibility 

of developing such a tracking system, 

and to evaluate the privacy implica 

tions, and examine the possibilities 

and implications of simplifying the rules 

governing deposit insurance coverage. 

The study as required by FDICIA 

was completed in June 1993. It de 

scribes several possible uses for a 

38 
Recent Developments 

cracking system and concludes that 

each of them is of limited value, and 

may be achieved with less-costly al 

ternatives, or is of dubious merit. The 

costs to insured depository institutions 

to develop and implement a simple 

deposit tracking system would range 

from $950 million to $1.3 billion, with 

annual recurringcostsexceeding$l 00 

million. In addition, the FDIC would 

incur $30.5 million in initial and firstyear costs, with annual recurring costs 

of $20 million. Furthermore, the study 

concludes that the development of a 

deposit tracking system would repre 

sent an unwarranted infringement of 

depositors' privacy. 

Because many of the above costs 

would be driven by the complexity of 

the current deposit insurance cover 

age rules, the study analyzes potential 

modifications to the rules and the po 

tential consequences that could occur 

if these modifications were adopted. 

The study also concludes that the 

FDIC should carefully consider the 

possibility of simplifying insurance 

coverage rules. FIL-15-93, FDIC, 2/26193; 

FR, 2/3193, p. 6903; Costs, Feasibility and Privacy 

implications of Tracking Deposits, FDIC, Jane 

1993. 

Study of "Two-Window" 

Deposit System 

The FDIC completed a study, as 

required by Section 321 of FDICIA, 

on the feasibility of authorizing in 

sured depository institutions to offer 

both insured and uninsured deposit 

accounts to customers. 

As discussed in this study, the 

"two-window" approach involves 

bank restructuring designed to insu 

late the deposit insurance funds from 

unnecessary risks and to free banking 

organizations from unnecessary, anti 

competitive constraints. Bank risk-tak 

ing is confined by further restricting 

the activities that may be funded with 

insured deposits. Activities deemed 

improper for funding with insured de 

posits are permitted for uninsured 

affiliates (perhaps subsidiaries) 

within the same banking organiza 

tion, but the insured entity is insu 

lated from nonbank risks through 

separate capitalization and a set of rein 

forcing "firewalls" to maintain effec 

tive legal and financial separation. All 

ownership, product-line, and location 

restrictions now applied to banking 

organizations are lifted so that new 

capital may be attracted and banking 

organizations may compete on a more 

level playing field with nonbank and 

foreign firms. 

The "two-window" system has 

similarities to the "narrow-bank" con 

cept. Some differences are the criteria 

used for determining acceptable uses 

of insured deposits, the restrictions 

imposed on nonbank-affiliate activi 

ties, and the structural design of the 

banking organization as a whole. 

The study concludes that "this 

probably is not the appropriate time 

to implement a significant change in 

the rules that govern the operations 

of the nation's banking system." 

FDICIA is intended to strengthen the 

deposit insurance system through a 

variety of reforms, including capitalbased supervision, prompt corrective 

action for troubled institutions, and 

implementation of risk-related assess 

ments. In addition, banking compa 

nies are being allowed to compete in 

an expanding number of product mar 

kets. If these developments do not 

ultimately result in a healthy and via 

ble banking system, it will be time to 

revisit the two-window proposal. Re 

port to the Congress on the Findings and Recommen 

dations Concerning the "Two-Window" Deposit 

System Proposal, FDIC, September 1992. 

Resolution Trust Corporation 

Smaller Sales Offerings of 

Hard-to-Sell Assets 

Interim Chief Executive Officer 

Roger C. Altman announced that the 

RTC will begin decreasing the size of 

its asset offerings and will subject 

large-scale sales proposals to a more 

rigorous pre-offering review as it 

proceeds with the marketing of its 

remaining inventory of largely hardto-sell assets. The emphasis on smaller 

transactions will not interfere with of 

ferings that are now moving into the 

marketplace, such as the RTC's Land 

Fund and Multiple Investor Funds. 

However, any new proposals of large 

transactions, generally in excess of 

$50 million, will be reviewed to en 

sure that there is adequate staff and 

contractor support to move the pro 

posals smoothly through the forma 

tive stage to a sale. The emphasis on 

smaller transactions, settlements and 

workouts will also extend to offerings 

of the RTC's private-sector asset 

managers. 

Mr. Altman said that in the months 

ahead there will be more auctions 

with smaller pools of assets and more 

individualized asset offerings reach 

ing the market through brokers and 

other traditional mechanisms. In 

addition to reducing stress to the 

agency's internal controls and con 

tracting program, this approach will 

create opportunities for the investor 

who has felt left out of the competi 

tion for the major pools sold in the 

past. The RTC Investor, May 1993, p. 1. 

New Loan Sales Directive 

In respect to mortgages and other 

loan assets, various "wholesale" pro 

grams have proven to be the most 

successful in both disposing of assets 

rapidly and maximizing recovery 

values. These programs include 

securitization, multiple investor fund 

(MIF) transactions, structured sales, 

whole-loan sales and national loan 

auctions. 

A new directive requires that: 

a) securitization will be the primary 

and priority sales method for all per 

forming l-to-4 family mortgages, multi

family and commercial mortgages, 

and consumer and other nonmortgage 

loans; b) MIF transactions (including 

both publicly offered MIFs and pri 

vately placed MIFs, or N-series trans 

actions) will be the primary and 

priority method of sale for nonper

forming multifamily and commercial 

mortgages; and c) structured sales, 

whole-loan sales and national loan 

auctions conducted by the National 

Sales Center will be the primary 

and priority methods of disposition 

for nonperforming l-to-4 family 

mortgages, nonperforming consumer 

loans and all other mortgage and loan 
FDIC Banking Review 

assets deemed not suitable for securi

tization or MIF transactions. 

As a result of the directive, all loan 

sales will be centralized in Washing 

ton, D.C., enabling the RTC to better 

coordinate its loan sales activities and 

maintain a steady flow of products 

into the marketplace. The RTC's field 

offices, managing agents, financial in 

stitution specialists and asset manag 

ers will continue to play a vital role in 

identifying assets available for sale, 

assisting with the due-diligence pro 

cess, locating and delivering asset-re 

lated documents, and providing other 

necessary support. These groups also 

will continue to have primary respon 

sibility for the sale of real estate owned, 

other assets, loan-servicing rights (in 

cooperation with the National Sales 

Center) and workout and settlement 

of distressed loan assets. 

Borrower workouts and settle 

ments of individual assets prior to sale 

will continue until they are "frozen" 

for a national sales effort. In some 

cases, performing mortgages and other 

performing loans may be sold in con 

junction with resolution transactions. 

The RTC Investor, February 1993, p. 6. 

Asset Sales Will Utilize 

Partnership Structure 

The RTC will dispose ofjudgments, 

deficiencies, and charge-offs (JDCs), 

and some nonperforming consumer 

loans having balances of under $50,000, 

through the use of a limited partner 

ship structure. The RTC will be the 

limited passive partner. The general 

partner, which will be the collection 

team, will manage and collect on the 

JDCs and pay for all the costs of the 

partnership, receiving for these ser 

vices a specified percentage of gross 

collections. Some preference will be 

given to minority- and women-owned 

investors who are interested in par 

ticipating. The RTC has encouraged 

firms to form teams to meet the vari 

ous requirements that will apply to 

participants in the partnerships. The RTC 

Investor, March 1993, p. 2. 

Secondary Market Support 

Program 

The RTC has become a major 

presence in the market for mortgagebacked and asset-backed securities, 

having sold (through September 

1992) 52 issues of securities with an 

aggregate book value of more than 

$28 billion. The agency's secondary 

market support program provides in 

vestors with increased information 

about the performance of the collat 

eral underlying the securities, thus 

enhancing the liqutdity and pricing of 

the securities. The program consists 

of: a) monthly statistical reports on the 

performance of the mortgage or asset 

pool underlying each issue of the se 

curities; b) periodic meetings to be 

begun with investors and rating agen 

cies, and c) an automated telephone 

access line (1-202-416-4300) which 

has been established on a trial basis. 

The RTC intends to revise and ex 

pand the reports to include a summary 

of the structure of each transaction, 

delinquency statistics, and other in 

formation. The RTC Investor, November 1992, 

p. 10. 

National Land Fund 

The RTC solicited partnership 

proposals for the National Land 

Fund, which will be the agency's first 

use of a partnership for the disposition 

of a large portfolio of distressed realestate assets. An official said the part 

nership structure would allow the 

RTC to privatize ownership of ten 

percent of its land holdings while re 

taining the opportunity to recover 

funds for the taxpayer in the future if 

land values rise above current levels. 

Approximately 60 to 70 percent of 

the fund will be comprised of per 

forming, subperforming and nonper 

forming loans; the remainder will be 

real estate owned. The assets are lo 

cated primarily in Arizona, California, 

Colorado, Florida and Texas and will 

be divided into four to six regional 

pools. 

Investors will contribute a mini 

mum of 25 percent of the bid price in 

cash to the partnership. The agency's 

contribution of the land will represent 

its equity interest in the partnership. 

The land portfolio is expected to have 

a book value of $2 billion and a gen 

eral partner will be selected based on 

the highest qualified bid submitted to 

the RTC. The RTC will act as a pas 

sive limited partner. Once selected, 

the private investor group as general 

partner will have broad authority for 

managing the Fund. The RTC Investor, 

December 1992, p, 1. 

Amended Policy on 

Contracting with Firms 

with Related Entity 

Defaults 

The RTC issued, in July 1992, a 

policy statement restricting RTC 

contracting with firms whose related 

entities are in default on financial 

obligations to the RTC, FDIC, or 

FSLIC in any of their capacities (the 

Default Policy — see this Review, 

Fall/Winter 1992), p. 40). The RTC 

is revising the Policy to exclude from 

its coverage contractor firms whose 

affiliated business entities have de 

faulted on RTC post-intervention 

nonrecourse seller financing, pro 

vided, in the sole discretion of the 

RTC, that no material dispute exists 

between the RTC and the contractor 

firm itself regarding the asset. FR, 

11II9192, p. 54503. 

Real-Estate Appraisals 

The RTC amended, effective 

December 2, 1992, its real-estate ap 

praisal regulations to identify addi 

tional transactions for which the 

services of an appraiser are not re 

quired. The final rule eliminates the 

requirement for depository institu 

tions under the conservatorship or re 

ceivership of the agency to obtain 

appraisals by certified or licensed ap 

praisers for real-estate-related finan 

cial transactions having a value of 

$100,000 or less. Also, it permits regu 

lated institutions to use appraisals 

prepared for loans insured or guaran 

teed by an agency of the U.S. Govern 

ment under certain conditions. FR, 

1112192, p. 49382. 

40 
Recent Developments 

FNMA to Purchase 

Multifamily Properties 

The Federal National Mortgage 

Association (Fannie Mae) will buy up 

to $100 million in permanent financ 

ing for RTC multifamily properties in 

which 35 percent of the units will be 

set aside at restricted rents for lowincome families. The RTC also will 

provide second mortgages to non 

profit organizations and government 

agencies, which allows such buyers to 

purchase the properties with mini 

mum down payments of five percent; 

for-profit purchasers will be required 

to put down 30 percent. 

This is a joint effort of the RTC's 

Affordable Housing Disposition Pro 

gram (AHDP) and Fannie Mae's $10 

billion initiative to help address the 

nation's unmet affordable housing 

needs. AHDP requires that 15 per 

cent of the total project units be 

occupied by "lower-income" families 

earning less than 80 percent of the 

area median income, and 20 percent 

of the total project units must be oc 

cupied by "very low-income" house 

holds earning less than 50 percent of 

the area median income. Most of the 

nearly 300 RTC-owned apartment pro 

perties available for financing under 

the RTC/Fannie Mae plan are locat 

ed in Arkansas, Arizona, California, 

Colorado, Florida, Georgia, Kansas, 

New Mexico, Oklahoma and Texas. 

The Silver Lining, RTC, Fall 1992/Winier 1993, 

p. I. 

Special Resources 

Clearinghouse 

The RTC established a Special 

Resources Clearinghouse to serve as a 

central poinr. for disseminating infor 

mation on RTC properties that have 

natural, cultural, recreational or scien 

tific values of special significance. Ex

amples include properties with 

nationally significant wetlands, endan 

gered species or historic sites. As of 

August 13, 1992, the RTC had iden 

tified 739 individual properties with 

special resources. The Clearinghouse 

service is available to both public and 

private parties. The RTC Investor, November 

1992, p. 9. 

Operations Update 

Through April 30, 1993, the RTC 

resolved 654 institutions with one res 

olution occurring during March and 

none in April. The RTC added one 

institution into its conservatorship 

program to bring the number of con

servatorships to 85 at the end of April. 

As of March 31, assets under RTC 

management, including both conser

vatorships and receiverships, totaled 

$91 billion. This asset inventory is the 

lowest the RTC has held since it was 

created in August 1989. The 84 con

servatorships (as of March 31) held 

$36 billion in gross assets, of which 

cash and securities (including a sub 

stantial amount of short-term securi 

ties purchased with the proceeds of 

asset sales) represented 35 percent; 

performing l-to-4 family mortgages, 

18 percent; other performing loans, 20 

percent; delinquent loans, 8 percent; 

real estate, 7 percent; investments in 

subsidiaries, 3 percent; and other as 

sets, 9 percent. Assets in receiverships 

remaining from the 654 institutions 

closed by the RTC amounted to $55 

billion on March 31. Because many of 

the relatively marketable assets have 

been sold before an institution enters 

a receivership, most of the assets re 

tained by the RTC in receivership 

consisted of lower-quality, less-mar 

ketable assets. Thus, real estate and 

delinquent loans represented 44 per 

cent of receivership assets, while cash, 

securities, and performing l-to-4 fam 

ily mortgages represented only 13 

percent. The $55 billion excludes 

approximately $15 billion in cash, 

liquid investments, and accounts 

receivable accumulated from receiver 

ship collections. 

From inception through March, 

the RTC collected $130 billion from 

securities, $94 billion from l-to-4 fam 

ily mortgages, $43 billion from other 

mortgages, $25 billion from non-mort 

gage loans, $12 billion from real es 

tate, and $16 billion from other assets. 

Book value asset reductions were $350 

billion, and the RTC recovered 92 per 

cent on these collections. The RTC 

has recovered 98 percent from secur 

ities, 97 percent from l-to-4 family 

mortgages, 85 percent from other mort 

gages, 93 percent from non-mortgage 

loans, 59 percent from real estate, and 

77 percent from other assets. The RTC 

has collected $15.1 billion in receiver 

ship income. 

As of the end of April, RTC resolu 

tions had protected 21.9 million de 

posit accounts from financial loss. 

Estimated resolution costs for the 654 

closed thrifts totaled $84.4 billion, be 

fore taking into account the reduction 

in loss estimates for already resolved 

institutions confirmed by GAO's pre 

liminary audit of the RTC's 1992 fi 

nancial statements. The $84.4 bil lion 

represented 34 percent of the total 

liabilities of these closed institutions 

at the time of resolution. If the in 

sured deposits of all 654 institutions 

had been paid out to depositors, the 

estimated resolution cost would have 

been $87.6 billion. The $3.2 billion 

difference represented the estimated 

savings, or premiums, over insured 

deposit payout costs. 

From its inception through March 

31,1993, the RTC obtained $122 bil 

lion in funds from external sources as 

follows: $50 billion in FIRREA ap 

propriations, $37 billion in loss funds 

authorized by 1991 Acts of Congress, 

and $35 billion in Federal Financing 

Bank borrowings. The RTC also ob 

tained $85 billion in recoveries from 

receiverships. RTC Review, May 1993. 

Federal Reserve Board 

Review Criteria for Bank 

Holding Company 

Applications 

The FRB issued a final rule to 

carry out provisions of FDICIA that 

affect bank holding companies and 

foreign banking organizations with 

operations in the U.S. The final rule, 

which is effective February 4, 1993, 

replaces an interim rule, adopted in 

April 1992, and amends Regulation Y 

to specify additional factors that the 

FRB must consider in acting on appli 

cations submitted under the Bank 

Holding Company Act to acquire a 

bank. Section 202(d) of FDICIA pro 

vides that the FRB must disapprove 

41 
FDIC Banking Review 

an application if: a) the bank holding 

company fails to provide the FRB 

with adequate assurances that it will 

make available such information on 

its operations or activities, or those of 

affiliates, as the FRB may require; or 

b) in the case of an application involv 

ing a foreign bank, the foreign bank is 

not subject to comprehensive super 

vision or regulation on a consolidated 

basis by the appropriate authorities in 

the bank's home country. The FRB's 

consideration of the managerial re 

sources of a bank holding company or 

bank includes evaluating the com 

petence, experience and integrity of 

their officers, directors and principal 

Shareholders. Press Release, FRB, 1/5/93; FR, 

i'/6, p. 471. 

International Banking 

Operations 

The FRB issued a final rule im 

plementing portions of the Foreign 

Bank Supervision Enhancement Act 

of 1991, and amending its Regulation 

K to reflect the FRB's new authority 

to supervise and regulate foreign 

banks that conduct or seek to conduct 

a banking business in the U.S. The 

rule requires in part that foreign banks 

seeking to conduct direct banking 

operations in the U.S. must be subject 

to comprehensive supervision by their 

home country authorities on a consol 

idated basis. An amendment to Regu 

lation Y requires a foreign banking 

organization to file an application with 

the FRB in order to acquire more than 

five percent of the share of a U.S. bank 

or bank holding company. The rule is 

effective immediately and replaces an 

interim regulation issued in April 

1992. Press Release, FRB, 1112/93; FR, 1/28, 

p. 6348. 

FBSEA provides in part that, after 

December 19, 1992, a state-licensed 

branch or agency of a foreign bank 

may not engage in any type of activity 

that is not permissible for a federal 

branch, unless the FRB has determined 

that such activity is consistent with 

sound banking practice, and, in 

the case of a state-licensed insured 

branch, the FDIC has determined that 

the activity would pose no significant 

risk to the deposit insurance fund. 

The FRB proposed procedures for 

state-licensed branches and agencies 

to request the FRB's permission to 

engage in or continue an activity that 

is not permissible for a federal branch, 

and the requirements for divestiture 

and cessation plans. Press Release, FRB, 

12/3U92;FR, 116(93,p. 513. 

Enforcement of Fair 

Lending Laws 

To address the concern that some 

minority consumers and small-business 

owners are experiencing discrimina 

tion by lenders, federal bank and 

thrift supervisors reiterated their com 

mitment to effective enforcement of 

fair lending laws. The regulators men 

tioned specifically 11 fair lending ac 

tivities, among which are; a) use of an 

internal second review system for 

consumer, mortgage and small-busi 

ness loan applications that would 

otherwise be denied; b) enhanced 

employee training that engenders 

greater sensitivity by financial institu 

tion management, and employees, to 

racial and cultural differences in our 

society; c) training of loan application 

processors to ensure that any assis 

tance provided to applicants in how to 

best qualify for credit is provided 

consistently to all loan applicants; 

d) efforts to ensure that all persons 

inquiring about credit are provided 

equivalent information and encour 

agement; e) and use of flexible under 

writing and appraisal standards that 

preserve safety-and-soundness criteria 

while responding to special factors 

in low- and moderate-income and 

minority communities. 

The agencies will continue to 

strengthen and refine their fair lend 

ing enforcement activities. Examin 

ers will routinely use HMDA data, as 

well as other information, to identify 

cases which require closer examina 

tion. Examiners will then conduct de 

tailed reviews and comparisons of 

loan and application files to examine 

for compliance with fair lending laws 

and regulations. The agencies will 

continue to develop and refine com 

puter-based programs to facilitate and 

improve this process. FRB, OCC, OTS, 

FDIC, Joint Release, 5/27/93. 

Revenue Limit on 

Securities Activities 

ofBHC Subsidiaries 

In July 1992, the FRB requested 

comment on alternative methods to 

adjust the ten percent revenue test 

limiting ineligible securities activities 

of Section 20 subsidiaries of bank 

holding companies (see this Review, 

Fall/Winter 1992, p. 42). Since the 

revenue test was last considered in 

1989, changes in the level and struc 

ture of interest rates have had un 

foreseen effects on the measure of 

whether a Section 20 subsidiary is 

"engaged principally" in ineligible 

securities activities. One possible al 

ternative test suggested was a revenue 

test that is indexed to interest-rate 

changes. The method proposed was 

to adjust current interest and dividend 

revenue in order to calculate the rev 

enue that would have been earned in 

the current period if the Treasury yield 

curve were as it was in September 

1989. 

Effective January 26, 1993, the 

Board will allow Section 20 subsidiar 

ies to measure compliance with the 

"engaged principally" test on the 

basis of the indexed revenue test on 

which comment was requested. To 

use that method as an alternative to 

the current revenue test. Section 20 

subsidiaries must notify the FRB of 

such an election and may not alter that 

election for two years. FR, 7/29/92, p. 

33507; 7/31,p. 33961;5/'18/93, p. 28963; Federal 

Reserve Bulletin, 3/93, p. 227; 4/93, p. 360. 

Capital Guidelines 

The FRB modified its risk-based 

capital guidelines, effective Decem 

ber 30, 1992, for state member banks 

and bank holding companies to lower 

the risk-weight from 20 percent to 

zero for certain transactions that are 

collateralized by cash and OECD 

central government securities, includ 

ing U.S. Government agency secur 

ities, provided the transactions meet 

Specified criteria. Press Release, FRB, 

12/23/92; FR, 12/30/92, p. 62180. 

The FRB issued a final rule to 

lower from 100 to 50 percent the 

risk-weight on loans to finance the 

42 
Recent Developments 

construction of l-to-4 family residen 

ces that have been presold. The rule, 

which implements a section of the 

Resolution Trust Corporation Refi 

nancing, Restructuring, and Improve 

ment Act of 1991 (RTCRRIA), is 

effective April 26, 1993. Press Release, 

FRB, 4120193; Fit, 5/14, p. 28491. 

The FRB is revising its capital-ade 

quacy guidelines for bank holding 

companies and state member banks, 

effective March 15, 1993, to provide 

explicit guidance on the types of in 

tangible assets that may be included 

in the Tier 1 capital calculation for 

risk-based and leverage capital pur 

poses. The revision was formulated in 

conjunction with the staffs of the 

FDIC, OCC, and OTS and, when 

made final by the other agencies, will 

achieve greater consistency among 

the agencies with respect to the capi 

tal treatment of intangible assets. FR, 

2/1'If93,p. 7973. 

Appraisals 

The FRB proposed to revise its 

Regulation B to implement an Equal 

Credit Opportunity Act amendment 

enacted as part of FDICIA. The pro 

posed revisions would define the ap 

praisal provision to cover applications 

to be secured by a lien on a residential 

structure containing l-to-4 family 

units, set time limits for an applicant 

co request a copy of an appraisal report 

and for a creditor to provide a copy, 

and require most creditors to notify 

applicants in writing of the right to 

receive a copy of an appraisal report. 

Comment is specifically requested on 

whether a more limited approach 

should be adopted or whether any 

regulations at all are desirable to im 

plement the Statute. FR, 1217/92,p. 57697. 

Loans to Member Banks' 

Officials and Principal 

Shareholders 

The FRB requested comment on 

whether it should retain, modify, or 

terminate a provision in its Regula 

tion which permits smaller banks to 

increase their aggregate insider lend 

ing limit. Under authority granted by 

FDICIA, the FRB amended the Reg 

ulation, effective May 18, 1992, to 

permit banks with deposits under 

$100 million to increase their lending 

limit from 100 percent up to 200 per 

cent of unimpaired capital and unim 

paired surplus, if they followed 

certain procedures. The smaller bank 

was required to declare to the FRB 

that, on the basis ofthe bank's lending 

experience, a higher limit was pru 

dent and necessary to attract or retain 

directors or to prevent restricting credit. 

The higher lending limit, sched 

uled to extend for one year through 

May 18, 1993, was extended for an 

additional six months. Prsss Release, FRB, 

5/7/93, 1993; FR, 5/4, p. 26507; 5/14, p. 28492. 

Home Mortgage Disclosure 

The FRB issued a final rule, effec 

tive January 1,1993, amending Regu 

lation C, which implements the 

Home Mortgage Disclosure Act 

(HMDA). FDICIA authorized the 

FRB, in consultation with the Depart

mentof Housingand Urban Develop 

ment, to develop a new exemption 

standard for nondepository mortgage 

lenders that is comparable to the ex 

emption for depository institutions. 

Under the standard that has been 

adopted, a nondepository mortgage 

lender with an office in a metropolitan 

area is covered if it meets either an 

asset-size test or a lending activity 

test. Such a lender continues to be 

covered if its assets exceed $10 mil 

lion. Any nondepository mortgage 

lender is covered if it originated 100 

or more home purchase loans (which 

includes refinancings of home pur 

chase loans) in the precedingcalendar 

year. This dual standard maintains 

coverage for all nondepository mort 

gage lenders that currently report 

under HMDA and extends coverage 

to firms that are active mortgage lend 

ers despite their smaller asset size. 

The FRB also has revised the instruc 

tions for reporting loan applications 

received through a loan broker or cor 

respondent, applicable to all lenders 

covered by HMDA. FR, 12/2/92,p. 56963. 

The FRB adopted amendments, 

effective March 1, 1993, to imple 

ment HMDA as amended by the 

Housing and Community Develop 

ment Act of 1992. Financial institu 

tions are required to make their loan 

application register data available to 

the public beginning March 31, 1993, 

after the register is modified in accor 

dance with the FRB's regulations. 

Also, they must make their disclosure 

statement, to be compiled by the 

FFIEC later in the year, available to 

the public within three business days 

down from 30 days now required 

after receiving it from the FFIEC. 

FR, 3/11/93, p. 13403. 

Mellon Can Provide 

Administrative Services 

to Mutual Funds 

The FRB gave permission to Mel 

lon Bank Corp. to provide adminis 

trative services to mutual funds, an 

approval said to be the first of its kind 

by the FRB. Mellon will indirectly 

acquire TBC Advisors, Boston, which 

provides administrative and advisory 

services to almost 100 open-end and 

closed-end investment firms. Among 

the conditions of the approval, Mellon 

will be able to have a representative 

from its subsidiary fund administrator 

serve as a director on a fund's board. 

However, that only applies to the ad 

ministration side, and no such repre 

sentation will be allowed on funds 

that are both advised and admin 

istered by the subsidiary. BBR, 4/26/93, 

p. 559. 

Disaster Area Relief 

The FRB granted temporary re 

lief, as authorized by the Depository 

Institutions Disaster Relief Act of 

1992, from certain provisions of Reg 

ulation Z governing waivers by con 

sumers of the right to rescind certain 

home-secured loans, so that borrow 

ers in disaster-affected communities 

in Florida, Hawaii, Louisiana, and 

California can gain easier access to 

loan funds for emergency purposes. 

The use of preprinted forms for con 

sumers to waive the right of rescission 

is permitted, if the home securing the 

extension of credit is located in the 

disaster area. A consumer must still 

provide the creditor with a signed, 

dated waiver statement chat a per 

sonal financial emergency exists. The 

order became effective on November 

43 
FDIC Banking Review 

12,1992, and expires for the different 

areas on dates specified. FR, 11112/92, 

p. 53545. 

Money-Laundering Policy 

Statement 

The FRB, as recommended by the 

FFIEC, issued a policy statement to 

address the problem of the use of 

large-value funds transfers for money 

laundering. To the extent practicable, 

the FRB is encouraging all domestic 

banking offices to implement the rec 

ommendations of the Financial Action 

Task Force (FATF) when sending a 

payment order over any funds transfer 

system, including Fedwire, CHIPS, 

SWIFT, and any proprietary networks. 

The FATF is primarily developing 

international guidelines to facilitate 

the identification and prosecution of 

money-laundering activities, and has 

developed recommendations to pro 

vide more complete information about 

the parties to a funds transfer. Pros 

Release and Policy Statement, FRB, 12/23192. 

Interbank Liabilities 

The FRB issued a new Regulation 

F, implementing Section 308 of 

FDICIA, to require banks, savings 

associations, and branches of foreign 

banks with deposits insured by the 

FDIC to develop and implement pru 

dential policies and procedures to 

evaluate and control exposure of their 

correspondent banks. The rule also 

establishes a regulatory limit that re 

quires that a bank ordinarily limit its 

overnight credit exposure to an indi 

vidual correspondent that is less than 

"adequately capitalized" to not more 

than 25 percent of the exposed bank's 

total capital. Credit exposure to corre 

spondents that are at least "adequate 

ly capitalized" is subject to prudential 

policies and procedures, which go into 

effect on June 19, 1993. The regula 

tory limit on credit exposure to an 

individual correspondent is phased in, 

with the limit set at 50 percent of the 

exposed bank's capital for a one-year 

period beginning on June 19, 1994, 

and reduced to 25 percent as of June 

19, 1995. Press Release, FRB, 12/17/92; FR, 

12/18, p. 60086. 

Daylight Overdrafts and 

Payments System Risk 

The FRB is adopting an amend 

ment to its Regulation J to require 

paying banks that receive presentment 

of checks from a Federal Reserve 

Bank to settle for those checks as soon 

as one hour after receipt of the checks. 

This amendment is necessary in order 

to measure daylight overdrafts accu 

rately under the FRB's payments 

system risk-reduction program. The 

intent of the program is to reduce both 

Federal Reserve and overall pay 

ments system risk. Effective: October 

14,1993. 

The FRB is adopting a policy 

under which Reserve Banks will 

charge a fee for average daily intraday 

overdrafts in reserve and clearing ac 

counts. A fee of 60 basis points (an 

nual rate) multiplied by the fraction of 

the day Fedwire is scheduled to oper 

ate will be phased in over three years 

(under current Fedwire operating 

hours the fee will equal 25 basis points 

(annual rate) when fully phased in). 

Reserve Banks will deduct from the 

gross fee an amount equal to 10 per 

cent of qualifying capital valued at the 

fee for a 10-hour operating day. Fees 

of $25 or less in any two-week period 

will be waived. The intent of the fee 

is to induce behavior that will reduce 

risk and increase efficiency in the pay 

ments system. Effective: April 14,1994. 

The FRB is adopting new proce 

dures for posting debits and credits 

to depository institutions' accounts at 

Federal Reserve Banks in order to 

measure daylight overdrafts accurate 

ly. Accurate measurement of daylight 

overdrafts is necessary in order to 

assess fees for the use of Federal 

Reserve intraday credit- Effective: 

October 14, 1993. FR, 10/14/92,pp. 46950, 

47084,47093. 

Netting Eligibility for 

Financial Institutions 

The FRB requested comment on 

including certain entities under the 

definition of "financial institution" 

for coverage by the netting provisions 

of FDICIA. Parties to a netting con 

tract agree that they will pay or 

receive the net, rather than the gross, 

payment due under the netting con 

tract. The Act provides certainty that 

netting contracts will be enforced, 

even in the event of the insolvency of 

one of the parties. The'Act's netting 

provisions, effective December 19, 

1991, were designed to promote ef 

ficiency and reduce systemic risk 

within the banking system and finan 

cial markets. 

In the FRB's view, the netting pro 

visions should extend to all financial 

market participants that regularly 

enter into financial contracts, both as 

buyers and sellers, where the failure 

of the participant could create sys 

temic problems in financial markets. 

The proposal sets out a two-part test 

for market participants, one regarding 

the nature of its market activity and 

one regarding the volume of its activ 

ity. FR, 5/19/93, p. 29150. 

Improved Check Settlement 

Procedures 

New procedures approved by the 

FRB, effective January 3,1994, to im 

plement same-day settlement of 

checks, include: a) primary and alter 

nate presentment point services for 

payor banks; b) supplementary payor 

bank information services for checks 

not collected through the Reserve 

Banks; and c) a new Fedwire product 

code to facilitate settlement for 

checks presented to payor banks di 

rectly by private-sector banks. The 

fee structures for the presentment 

point and information services will in 

clude daily minimum and variable 

fees. A paying bank will be required 

to settle for checks presented by 8 

a.m. local time at a location desig 

nated by the paying bank on the same 

business day without charging a pre 

sentment fee unless it returns the 

checks before the time for settlement. 

Regulation CC allows banks to vary 

provisions of the regulation by agree 

ment. FR, 6/3/93,p. 3/525; BBR,5/31,p.794. 

Withdrawals From a 

Priced Service Line 

The FRB adopted factors for 

evaluating Federal Reserve Banks1 

44 
Recent Developments 

requests to withdraw from a priced 

Federal Reserve service line, effec 

tive October 29, 1992. Normally, 

these factors would be applied after a 

Reserve Bank determines that it can 

no longer comply with the FRB's 

pricing principles. The Monetary 

Control Act of 1980 requires chat fees 

for Federal Reserve-priced services 

be established on the basis of all direct 

and indirect costs, including a PrivateSector Adjustment Factor. 

The withdrawal factors are un 

changed from the factors proposed by 

the FRB in July 1992 (see this Review, 

Fall/Winter 1992, p. 44). They are 

listed as: a) it is likely that other ser 

vice providers would supply an ade 

quate level of the same service, in 

respect to access, price, and quality, in 

the relevant market(s) if the Federal 

Reserve withdraws from the service; 

b) if other service providers are not 

likely to provide an adequate level of 

the same service in the relevant mar 

kers), it is likely that users of the 

service could obtain other substitu

table services that could reasonably 

meet their needs; c) withdrawal from 

the service would not have a mat 

erial, adverse effect on the Federal 

Reserve's ability to provide an ade 

quate level of other services, or on the 

System's ability to discharge other re 

sponsibilities; and d) the public ben 

efits of continued Federal Reserve 

provision of the service do not out 

weigh the benefits of withdrawing 

from the service. 

If any other public benefit, not ad 

dressed under the previous factors, 

were identified that could be achieved 

through continued provision of the 

service, the FRB would consider 

whether the public benefit outweighed 

the withdrawal benefits. FR, 11/6/92, p. 

53/13; 11J12, p. 53141. 

The FRB approved the Federal 

Reserve Banks' proposal to withdraw 

from the priced definitive securities 

safekeeping service by year-end 1993. 

This withdrawal eliminates all priced 

safekeeping, including the safekeep 

ing of definitive securities pledged to 

state and local governments, but does 

not affect the safekeeping of collateral 

pledged to the discount window, to 

the Treasury Department, or to 

Federal Government agencies. Sec 

ondary market purchase and sale of 

securities, which is currently included 

in the definitive securities service 

line, will continue to be offered but 

will be included under another ser 

vice line after 1993. FR, Iil6/92,p. 531/5. 

Office of the Comptroller 

of the Currency 

Inter-Agency Policy on 

Credit Availability 

The OCC, FDiC, FRB, and OTS 

announced a program directed at 

dealing with problems of credit avail 

ability, especially for small and 

medium-sized businesses, involving 

regulatory and other administrative 

changes which are summarized in part 

below. 

1. Eliminating Impediments to 

Loans to Small and Medium-Sized 

Businesses. Strongand well-managed 

banks and thrifts will be permitted to 

make and carry a basket of loans with 

minimal documentation requirements, 

consistent with applicable law. To en 

sure that these loans are made to small 

and medium-sized businesses, there 

will be a ceiling on the size of such 

loans and limits on the aggregate of 

such loans a bank may make. 

2. Reducing Appraisal Burden and 

Improving the Climate for Real Es 

tate. The agencies will alter their real

sstate appraisal rules so as not tc 

require an appraisal by a licensed or 

certified appraiser for certain loans, 

when obtaining an appraisal may in 

crease the cost of credit significantly, 

or cause a loan not to be made, or if 

the appraisal is counterproductive from 

a safety-and-soundness perspective. 

As a matter of policy, loans secured by 

real estate should be evaluated based 

on the borrower's ability to pay over 

time, rather than a presumption of 

immediate liquidation. 

3. Enhancing and Streamlining 

Appeals and Complaint Processes. 

Each agency will ensure that its 

appeals process provides a fair and 

speedy review of examination com 

plaints and that there is no retribution 

against either the bank or the exam 

iner as the result of an appeal. Com 

plaint processes will be reviewed to 

improve both the care with which 

complaints are scrutinized and the 

timeliness of responses. 

4. Improving Examination Process 

and Procedures. The agencies have 

agreed, in particular, to: eliminate 

duplication in examinations by multi 

ple agencies, unless clearly required 

by law; increase coordination of 

examinations among the agencies 

when duplication is required; and es 

tablish procedures to centralize and 

streamline examination in multibank 

organizations. 

5. Continuing Further Efforts and 

Reducing Burden. Under current 

practice, delinquent loans that have 

been partially charged off cannot be 

returned to performing status even 

when the borrower is able to, and fully 

intends to, pay the remaining interest 

and principal to the bank in a timely 

fashion. The agencies will work to 

develop common standards for deter 

mining when a loan may be returned 

to accrual status, ^//regulations and 

interpretations are being reviewed to 

minimize burden while maintaining 

safety-and-soundness standards. 

The agencies will work to com 

plete virtually all of the changes out 

lined above within the next three 

months. Once the specifics of any of 

the changes are agreed upon, that 

change will be made and published, 

before the completion of other chan 

ges. Joint Release, OCC, FDIC, FRB, OTS, 

3/10/93. 

The federal regulators of banks 

and thrifts announced additional ini 

tiatives to implement the President's 

program to improve the availability of 

credit to businesses and individuals. 

These initiatives include changes to 

regulatory reporting requirements 

and the issuance of joint policy state 

ments on the valuation of real-estate 

collateral, use of the "Special Men 

tion" category in reviewing loans, and 

improved coordination of examinations. 

45 
FDIC Banking Review 

Joint Release, OCC, FDIC, FRB, and OTS, 

6110/93. 

Inter-Agency Policy on 

Documentation ofLoans 

The OCC, FDIC, FRB, and OTS 

announced further details on the im 

plementation of their March 10 pro 

gram to increase credit availability. 

The strongest banks and thrifts, those 

with regulatory ratings of 1 or 2 and 

with adequate capital, will now be 

able to make and carry some loans to 

small and medium-sized businesses 

and farms with only minimal docu 

mentation. The total of such loans at 

an institution will be limited to an 

amount equal to 20 percent of its total 

capital. These loans will be evaluated 

solely on the basis of performance and 

will be exempt from examiner criti 

cism of documentation. Each minimal 

documentation loan is subject to a max 

imum loan size of $900,000 or three 

percent of the lending institution's 

total capital, whichever is less. If a 

borrower has multiple loans in the ex 

empt portion of the portfolio, those 

loans must be aggregated before the 

maximum is applied. 

The package also offers some relief 

for banks that do not qualify for the 

program, and for loans that are not in 

the exempt portion of a bank's port 

folio. The policy statement also in 

cludes guidelines which provide 

institutions some additional flexibi 

lity in applying their documentation 

policies for small and medium-sized 

business and farm loans without ex 

aminer criticism. Joint Release, OCC, FDIC, 

FRB, OTS, 3/30/93. 

New Proceduresfor Identifying 

Mortgage-Lending 

Discrim in ation 

The OCC adopted new examina 

tion procedures, effective immediately, 

for use in identifying discrimination 

in home mortgage loans by national 

banks. The procedures focus on the 

way banks deal with a "middle group" 

of applicants, i.e., not those who are 

either clearly qualified or unqualified, 

but rather applicants who might qual 

ify for a loan but had some problem or 

weakness in their loan applications. 

The procedures deal only with home 

mortgage loans, because those are the 

only loans for which banks are permit 

ted to collect information about the 

race and national origin of the appli 

cant. In addition, statistical analysis of 

loan decisions will be developed for 

use in augmenting the examination 

procedures at large banks. Also, the 

OCC will review bank activities to 

determine how potential borrowers are 

treated before they file a loan applica 

tion. To that end, a pilot program will 

employ minority and non-minority 

"testers" to identify discrimination in 

the pre-application process. NewsRelease, 

OCC, 5/5/93. 

Inter-Agency Group to Study 

Mortgage-Lending 

Discrimination 

HUD Secretary Henry G. Cisneros 

and Comptroller of the Currency 

Eugene A. Ludwig announced the 

formation of a working group to 

strengthen efforts to counter discrim 

ination in mortgage lending. The group 

has 60 days to submit its report. A key 

feature will be a technology and infor 

mation exchange. HUD will share 

with OCC its testing methods learned 

from its support of private fair housing 

groups and state and local fair housing 

agencies. OCC will share with HUD 

the results of its Home Mortgage Dis 

closure Act (HMDA) analysis. The 

HMDA data will be used by HUD 

to target lenders in three unnamed 

communities for pre-application test 

ing under the Fair Housing Initiatives 

Program. The OCC will also be test 

ing lenders to determine the extent of 

discrimination by mortgage lenders in 

the pre-application process. Through 

the working group, HUD and OCC 

will work to develop an inter-agency 

definition of what constitutes lending 

discrimination for purposes of the 

Equal Credit Opportunity Act (en 

forced by financial institution regu 

lators) and the Fair Housing Act 

(enforced by HUD). Joint Release, HUD 

andOCC,5/18/93. 

New Rule Proposed 

on Real-Estate 

Appraisals 

The OCC, FDIC, FRB and OTS 

proposed amending their regulations 

on real-estate appraisals to reduce 

regulatory burden. The proposed rule 

would: a) increase the threshold level 

for required appraisals from $100,000 

to $250,000; b) expand and clarify ex 

isting exemptions to appraisal re 

quirements; and c) identify additional 

circumstances when appraisals are not 

required. 

The proposed rule would limit di 

rect and indirect costs of real-estate 

appraisals to borrowers, costs that the 

agencies said can restrict the availabil 

ity of credit. Business loans under $1 

million secured by real estate would 

not require appraisals when realestate collateral is not the primary 

source of repayment. The proposed 

rule exempts from the agencies' realestate appraisal requirements transac 

tions thatare insured orguaranteed by 

a U.S. Government agency or govern 

ment-sponsored agency, and reduces 

the number of minimum standards for 

the performance of real-estate apprai 

sals. Joint Release, OCC, FDIC, FRB, OTS, 

5/26/93; FR, 6/4,p. 31878. 

Capital Treatment of 

Intangible Assets 

The OCC amended its risk-based 

capital guidelines, effective March 29, 

1993 to replace certain criteria used 

in determining qualifying intangi 

ble assets with a specific list of qual 

ifying intangible assets. Among the 

amendments are increasing the limi 

tation on all qualifying intangible as 

sets from 25 percent to 50 percent of 

Tier 1 capital of which purchased 

credit-card relationships can consist 

of no more than 25 percent of Tier 1 

capital. Qualifying intangible assets 

must be valued at least quarterly at 

the lesser of 90 percent of the fair 

market value or 100 percent of the 

46 
Reuent Developments 

remaining unamortized book value. 

FR. 3129191, p. 16481. 

Risk-Based Capital: 

Multifamily Housing 

Loans 

The OCG issued a proposal, 

implementing RTCRRIA, to permit 

national banks to hold less capital 

against certain loans secured by qual 

ifying multifamily residential property, 

by including such loans in the 50 per 

cent risk-weight category. Certain 

privately issued mortgage-backed se 

curities (MBSs) would qualify fora 50 

percent risk-weight if, at the time of 

origination of the MBSs, they are 

secured by qualifying multifamily 

residential property loans that have 

performed in accordance with the terms 

of the loans for at least one year. FR, 

9/17/92. p. 42901. 

Changes in Directors and 

Executive Officers 

The OCC issued a final rule, effec 

tive May 10, 1993, which continues 

the requirement that national banks, 

within certain specified categories, 

file notices with the OCC prior to 

adding or replacing members of their 

boards of directors or prior to employ 

ing individuals as senior executive of 

ficers or changing the responsibilities 

of individuals from one senior execu 

tive position to another. The OCC 

also requested comments on a pro 

posed modification to the definition 

of change in control. ^7?. 51! 0/93,p. 27443. 

Prompt Corrective Action 

The OCC issued procedures for 

implementing the "prompt corrective 

action" provisions of Section 38 of 

the Federal Deposit Insurance Act, as 

added by Section 131 ofFDICIA.The 

legislation establishes a system of PCA 

that classifies insured depository in 

stitutions into five categories based 

on their relative capital levels. Regu 

lations to implement PCA have been 

adopted also by the FRB, FDIC, and 

OTS (see this Review, Fall/Winter 1992, 

p. 36). BankingCinuIar 268\ OCC, 2/25/93. 

Supreme Court Upholds 

Banks' Power to Sell 

Insurance in Small Towns 

The U.S. Supreme Court over 

turned a decision by the U.S. Court of 

Appeals for the District of Columbia 

that Congress in 1918 had repealed a 

1916 law that permits banks in towns 

not exceeding 5,000 in population to 

sell insurance. 

The case now returns to the Ap 

peals Court for its consideration of a 

ruling by the OCC in 1986 allowing 

national banks to sell insurance na 

tionwide from a branch located in a 

small town. WSJ, 6/8/93,p. A4, 

The Appeals Court decided that 

no law prohibits the OCC from per 

mitting the selling of insurance na 

tionwide by national banks in towns 

with 5,000 persons or less. AB. 7/19/93, 

p. I. 

Securities Offerings 

Disclosure 

The OCC proposed revising its 

regulations governing the disclosure 

requirements for offers and sales of 

national bank securities. Regulations 

detailing the contents of offering doc 

uments covering national bank se 

curities would be eliminated, and 

instead offering documents would 

have to contain the information that 

would be required by the appropriate 

Securities and Exchange Commission 

(SEC) form for registration. Also pro 

posed is the cross referencing of cer 

tain definitions and exemptions in the 

Securities Act of 1933 as well as a 

number of SEC rules. The proposal 

seeks to treat national bank securities 

more like those of other corporations 

and eliminate a duplicative system of 

regulations and forms. FR, JO/15/92, p. 

47280. 

Procedures for Bank Mergers 

and Consolidations 

The OCC issued an interim rule, 

effective November 3, 1992, and re 

quested comments on procedures for 

national banks to follow in undertak 

ing mergers or consolidations with 

federal savings associations. This 

action is necessitated by FDICIA, 

which authorized such transactions but 

did not establish procedures. 

This authority to merge or consoli 

date with a federal savings association 

supplements the long-established au 

thority of national banks to engage in 

purehase-and-assumption transac 

tions with federal and state-chartered 

depository institutions, including sav 

ings associations, and to merge or con 

solidate with other national banks and 

with state-chartered banking institu 

tions, including savings associations 

engaged in the business of receiving 

deposits. FR, 11/3/92,p. 49639. 

Receiverships 

The OCC is removing its receiver 

ship regulation, effective December 

19, 1992. This regulation defines two 

possible insolvency tests the OCC 

may consider in determining whether 

to appoint a receiver for a national 

bank, these being a "net worth insol 

vency" test and a "liquidity insolven 

cy" test. Under the regulation, the 

OCC may also use alternate methods 

to determine whethera national bank 

is insolvent. Section 133 of FDICIA 

provides the OCC, and the other fed 

eral banking agencies, with uniform 

grounds for appointing either a con 

servator or a receiver. Some of these 

grounds are similar to, and have the 

same effect as, the net worth test and 

the liquidity test in the regulation. FR, 

12114/92, p. 58972. 

Proposal Would Eliminate 

Duplicative Reportingt 

Require Explanation of 

Mortgage Denials 

A proposed rule would eliminate 

the monthly reports on home mortgage 

loan activity required for national banks 

subject to the reporting requirements 

of HMDA. The rule would require 

national banks to report the reason for 

denial of a home mortgage loan. Under 

the existing regulation, this information 

is optional. National banks also would 

be required to update their HMDA 

loan/application registers within 30 cal 

endar days after a decision is made on 

a loan application. News Release, OCC, 5/10/93; 

FR, 5/10, p. 27484. 

47 
FDIC Banking Review 

Deductions for Tax Losses 

The documentation burdens on in 

stitutions filing for tax deductions for 

their loan losses are being reduced 

under a new procedure. In most cases, 

institutions have supported their bad 

debt deductions with internal docu 

mentation. Under an agreement an 

nounced by the OCC, FDIC, FRB, 

and OTS, when examiners find an 

institution's loan-loss classification 

standards to be consistent with reg 

ulatory standards regarding loan 

charge-offs, examiners are authorized 

to provide, upon request, a letter to 

the institution at the conclusion of the 

examination that expressly states this 

finding. The IRS will accept these 

"express determination" letters, en 

abling banks and thrifts to establish 

for federal income tax purposes a con 

clusive presumption of worthlessness 

for loans that have been charged off 

for regulatory reporting purposes. Joint 

Release, OCC, FDIC, FRB OTS, PR-140-92, 

FDIC, 10/5/92. 

Office of Thrift Supervision 

Encouraging Lending to Lowand Moderate-Income 

Home Buyers 

In a letter to all savings institutions 

regulated by the OTS, Acting Director 

Jonathan L. Fiechter discussed steps 

by the agency and the thrift industry 

to increase the availability of home 

loans to low- and moderate-income 

home buyers. 

Director Fiechter said the OTS will 

do the following: 

a) review the risk profile and pro 

fitability of affordable housing lend 

ing over the past several years, and 

identify particular techniques or char 

acteristics that have been associated 

with successful programs; 

b) develop a specialized program 

for safety-and-soundness examiners 

to help them more effectively evalu 

ate and understand affordable hous 

ing lending; 

c) continue working with an interagency affordable housing task force 

that is, among other projects, examin 

ing regulatory and other barriers to 

affordable housing lending; 

d) explore methods to better un 

derstand the affordable housing lend 

ing performance of the thrift industry 

using HMDA data and other tools; 

e) endeavor to improve the CRA 

examination process and explore how 

it can be made more objective and 

focused on lending performance, with 

particular mention of documentation 

cost and burden that hinder the deliv 

ery of credit to underserved commu 

nities; and 

f) consult with industry and com 

munity groups to solicit ideas and input 

on OTS' initiatives. NEWS, OTS,5/7/93. 

Measures to Improve 

Credit Availability 

In a move to make credit more 

readily available, the OTS adopted a 

regulation to reduce the paperwork 

and make it easier for many small and 

medium-sized businesses and farms 

to get loans from savings associations. 

The regulation implements a policy 

statement issued by OTS and the 

other federal banking regulators on 

March 10, 1993 (see OCC heading). 

While the rule is effective immedi 

ately, the OTS asked for public com 

ment during a 30-day period. NEWS, 

OTS, 51/3/93. 

Qualified Thrift Lender Test 

The OTS amended its regulations 

governing the Qualified Thrift Lender 

(QTL) test to implement changes con 

tained in FD1CIA, effective Decem 

ber 19, 1991. The rule lowers thrifts' 

required "actual thrift investment per 

centage" (ATIP) of housing-related 

investments from 70 percent to 65 

percent. It also expands the list of 

items includable as qualified thrift in 

vestments (QTI) and increases cer 

tain QTI percentage "baskets." The 

FDICIA amendments also changed 

the measuring period over which a 

thrift's ATIP is computed, setting a 

measuring period of 9 out of every 12 

months. 

OTS will continue to consider re 

quests for temporary QTL waivers, 

on a case-by-case basis. An association 

seeking such a waiver, however, must 

demonstrate that it is unable to com 

ply in a timely manner with the new 

test safely and soundly as a result of 

national, regional or market sector 

economic conditions. Transm'utalNo. 81, 

OTS, 3126/03; FR, 3/19, p. J5082. 

Capital Treatment of 

Equity Investments 

The OTS changed its risk-based 

capita] treatment of certain equity in 

vestments to parallel the capital treat 

ment of those investments under the 

rules applicable to national banks, ef 

fective April 19,1993. Savings associa 

tions will no longer be required to 

deduct certain equity investments from 

capital and from total assets when 

computing their risk-based capital. In 

stead, such equity investments, de 

fined as those that are permissible for 

both savings associations and national 

banks, are now placed in the 100 

percent risk-weight category. Three 

types of equity investments most af 

fected by the change are: Fannie Mae 

stock, Freddie Mac stock, and certain 

loans with equity participations that 

give lending institutions a stake in the 

profits of a property or project. Trans

mittalNo. 82, OTS, 3/26/93; FR, 3/19, p. 15085. 

Valuation and Regulatory 

Capital Treatment of 

Foreclosed Assets 

The OTS is revising its policy 

guidance to require savings associa 

tions to use fair value rather than net 

realizable value for valuing foreclosed 

assets subsequent to acquisition, ef 

fective December31,1992. The OTS 

also is amending its capital regulation 

to place all assets previously assigned 

to the 200 percent risk-weight cate 

gory, including foreclosed assets, into 

the 100 percent risk-weight category. 

The changes will make the account 

ing treatment of foreclosed assets 

consistent with generally accepted 

accounting principles as applied by 

the other federal banking agencies, 

and the capital treatment of certain 

items, including foreclosed assets, 

consistent with that accorded these 

assets by the other federal banking 

agencies. FR, 1/6/93, p. 474. 

48 
Recenc Developments 

Capital: Concentration Risk business persons in conducting the insider participating in or benefiting 

and Risk ofNontraditional affairs of the institution. The OTS from a transaction has acted in full 

Activities said it will not bring civil claims conformity with his or her fiduciary 

against directors and officers who ful duties." The OTS solicited comments, 

pursuant to Section 305 of FDICIA, 

on amending the agency's capital reg 

ulation to take adequate account of 

concentrations of credit risk and the 

risks of nontraditional activities. The 

statute also requires that the OTS de 

velop a final rule on interest-rate risk, 

which is being treated separately. 

This initiative is being undertaken on 

acoordinated basis with theocher fed 

eral banking agencies. 

Among the several issues are what 

factors should be taken into account 

in defining concentrations of credit 

risk for risk-based capital purposes, 

i.e., industry, geography, collateral, 

and loan type. Also, how risk-based 

capital standards should be revised, 

if at all, to take adequate account of 

concentrations of credit risk. The 

agencies' risk-based capital regulations 

will be amended to explicitly incorpo 

rate the risks of nontraditional activi 

ties. Among the issues are what the 

OTS should consider to be a non

traditional activity, and what factors 

should be taken into account when 

evaluating the risk of such activities. 

FR, 1015192, p. 45757. 

Duty Guidelines for 

Officers and Directors 

The OTS issued guidelines deal 

ing with the responsibilities of those 

who serve as directors and officers of 

federally insured savings and loan as 

sociations. The OTS noted the need 

for all thrifts to be able to attract and 

retain experienced and conscientious 

directors and officers. Similar to the 

responsibilities owed by directors and 

officers of all business corporations, 

they have a duty of loyalty, which 

requires directors and officers to ad 

minister the affairs of the institution 

with candor, personal honesty and 

integrity. They are prohibited from 

advancing their own personal or busi 

ness interests, or those of others, at 

the expense of the institution. The 

duty of care requires directors and of 

ficers to act as prudent and diligent 

fill their responsibilities and make 

business judgments on a fully informed 

basis and after proper deliberation. 

Claims against directors and officers 

of thrifts are made following a de 

tailed investigation. In most cases, the 

OTS attempts to alert proposed de 

fendants in advance of filing claims in 

order to permit them to respond to 

proposed charges informally and to 

discuss the prospect of prefiling reso 

lution of the proposed claims. 

One factor considered in deter 

mining whether to bring an action 

against a director is the distinction 

between inside and outside directors. 

The most common claims brought 

against outside directors either in 

volve insider abuse or situations where 

the directors were on notice of cir 

cumstances existing at the institution 

that require correction and failed to 

take steps to implement corrective 

measures after receiving such notice. 

NEWS, mid attacked Statement, OTS, 11116/92. 

Loans to Officials and 

Shareholders of Savings 

Associations 

The OTS amended its regulations 

pertaining to extensions of credit by 

savings associations to their executive 

officers, directors, and principal 

shareholders, and their related inter 

ests. The amendments incorporate 

the relevant provisions of the FRB's 

Regulation O. Effective November 5, 

1992, the rule limits individual loans 

to 15 percent of unimpaired capital 

and unimpaired surplus for loans that 

are not fully secured, and an addition 

al ten percent of capital and surplus 

for fully secured loans. The overall 

lending limit to insiders would be 100 

percent of unimpaired capital and 

unimpaired surplus, but for institu 

tions with deposits of less than $100 

million, the limit could be as high as 

200 percent of capital and surplus. 

The rule states, however, that "sim 

ply because a transaction satisfies the 

quantitative and procedural require 

ments . . . does not mean that an 

The OTlS will not adopt at this 

time an additional rule, also proposed, 

that would govern business transac 

tions, other than extensions of credit, 

between savings associations and their 

insiders. FR, 10/6/92, p. 45977; BBR, 10/12, 

p.535. 

Sales of Securities at Savings 

Association Offices 

The OTS adopted amendments to 

prohibit sales of the securities of a 

savings association or its affiliates in 

any office of the association except for 

sales of stock in connection with the 

association's conversion from the mu 

tual to the stock form of organization, 

and subject to certain conditions. One 

customer safeguard is the use of a 

signed acknowledgment form before 

purchase, stating that the securities 

purchaser is aware that the security is 

not a deposit or account, is not feder 

ally insured, and the purchaser has 

received an offering circular that de 

scribes the offering and its risks. FR, 

10/7/92, p. 46085. 

Operating Subsidiaries and 

Service Corporations 

The OTS adopted regulations, ef 

fective November 30, 1992, to author 

ize federal savings associations to 

establish and acquire "operatingsub 

sidiaries." These subsidiaries may en 

gage only in activities authorized for 

all federal associations to undertake 

directly. The conditions are specified 

under which a federal association may 

establish an operating subsidiary, cer 

tain aspects of the service corporation 

regulations are clarified, and some re 

strictions are removed involving loans 

and other transactions by service cor 

porations. FR, JO/29/92, p. 48942. 

Appeals Court Reverses 

Decision on Goodwill 

A federal appeals court panel re 

versed a ruling by a U.S. claims court 

judge in July 1992 that FIRREA ab 

rogated a contract between the gov 

ernment and Glendale Federal Bank 
FDIC Banking Review 

involving the right of thrifts to count 

"supervisory goodwill" as capital (see 

this Review, Fall/Winter 1992, p. 48). 

The claims court had ruled that the 

government was liable for damages or 

restitution for the monetary losses and 

loss of business suffered by Glendale. 

The appeals court said the lower court 

incorrectly applied the doctrine of 

sovereign immunity, and also the 

thrifts, in their negotiations with reg 

ulators, failed to protect themselves 

from the possibility that Congress 

would later change the accounting 

rules. WSJ, 5126193,p. C18. 

OTS Repeals Obsolete Rules 

As part of an ongoing program to 

balance the regulatory burden on the 

thrift industry with safety-and-sound

ness considerations, the agency has 

repealed a number of obsolete rules. 

Among the changes are: a) the num 

ber of directors required for a federal 

savings association is reduced from 

seven to five, making the thrift re 

quirement consistent with that for na 

tional banks; b) the regulation that 

governs liability growth is repealed, 

because current OTS policy incorpo 

rates asset growth restrictions that more 

adequately address a thrift's safe-and

sound operations; c) a requirement that 

at any one time the average maturity 

of a federal savings association's port 

folio of corporate debt securities may 

not exceed six years is deleted, be 

cause new capital rules and risk man 

agement policies better control this 

risk; and d) a regulation limiting the 

amount of secured debt that can be 

incurred by service corporations (sub 

sidiaries) of thrift institutions is no 

longer needed because current capital 

requirements are imposed on thrifts 

and most service corporations on a 

consolidated basis. NEWS, OTS, 1/13/93; 

FR, 1114, p. 4308. 

Supervisory Conversions 

Amendments to the agency's regu 

lations generally are expanding the 

number of capital-deficient, mutual 

savings associations eligible to under 

take voluntary supervisory mutual-to

stock conversions. The rule establishes 

required post-conversion capitalization 

standards, revises the approval stan 

dards, and reduces the documentary 

burden and expense imposed by 

the current requirement for interim 

audited balance sheets and certain 

accounting opinions. Effective: Decem 

ber 2, 1992. FR, Il/2/92,p. 49377. 

Savings Association 

Membership in 

FHLBank System 

The OTS adopted a final rule 

under which, beginning in two years, 

membership in a Federal Home Loan 

Bank will no longer be required for 

state-chartered savings associations. 

Mandatory membership for federally 

chartered savings associations and 

savings banks will remain in effect 

under existing law. There are now 

about 1,300 federal S&Ls. 

An estimated 600 state-chartered 

institutions would be able to leave the 

system, starting in 1995. About 1,300 

commercial banks and 25 credit 

unions have joined the system since 

they were made eligible by FIRREA. 

There are also 360 state savings bank 

members, also voluntary, concen 

trated in the Northeast. Officials do 

not expect a mass flight of state-char 

tered S&L members. It is anticipated 

that turnover will be light, and 600 or 

more commercial banks will become 

members over the next two years. 

Transmit/a/ No. 80, OTS, 3126193; FR, 3/18, p. 

145W;AB,3/!9,p.2. 

S&L Charter Conversions 

Continue 

During the last 18 months, 91 state 

and federal savings and loan associa 

tions have switched to savings bank 

charters {as of Fall 1992). Institutions 

converting represent about 5 percent 

of the total number of private-sector 

thrifts, and their assets aggregating 

$18.5 billion are 2 percent of the in 

dustry. An additional 30 S&Ls have 

applications to convert pending at 

OTS, and another is seeking to change 

to a commercial bank. These 31 S&Ls 

have assets of $5.2 billion. Twenty 

states and Puerto Rico issue savings 

bank charters. Since North Carolina 

passed a law in 1991, there have been 

29 conversions in the state, and 11 are 

pending. Pennsylvania has had 21 

conversions, with eight pending, and 

in Illinois, 19 with three pending. 

The deposits of converted thrifts 

remain federally insured; however, 

the institutions would change from 

beingregulated andsupervised by the 

OTS to regulation and supervision by 

the states and the FDIC. An advan 

tage of the savings bank charter cited 

by some executives is the option to 

use "bank" in the name of an institu 

tion. Also, the conversion would save 

the costs of examinations charged by 

the OTS. For example, for a $100-mil

lion asset S&L, the annual savings on 

supervisory and examination fees from 

conversion would be about $25,000. 

AB, 1112192,p. /. 

Study of Thrift Industry 

Viability 

A study by OTS' Research Divi 

sion examines the expected profit 

ability of thrifts in the future as 

adjustable-rate and as fixed-rate mort 

gage portfolio lenders. From 1987 to 

1992, thrifts engaged in fixed-rate 

lending were more likely to earn 

higher returns than those engaged in 

other business strategies and were 

more likely to be among those institu 

tions that consistently performed well 

over time. However, since then com 

petitive pressures have driven down 

mortgage lending spreads. The need 

to control interest-rate risk further 

reduces the profitability of holding 

fixed-rate loans. The result is that 

while properly priced adjustable-rate 

lending will continue to be profitable, 

fixed-rate loans held in a thrift's port 

folio will continue to be profitable 

only for lenders with tight cost con 

trols. Stricter management controls 

over operating costs may achieve the 

needed results. Otherwise, greater 

efficiency may have to be realized 

through the economies of larger scale 

operations that would result from 

further industry consolidation, NEWS, 

OTS, II5193; The Viability of the Thrift Industry, 

OTS, 41 p., December 1992. 

50 
Recem Develop men is 

Federal Financial Institutions 

Examination Council 

Report on Regulatory Burden 

The FFIEC invited public com 

ment, and conducted a series of pub 

lic meetings pursuant to Section 221 

of FDICIA, in connection with a 

study of the regulatory burden im 

posed on insured depository institu 

tions. In its report to Congress in 

December, the FFIEC said that the 

four federal banking agencies and the 

Treasury Department have under 

taken extensive reviews of their poli 

cies, procedures, recordkeeping and 

documentation requirements. The 

Council found that the annual cost of 

regulatory compliance may be as high 

as $17.5 billion, or up to 14 percent 

of total noninterest expenses of the 

banking industry in 1991. Over 60 

specific initiatives were recommend 

ed which the agencies could under 

take themselves to relieve individual 

burden requirements. Those initiatives 

are in addition to the numerous ac 

tions the agencies have taken during 

the past year. Many aspects of regula 

tory burden flow not solely from the 

agencies themselves, but rather are 

imposed through legislation. The 

Council's member agencies have 

agreed to continue meeting to iden 

tify and recommend possible sta 

tutory changes to reduce regulatory 

burden further. Study on Regulatory Burden. 

FFIEC, 12117/92. 

Disclosure ofEstimated 

"Fair Values" 

Section 121 of FDICIA requires 

the federal bank and thrift regulatory 

agencies to develop jointly a method 

for insured depository institutions to 

provide disclosures of the estimated 

"fair value" of their assets and liabili 

ties, to the extent feasible and practi 

cable, as supplemental information in 

certain reports filed with the agencies. 

To implement the law, the FFIEC 

is requesting public comment on 

whether it is feasible and practicable 

for banks and savings associations to 

include supplemental fair value dis 

closures for their on- and off-balance

sheet assets and liabilities on an 

annual basis in their Call Reports and 

Thrift Financial Reports (TFRs). In 

particular, comment is requested on 

the additional costs (both start-up and 

annual) that individual institutions 

would expect to incur if they are re 

quired to estimate the fair values of 

their assets and liabilities for purposes 

of theii Call Reports and TFRs. 

The FFIEC also sought comment 

on whether those insured institutions 

that will be required to file annual re 

ports pursuant to Section 112 should 

provide supplemental fair value dis 

closures for their assets and liabilities 

in these reports, in accordance with a 

proposed method developed jointly 

by the regulatory agencies. Section 

112 applies to institutions with $150 

million or more in total assets or such 

higher amount as the FDIC may deter 

mine. Under the proposed method, 

institutions subject to the Section 112 

annual report requirement would in 

clude in their audited, annual GAAP 

financial statements the disclosures 

about fair values of financial instru 

ments that currently are prescribed by 

FASB Statement No. 107. In addi 

tion, supplemental unaudited disclo 

sures about fair values of nonfinancial 

assets and liabilities would accompany 

the annual financial statements and 

would be made by applying the con 

cepts and principles in Statement No. 

107 and other relevant GAAP stan 

dards. Comment is specifically re 

quested on whether it is feasible and 

practicable for institutions to provide 

these disclosures for nonfinancial as 

sets and liabilities in their Section 112 

annual reports. FIL-33-93, FFIEC, 513/93: 

FR, 4113, p. 19257. 

Policy Statement on Money 

Laundering 

The FDIC, FRB, OCC and OTS 

adopted a policy statement issued by 

the FFIEC on the use of large-value 

funds transfers for money laundering. 

Historically, law enforcement efforts 

to curtail money-laundering activities 

have focused on the identification 

and documentation of currency-based 

transactions; however, recent investi 

gations have focused on the use of 

funds transfer systems. The FFIEC is 

encouraging all domestic banking of 

fices to implement recommendations 

developed by the Financial Action 

Task Force when sending payment 

orders over funds transfer systems. 

FATF is primarily developing inter 

national guidelines to facilitate the 

identification and prosecution of 

money-laundering activities. Finan 

cial institutions should include, to the 

extent practical, complete originator 

and beneficiary information when 

sending payment orders over any 

funds transTer system, including 

Fedwire, CHIPS, SWIFT, and any 

proprietary networks. FIL-I6-93, FDIC, 

3/4/93; Press Release, FFIEC, 3111: FR, 3/17, p. 

14400. 

Reporting of Small-Business 

and Small-Farm Lending 

The FFIEC approved annual re 

porting requirements for insured de 

pository institutions, including banks, 

thrifts, and U.S. branches of foreign 

banks, on bans to small businesses 

and small farms. The requirements, to 

be effective on the June 30, 1993 re 

port date, would implement Section 

122 of FDICIA. 

In general, the institutions would 

be required to report information 

once each year as of June 30 on the 

number and amount currently out 

standing of: (a) nonfarm nonresiden

tial real-estate loans and commercial 

loans with original amounts of 

$100,000 or less, more than $100,000 

through $250,000, and more than 

$250,000 through $1 million and (b) 

agricultural real estate and agricul 

tural loans with original amounts of 

$100,000 or less, more than $100,000 

through $250,000, and more than 

$250,000 through $500,000. Thus, 

business loans with "original amounts" 

of $1 million or less and farm loans 

with "original amounts" of $500,000 

or less would serve as proxies for loans 

to small businesses and small farms. 

FR, 11// 7/92, p. 54235. 

Electronic Funds Transfer 

(EFT) Systems 

The FFIEC issued a statement on 

the risks associated with switch and 

network services in retail electronic 

51 
FDIC Banking Review 

funds transfer (EFT) systems. An EFT 

network is the combination of inter 

connected terminals and computers 

that process fund transfers and other 

electronic messages among participat 

ing financial institutions. The switch is 

the computer system that facilitates 

the transfer of these electronic mes 

sages between the terminals and the 

appropriate participants. Financial in 

stitutions are responsible for ensuring 

that there are sufficient controls cov 

ering switch processing, that contracts 

adequately define participants' liabil 

ities and responsibilities, and that 

settlement procedures do not pose 

undue risk to an institution. The con 

trols are listed that should be in place 

in an EFT switch or network services 

environment. Examiners will eval 

uate EFT switches and network ser 

vices during the regular supervisory 

review of each institution. F1L-30-93, 

FDIC, 4/29193; Press Release, FFIEC, 4/7. 

"A Citizens Guide to the 

CRA" 

The FFIEC issued a revised edi 

tion of its 1986 booklet that discusses 

the coverage of the Community Rein 

vestment Act, policy framework, and 

requirements in respect to financial 

institutions and supervisory agencies. 

It also provides information on how 

the public can be involved in the CRA 

process by communicating with their 

local financial institutions and the 

regulators, and how the agencies con 

sider public input when acting on ap 

plications from institutions. FIL-73-92, 

FDIC, 10/19/92. 

National Credit Union 

Administration 

Truth in Savings 

The NCUA proposed a new regu 

lation to implement the Truth in Sav 

ings Act (TISA). The Act requires all 

credit unions to disclose fees, divi 

dend (or interest, if applicable) rates 

and other terms concerning accounts 

to members or potential members 

before they open accounts. TISA re 

quires credit unions that provide 

periodic statements to members to 

include information about fees im 

posed, dividends (or interest, where 

applicable) earned and the annual 

percentage yield earned on those 

statements. TISA imposes substan 

tive limitations on the methods used 

by credit unions to determine the 

balance on which dividends are calcu 

lated. Rules dealing with advertise 

ments for accounts are also included 

in the law. 

Section 272(b) of TISA mandates 

that the NCUA's regulations must be 

"substantially similar" to those issued 

by the FRB, but the NCUA may 

take into account the unique nature 

of credit unions and the limitations 

under which they may pay dividends. 

FR, 11130/92, p. 56686. 

Court Says Banks Have 

Legal Standing in 

NCUA Case 

The U.S. Court of Appeals for the 

D.C. Circuit ruled that banks have 

legal standing to challenge decisions 

of the NCUA. Four North Carolina 

banks and the American Bankers As 

sociation had opposed the NCUA's 

approval of the expansion of AT&T 

Family Credit Union in Winston 

Salem, claiming that the decision vio 

lated the principle of the common 

bond. The Arkansas Banker, 5193, p.22. 

Reserves 

The NCUA is amending its regu 

lations, effective January 21, 1993, to 

modify the valuation of the allowance 

for loan losses to better conform with 

generally accepted accounting princi 

ples (GAAP). This change will require 

credit unions to provide an allowance 

for loan losses sufficient to cover spe 

cifically identified loans, as well as 

estimated losses inherent in the loan 

portfolio, such as loans and pools of 

loans for which losses are probable, but 

not identifiable on a specific loan-by

loan basis. 

Historically, credit unions have es 

tablished a valuation for the allowance 

for loan losses based strictly on non

performing or delinquent loans. This 

practice, however, is inconsistent with 

GAAP. The NCUA said that greater 

emphasis is needed on complying with 

GAAP through estimating probable 

losses inherent in the total loan port 

folio when calculating a valuation of 

[he allowance for loan losses. FR, 12/22/92, 

p. 60720. 

Frequency of Call Reports 

The NCUA will require, effective 

March 31,1993, federally insured credit 

unions whose assets exceed $50 mil 

lion, to file with the NCUA a quarterly 

Financial and Statistical Report (the 

"call report"). All other credit unions 

will continue to be subject to the cur 

rent requirement of filing a semian 

nual call report. Credit unions whose 

assets exceed $100 million as of March 

31, 1992 are already required to file 

quarterly. FR, 1/22/93,p. 5570. 

Supervisory Committee 

Audits 

The NCUA proposed amending its 

regulations to require independent 

annual audits (opinion audits) for fed 

erally insured credit unions with as 

sets exceeding $50 million, and add a 

nonstatistical sampling option for in 

dependent, licensed, certified public 

accountants in the verification of 

members' accounts consistent with ap 

plicable generally accepted auditing 

standards (GAAS). The supervisory 

committee and/or its auditors would be 

required to provide NCUA the option 

to photocopy working papers support 

ing die audit, and failure to do so could 

result in NCUA rejecting the audit. 

Sections of the current regulation would 

also be amended to more properly re 

flect current accounting/auditing ter 

minology. FR, 416/93, p. 17809. 

Management Official 

Interlocks 

The NCUA proposed amendments 

to its regulation, pursuant to the De 

pository Institution Management In 

terlocks Act, that will affect credit 

unions having interlocking relation 

ships with another type of financial 

institution. The changes implement 

statutorily-mandated exceptions to the 

prohibitions on management inter 

locks. These exceptions relate to 

advisory directors, certain types of 

52 
Recent Developments 

savings associations and savings and 

loan holdingcompanies, interlocks in 

volving diversified savings and loan 

holdingcompanies, and tlie extension 

of the grandfather period under the 

statute. FR, 31819.1,p. 12910. 

Securities Activities 

The NCUA proposed revising its 

high-risk test for Collateralized 

Mortgage Obligations (CMOs) and 

Real-Estate Mortgage Investment 

Conduits (REMICs). CMOs and 

REMICs would be subject to an aver 

age life test, an average life sensitivity 

test (currently in use), and a price sen 

sitivity test. The revised test would 

be consistent with the FFIEC's 

High-Risk Securities Test (HRST) 

for mortgage derivatives, which ap 

plies to other depository institutions 

(see this Review, Spring/Summer 1992, p. 51). FR, 

1122/93. p. 5664. 

Measures to Reduce 

Regulatory Burden 

The NCUA proposed several 

amendments to reduce regulatory bur 

den: the maturity date of investments 

not considered risk assets would be 

extended from three to five years; 

the dollar value for determining when 

loans are subject to the business 

loan regulation to be increased from 

$25,000 to $50,000; recordkeeping re 

quirements for business loans to be 

made consistent with the proposed 

definition of member business loans; 

and the de minimus amount for an ap 

praisal performed by a state-certified 

or licensed appraiser would be in 

creased from $50,000 to $100,000. FR, 

4/26193, p. Z1953. 

State Legislation and 

Regulation 

Court Allows CU Common 

Bond Expansion 

Colorado: A Colorado District 

Court judge ruled that the state Dis 

trict Services Commissioner had the 

discretionary authority under a state 

law to grant the 28,500-member 

Lowry Federal Credit Union a state 

charter and expanded field of member 

ship that includes the entire 222,000 

population of Aurora, Colorado. ABA 

Bankers Weekly, 1/19/93, p. 5. 

Branching Decision Suit 

Dismissed 

Illinois: A U.S. District Court dis 

missed a suit filed by the Community 

Bankers Association that challenged a 

decision in November 1992 by the 

OCC permitting First of America 

Bank-Mclean County, owned by 

Bank of America in Kalamazoo, Mich 

igan, to convert a recently acquired 

savings and loan association into 

branch banks. An official of the state 

bankers association said the decision 

will allow national banks to branch 

statewide, regardless of home office 

protection, and would put state-char 

tered banks at a competitive disad 

vantage. Under the state law, a branch 

may not be established within 200 

yards of the main office of an existing 

bank in any metropolitan market. BI3R, 

2/22/93, p. 234 

Limit on Deposits BHCs 

May Control 

Kansas: A new law allows a bank 

holding company to control up to 15 

percent of deposits in the state, an 

increase from the current limit of 12 

percent, effective upon publication in 

the Statute Book. 

An official of Fourth Financial 

Corp., the state's largest bank holding 

company, said the change would en 

able the company to add about $1 

billion in deposits to its current total 

of $3.8 billion. He noted that 35 states 

have no such cap, and those having 

the cap limit control to an average of 

18 percent. BBR,4H9l93,p.537. 

S&L Regulatory Agency 

Abolished 

Kansas: The Savings and Loan De 

partment and Office of the Commis 

sioner have been eliminated, and their 

responsibilities transferred to the Of 

fice of the State Bank Commissioner 

and the State Banking Board, ef 

fective June 18. By then the S&L 

agency's regulatory constituency may 

have ceased to exist. Of the state's 

13 S&Ls, 11 have applied for federal 

charters, and 2 are expected to be 

sold. BBR, 3/29/93, p. 422. 

CUs Must Obtain 

Deposit Insurance 

Massachusetts: The state Banking 

Commissioner extended for a second 

time a mandate that all Massachusetts 

credit unions, including 33 institutions 

still uninsured, have federal deposit 

insurance. The uninsured credit unions 

are expected to be approved for fed 

eral deposit insurance, merge with 

other institutions, or be liquidated and 

closed by the reset deadline of mid

1993. The Globe, Bosttm, lf/2/93 

Frauds Imw 

Michigan: A law, effective January 

1, 1993, provides that a lawsuit may 

not be brought against a financial in 

stitution to enforce certain promises 

or commitments unless the promise or 

commitment is in writing and signed 

by an authorized signor. Legislative-Legal 

Bulletin, Michigan Bankers Association, 11/30/92. 

Court Upholds Out-of-State 

Export of Credit-Card Fees 

Minnesota: The U.S. Supreme 

Court ruled in favor of defendant 

banks who claimed the right as na 

tional banks to export interest rates 

permitted by their home states to cus 

tomers, regardless of the laws of the 

customers' home states. Minnesota law 

forbids banks from charging late fees 

and charges to credit-card holders for 

OverlimitS. TheArkansas Banter, 2/93. p. 12. 

Joint Examination Agreement 

Mississippi: An agreement, effective 

January 1, 1993, between the Depart 

ment of Banking and Consumer Fi 

nance and the FDiC provides that: a) 

the Banking Department and FDIC 

will jointly develop a tentative exam 

ination schedule annually for the fol 

lowing calendar year; b) the Banking 

Department will independently ex 

amine all state-chartered banks with 

under $500 million in total assets on 

an annual basis; c) the FDIC will con 

duct annual independent examina 

tions of state nonmember banks with 

under $500 million in total assets that 
FDIG Banking Review 

are a cause for supervisory concern as 

dictated by their CAMEL composite 

rating; d) the FDIC will conduct inde 

pendent examinations every other 

calendar year of state nonmember 

banks with under $500 million in total 

assets that are not a cause for supervi 

sory concern; e) the Banking De 

partment and FDIC will examine 

concurrently on an annual basis those 

banks with total assets of $500 million 

or more. The Mississippi Banker, 1193, p. 10. 

Interstate Banking 

Montana: Banks headquartered in 

the seven-state region surrounding 

Montana Idaho, Wyoming, North 

Dakota, South Dakota, Minnesota, 

Wisconsin and Colorado — will be 

allowed to purchase banks in the state 

on a re'ciprocal basis, effective Octo 

ber 1, 1993. Banks which can be pur 

chased must have been in existence at 

least six years. Any out-of-state bank 

holding company's share of total de 

posits in the state is limited to 18 

percent in 1993, increasing by one 

percentage point annually to a peak of 

22 percent in 1997. The total share of 

deposits in the state held by banks 

owned by all out-of-state holding 

companies cannot exceed. 49 percent. 

United States Banker, 5/93, p. 14; AB, 4/14, p. 12. 

Banks' Environmental 

Liability Is Limited 

New Jersey: In foreclosures, a new 

law allows lenders to take any actions 

necessary to protect a property's value 

prior to sale without incurring liability 

for past environmental damage on the 

property. The lender is shielded pro 

vided it did not actively participate in 

the management of the property prior 

to foreclosing on it. BBR, 5/24/93, p. 762. 

Low-Cost Checking 

New Jersey: Effective December 1, 

1992, all commercial banks, savings 

banks, savings and loan associations, 

and most credit unions, in the state are 

required to offer no-frills, low-cost 

checking accounts, to be used primar 

ily for personal or household pur 

poses. The required account has a $50 

initial deposit, a minimum balance 

thereafter of $1, eight free checks 

per month, with additional checks 

charged at 50 cents per item. Institu 

tions that already offer a low-cost 

account are permitted to ask the 

Banking Department to approve such 

accounts based on their consistency 

with the general purposes of the 

state's new consumer banking laws. 

The Star Ledger, Newark, 12/2/92. 

Foreign Banking Regulations 

Proposed 

New York: The Banking Depart 

ment proposed regulations which 

include a requirement that represen 

tative offices of foreign banking cor 

porations be licensed, examined, and 

supervised by the state. All currently 

registered REP offices would have to 

be licensed by September 1994, and 

all new offices licensed immediately. 

Included in the activities permitted to 

REP offices would be the solicitation 

of loans, and executing loan documents 

for loans of $1 million or more, but 

they would be prohibited from engag 

ing in certain activities, among which 

are trading activities for the account 

of the foreign corporation, approving 

loans, executing loan documents for 

loans of less than $1 million, and dis 

bursing or transmitting funds. Factors 

to be considered by the Banking Su 

perintendent in acting on applications 

to establish and maintain branch, 

agency or REP offices are specified. 

BBRJ1123/92, p. 718. 

Equity Investments in 

Community Projects 

New York: Under a state Banking 

Department proposal, N.Y. state 

banks and trust companies would be 

permitted to make real-estate equity 

investments in community develop 

ment projects that serve a public pur 

pose. Investments in a single project 

could not exceed two percent of the 

bank or trust's capital stock, surplus, 

and undivided profits. Total invest 

ments in all community development 

projects could not exceed five per 

cent. BBR, 11/9/92, p. 662. 

Law Eliminates Depositor 

Priority Claims in State 

Bank Failures 

Texas: The Governor signed legis 

lation requiring all creditors to be 

treated equally when a state-char 

tered bank fails. Claims for payment 

against a failed state institution will 

have the same priority as such claims 

would have in a national bank failure 

under federal law. Before the new leg 

islation, the claims of a state bank's 

depositors were given a priority sta 

tus. This is said to have become det 

rimental to state banks and their 

creditors, because the FDIC used the 

priority list to prevent payments to 

some creditors, particularly those who 

had sold federal funds to the failed 

banks. BBR, 4/5/93, p. 463. 

Bank and Thrift Performance 

Commercial Banks' Earnings 

Set Record in First 

Quarter 

Insured commercial banks earned 

$10.9 billion (preliminary) in the first 

quarter of 1993, a record total for a 

quarter. Industry profits were $3.3 bil 

lion higher than a year earlier, and 

$2.4 billion above the previous quar 

terly record set in the third quarter of 

last year. For the year 1992, insured 

commercial banks earned $32.2 bil 

lion, also a record high. 

The FDIC cited for the first quar 

ter three main causes for the strong 

earnings performance: l)assetquality 

improvement, leading in part to lower 

provisions for loan losses; 2) contin 

ued wide net interest margins; and 3) 

the adoption for regulatory reporting 

purposes of generally accepted ac 

counting principles that permit the 

recognition of larger amounts of "de 

ferred tax assets," the effect being a 

one-time increase in reported income. 

The average return on assets 

(ROA) in the first quarter rose to an 

annualized 1.24 percent for insured 

commercial banks, and excluding the 

accounting gains and other nonre 

curring transactions was 0.96 percent 

also a record high. The earnings 

54 
Recent Developments 

results were broad-based, as banks 

grouped by geographic region and by 

asset size all averaged ROAs above 

one percent. Almost two out of every 

three banks reported higher earnings 

than a year ago, and only one out of 

every twenty banks was unprofitable. 

Most of the growth in commercial 

bank assets in the quarter consisted of 

mortgage-backed securities, which 

increased by $16.8 billion, and in U.S. 

Treasury securities, which grew by 

$9.9 billion. Total loans held by com 

mercial banks declined for the eighth 

time in the last nine quarters. 

Savings banks insured by the BIF 

experienced their fifth consecutive 

profitable quarter following three un 

profitable years. Nearly 96 percent of 

firms in the industry were profitable, 

up from 87 percent in the previous 

quarter. First-quarter net income of 

$517 million was 34 percent above the 

previous quarter. Improved profit 

ability resulted from lower noninterest expenses, an increase in 

nonrecurring extraordinary gains, and 

lower loan-loss provisions. The 

industry's return to profitability is at 

tributable also to FDIC's resolution 

of troubled institutions. The industry 

continues to downsize through unas 

sisted mergers and acquisitions. As of 

March 31, 1993, BIF-insured savings 

banks held $202.7 billion in assets, 

down by 6 percent in the quarter. PR

64-93, FDIC, 619193; PR-18-93, 319; FDIC 

Quarterly Banking Profile, First Quarter 1993, 

Fourth Quarter 1992. 

S&Ls Continue Strong 

Financial Performance 

The nation's private-sector savings 

and loan associations earned over $1.7 

billion in the first quarter of 1993, 

representing a return on assets (ROA) 

of 0.96 percent. These institutions 

earned a record $5.1 billion in the year 

1992, up from $1.8 billion in 1991. 

The thrifts' continuing profitability 

for nine consecutive quarters reflects 

primarily the favorable interest-rate 

spreads and decline in troubled as 

sets. The interest-rate spread, 3.02 

percent in the first quarter, has steadi 

ly increased over the past two years. 

Troubled assets declined by $10.4 

billion over the past year to $20.9 

billion, or 2.85 percent of assets. 

The thrift industry continues to 

shrink, as the number of private-sec 

tor S6cLs declined to 1,802 on March 

31, 1993 from 2,064 a year earlier. 

Total assets held by these institutions 

were $738 billion at the end of March, 

down from $859.8 billion on the 1992 

date. Ninety-six percent of the 1,802 

thrifts met the capital standards set by 

FDICIA, including 84 percent rated 

"well-capitalized." Only 68 thrifts, or 

less than 4 percent, failed the stan 

dards in the first quarter, including 12 

rated "critically undercapitalized." 

OTS Acting Director Jonathan L. 

Fiechter said thrifts have maintained 

their asset holdings in traditional 

lending activities in l-to-4 family and 

multifamily mortgages, mortgagebacked securities and consumer 

loans, and there is no evidence of a 

major shift out of thrifts' traditional 

lending channels into government se 

curities. NEWS, OTS, 3111193; 6/17. 

Mr. Fiechter said that 183 thrifts, 

with nearly 16 percent of the assets of 

private-sector thrifts, are on the 

agency's problem list. While most of 

these remain solvent, 75 percent are 

losing money. He expressed concern 

over the number of problem thrifts, 

and that so many of these are losing 

money, in the current favorable eco 

nomic environment. AB, 6118/93, p. 2. 

HMD Data Not Adequate 

on Banks' Mortgage 

Lending to Minorities, 

Report Says 

A Consumer Bankers Association 

official said that Home Mortgage 

Disclosure Act data released by the 

FRB does not capture the recent 

progress that banks have made in their 

mortgage lending to minorities and 

low- to moderate-income consumers, 

According to HMDA statistics avail 

able in late October 1992, mortgage 

lending disparities did not change 

much in 1991, compared to 1990, 

when the FRB began releasing the 

data. However, many banks' programs 

are too new to be adequately reflected 

in these figures, the official said. Also, 

the programs have been held back by 

the recession, and also possibly dis 

torted by the surge of conventional 

mortgage refinancing. 

The GBA surveyed its member 

ship of banks, holding companies, and 

thrifts for 1991 and the first half of 

1992, receiving information from 140 

large and medium-size institutions on 

their minority and low- to moderateincome mortgage lending programs. 

Of the responding institutions, 91.4 

percent had such programs. Of these, 

94.5 percent offered special afford 

able mortgage products that were 

more flexible or more affordable to 

help applicants qualify. Over threefourths of the lenders had enhanced 

marketing plans targeted at minority 

and low-income groups. Among other 

results of the survey, over 86 percent 

of lenders have a policy requiring an 

automatic review of rejections, typi 

cally by senior officers. This is of par 

ticular interest in view of the study by 

the Federal Reserve Bank of Boston 

(see relevant discussion under the 

heading entitled Recent Articles and 

Studies) showing the strong role 

played by judgment in the approval 

process. Affordable Mortgage Survey, Consumer 

Bankers Association,.!une 30,1992;BBR, 1112192, 

p. 629. 

1992 Was Good Yearfor 

Credit Unions 

Deposits in the nation's federally 

insured credit unions grew 13.6 per 

cent in 1992, the highest rate of 

growth in five years. Reserves in 

creased at a faster rate 20.6 percent 

bringing capital to a record high of 

8.1 percent. The loan portfolio grew 

at a rate of 5.0 percent in 1992, and the 

loan-to-share ratio was 60 percent on 

December31, 

Net earnings after reserve transfers 

for the nearly 13,000 federally insured 

credit unions rose 73 percent, to $3.1 

billion from $1.8 billion in 1991. 

Delinquencies declined 16 percent to 

1.3 percent at year-end, down from 

1.6 percent in 1991. 

Shares in troubled credit unions 

also declined as a percent of total in 

sured shares, from 4.2 percent in 1991 

55 
FDIC Banking Review 

to 2.8 percent. The 1992 ratio is less 

than one-third of the 6.3 percent in 

1988. The number of troubled credit 

unions was 608 on December 31, 

1992, down from 683 in 1991 and 

1,022 in 1988. The National Credit 

Union Share Insurance Fund currently 

has an equity ratio of 1.26 percent. 

NCUANEWS,2H6I92, 

Credit Union Interstate 

Services Network 

Credit unions in 12 states will pro 

vide services to each other's custom 

ers, beginning July 1, 1993. In effect 

an interstate branching system, the 

network is expected to serve 6 million 

customers in 450 credit unions. States 

already in the network are New York, 

New Jersey, Pennsylvania, Virginia, 

North Carolina, Georgia, Tennessee, 

Alabama, Florida, Illinois, Louisiana, 

and Colorado. This will be a much 

more extensive sharing of interstate 

facilities between credit unions than 

has occurred previously. In Michigan, 

California, and Texas, credit unions 

have serviced each other's customers 

fora number of years. An NCUA offi 

cial said the network does not face any 

regulatory obstacles. Federal law per 

mits credit unions to share facilities. 

AB, 6/8193, p. /. 

Recent Articles and Studies 

Effects of "Prompt Corrective 

Action" on the Bank 

Insurance Fund (BIF) 

A provision of FDICIA requires 

supervisors of depository institutions 

to impose limits op the activities of 

institutions with relatively low capita) 

ratios, and if their ratios fall below 

some critical level to close the institu 

tions promptly. In this article, R. Alton 

Gilbert considers the likely effects of 

prompt corrective action (PCA) legis 

lation on BIF losses resulting from the 

failure of commercial banks. 

The argument for PCA legislation 

is said to rest on several assumptions. 

First, depository institutions have an 

incentive to assume greater risk as 

their capital ratios decline. Also, the 

longer an institution operates with a 

low capital ratio, the greater its oppor 

tunity to act on incentives to assume 

risk. Supervisors have been ineffective 

in limiting the risk assumed by poorly 

capitalized institutions. The insur 

ance fund losses due to the failure of 

individual institutions reflect, to some 

extent, the risk assumed by these in 

stitutions after they became poorly 

capitalized. Finally, the actions man 

dated for supervisors in the legislation 

will constrain the risk assumed by poor 

ly capitalized institutions, thereby lim 

iting insurance fund losses if they fail. 

The study utilizes a sample of 854 

banks that failed in the years 1985

1990. Most of the banks were relatively 

small, and concentrated in certain re 

gions. The evidence is found not to 

support the claimed relationship be 

tween the length of time an institu 

tion operates with a low capital ratio 

before failure and the BIF loss. The 

findings, instead, support a view that 

in recent years, supervisors have been 

effective in constraining the risk 

assumed by poorly capitalized banks. 

These results raise doubts about 

whether PCA legislation will reduce 

BIF losses. Review, FederalReserve Bank oj'St. 

Louis, JulylAugust 1992, pp. 3-22. 

Derivative Instruments 

Source ofRisk Concerns 

This report, which was prepared 

for the central banks of the Group-ofTen countries, focuses on the role and 

interaction of banks in non-traditional 

markets, notably the markets for 

derivative instruments, and linkages 

among various segments of the inter 

bank markets and among the partici 

pants, and associated risk concerns. 

The report observes that the chang 

ing nature of international interbank 

operations has significantly altered the 

risk environment facing banks. The 

participation in wholesale markets by 

entities subject to few disclosure re 

quirements, as well as the growth of 

off-balance-sheet activities more gen 

erally (adequate details of which are 

rarely disclosed), has made the assess 

ment of counterparty risks consider 

ably more difficult. The complexity 

of risks encountered in banks1 deriva 

tive operations also presents major 

challenges. So does the management 

of the large intraday credit exposures 

and settlement positions that have 

arisen as a result of the increase in 

wholesale market trading. Cash li 

quidity and market liquidity risks have 

also become more problematic for a 

number of participants. Market risk, 

by contrast, is said to be more manage 

able now than in the past, owing to the 

efforts that firms have made in recent 

years to control these risks through 

the use of derivative instruments and 

other techniques. Market risks also 

are priced more easily than other risks. 

The report calls in particular for 

management awareness and under 

standing, at all levels, of the risks being 

taken on by their institutions. Greater 

attention than in the past should be 

paid to the risk exposure from prob 

lems at institutions or in markets on 

which they rely heavily. Firms must 

develop contingency plans for dealing 

with such circumstances. 

In respect to measures to strengthen 

the institutional underpinnings of 

wholesale markets, there is scope for 

enhancing netting schemes. Properly 

designed netting arrangements can 

reduce risks associated with a given 

level of activity. Market participants 

and central banks should encour 

age efforts aimed at improving and 

achieving some harmonization of ac 

counting and reporting practices with 

respect to off-balance-sheet instru 

ments. To the extent possible, devel 

opment of accounting guidelines 

should be done in an internationally 

coordinated manner. Ways of making 

public disclosure of financial positions 

more meaningful should also be 

undertaken. Continuing cooperative 

efforts are needed to resolve uncer 

tainties with respect to the laws af

fectingfinancial markets in individual 

countries and the application of vari 

ous laws to international financial ac 

tivities. Also, there is a strong need for 

better, more comprehensive and more 

meaningful statistics concerning deriv 

ative markets and the involvement of 

banks and other financial institutions 

56 
Recent Developments 

in them. Recent Developments in international 

Interbank Relations, Bankfor International Settle 

ments, Ortober 1992. 

report by Standard Poor's Corp. 

concluded that trading in swaps and 

options is less risky, and less capital is 

required, than for bank lending, AB, 

11/9192,p. I. 

Regulatory Costs to 

Community Banks 

A study conducted in 1992 for the 

Independent Bankers Association of 

America analyzed the costs of compli 

ance with regulatory areas that were 

considered to be the most burden 

some by community banks. Com 

munity banks are defined as locally 

owned and operated institutions. The 

study focused on 13 regulatory areas. 

It did not extend to other areas of 

regulation or to institutions other than 

community banks, and also did not 

consider any of the additional reg 

ulatory requirements imposed by 

FDICIA. 

The annual cost for community 

banks to comply with the 13 regula 

tory areas is estimated at $3.2 billion, 

representing 24 percent of the banks' 

net income before taxes, and requir 

ing an estimated 48 billion annual 

compliance hours. These results, the 

study says, substantiate a report by 

the FFIEC (see FFIEC section, 

above) suggesting that the annual cost 

to all banks of regulatory compliance 

may be as high as $17.5 billion, and 

that the regulatory burden is greater 

for smaller banks. Smaller banks were 

found to experience the highest com 

pliance cost in relation to total assets, 

equity capital and net income before 

taxes. Banks with assets under $30 

million incur almost three times the 

compliance cost per $1 million in as 

sets compared to banks in the $30-65 

million-asset range, and four times 

the cost ratio of banks with over $65 

million in assets. 

The most burdensome regulatory 

area identified was the Community 

Reinvestment Act (CRA), which costs 

community banks annually approxi

mately$l billion and 14.4 million em 

ployee hours. CRA compliance costs 

the average community bank about 

$1,256 for each $1 million in total as 

sets. The least expensive of the 13 

categories was HMDA, which costs 

community banks an aggregate $17.4 

million annually. On a scale from least 

beneficial and useful to most beneficial 

and necessary, banks rated the 13 cat 

egories as follows: 1) CRA, 2) HMDA, 

3) Geocoding-Geographic Loan Cod 

ing, 4) Expedited Funds Availability 

Act, 5) Real Estate Settlement Proce

dures Act, 6) Truth in Lending, 

7) Bank Secrecy Act, 8) Equal Credit 

Opportunity Act, 9) Loans to Insiders, 

10) Appraisal Requirements, 11) For 

mal Written Policies, 12) Call Reports, 

and 13) Regulatory Examinations. 

Regulatory Burden — The Cost to Community 

Banks,!ndepetident Bankers Association ofAmerica, 

January 1993. 

study sponsored by the University 

of Wisconsin found that by eliminat 

ing unnecessary paperwork in con 

nection mainly with the Community 

Reinvestment Act, Truth in Lending 

Act, and the Equal Credit Opportunity 

Act, banks could save enough to lower 

their loan rates by a percentage point. 

Almost one-fifth of surveyed banks said 

that CRA concerns had caused them 

to restrict product offerings. The study 

emphasizes the need for further research 

on the benefits to the public of the 

voluminous consumer disclosures cur 

rently required. Usingacost-estimation 

method that takes account of certain 

offsetting financial and social benefits, 

the study puts the costs of banks' com 

pliance with 15 consumer protection 

and public-interest rules at 13.6 percent 

of pre-tax income in 1991MB, 416193, p. /,

4/16, p. 6. 

Racial Discrimination in 

Mortgage Lending 

This study, by Alicia H. Munnell, 

Lynn E. Browne, James McEneaney 

and Geoffrey M. B. Tootell, explores 

the factors affecting the decision 

to approve or deny mortgage applica 

tions, using data obtained from a sam 

ple of financial institutions operating 

in the Boston Metropolitan Statistical 

Area (MSA). 

In a previous study in 1989, the 

Federal Reserve Bank of Boston ex 

amined the pattern of mortgage lend 

ing in the City of Boston and found 

that the number of mortgage origina 

tions relative to the owner-occupied 

housing stock was 24 percent lower 

in black neighborhoods than in white 

neighborhoods, after taking account 

of economic variables such as income, 

wealth, and other factors. That study, 

however, could not distinguish be 

tween discrimination in the housing 

market and discrimination in the 

mortgage market. This new study was 

made possible by amendments to the 

HMDA in 1989 which require lenders 

to report not only the location of loans 

actually made, but also the sex, race, 

and income of individual applicants 

and whether the application was ap 

proved or denied. 

The Federal Reserve Bank of Bos 

ton, with the support of the other su 

pervisory agencies, asked financial 

institutions operating in the Boston 

MSA to provide additional informa 

tion on the variables that lenders have 

said they consider in the mortgage 

lending decision. This information was 

requested for applications for conven 

tional mortgage loans in 1990. The 

study found that minority applicants, 

on average, have greater debt bur 

dens, higher loan-to-value ratios, 

weaker credit histories, and they are 

less likely to buy single-family homes 

than white applicants, and that these 

disadvantages do account for a large 

portion of the difference in denial rates. 

Including the additional information 

on applicant and property characteris 

tics reduces the disparity between 

minority and white denials from the 

originally reported ratio of 2.7 to 

roughly 1.6 to 1. The adjusted ratio 

implies that even after controlling for 

financial, employment, and neighbor 

hood characteristics, black and Hispan 

ic mortgage applicants are roughly 60 

percent more likely to be turned 

down than whites. 

The survey confirms a perception 

that a good application will seldom 

57 
FDIC Ban king Review 

be rejected simply because the appli 

cant is a member of a minority group. 

However, the majority of borrowers, 

both white and minority, are not per 

fect, and lenders have considerable 

discretion over how they take account 

of these imperfections. For the same 

imperfections, whites seem to enjoy a 

general presumption of creditworthi

ness that black and Hispanic appli 

cants do not, and lenders appear to 

be more willing to overlook flaws for 

white applicants than for minority 

applicants. Denied applications by 

blacks and Hispanics in most cases in 

the study had poorer objective quali 

fications than for whites' denials. As a 

result, a systematic bias in mortgage 

lending is very difficult to document 

at the institution level, particularly 

when the number of minority appli 

cations is small, as it is in the vast 

majority of cases. Thus, under exist 

ing examination procedures, examin 

ers can be expected to uncover only 

the most flagrant abuses. 

The study abstracts from discrimi 

nation that may occur elsewhere in 

the economy. For example, if minori 

ties are subject to discrimination in 

education or labor markets, they will 

have lower incomes, and other loandecision variables may be less favor 

able. Also, differential treatment may 

occur at many stages in the lending 

process, for example, minorities may 

be discouraged from applying for a 

mortgage loan as a result of a pre

screening process. Similarly, if blacks 

or Hispanics, whencompared to whites, 

receive less "coaching" when filling 

out an application, they are likely to 

have a poorer application. Mortgage Lend 

ing in Boston: Interpreting HMDA Data, Federal 

Reserve Bank of Boston, Working Paper No. 92-7, 

October 1992, 

Cross-Lender Variation in 

Home Mortgage Lending 

This research by Robert B. Avery, 

Patricia E. Beeson and Mark S. 

Sniderman shows that for over 9,000 

HMDA-reporting lenders that ac 

counted for nearly 2 million homepurchase loan applications in 1990, 14 

percent of applications and 12 percent 

of loans were associated with minority 

applicants. However, about 40 per 

cent of all the lenders reported no 

minority applications that year. Half 

of the lenders originated 8 percent 

or fewer of their loans to minorities, 

while one-fourth extended more than 

18 percent. 

Previous studies, such as a report 

published by the Federal Reserve Bank 

of Boston (see above), have centered 

primarily on the minority/low-income 

applicants for credit, and the actions 

taken on their applications. This more 

recent study concludes that for the 

U.S. as a whole, the variance across 

lenders in either minority or lowincome originations, relative to total 

originations, is overwhelmingly ac 

counted for by the variance in appli 

cation rates, not by actions taken on 

the applications. The data show 

that differences across lenders in 

either their application flows or ap 

proval processes cannot be accounted 

for by variations in clientele or loan 

products. Also, only a small portion of 

the disparity can be explained by dif 

ferences in the type of loan being 

sought (loan size, FHA/VA versus con 

ventional, etc.), or by applicants' per 

sonal characteristics as recorded in the 

HMDA data (income, gender, co-ap 

plicant, etc.\ or by geographic market 

served. 

Lenders operating in the same 

market and who have high minority 

application rates are found to draw 

their relatively larger volume of mi 

nority business from a broad range of 

neighborhoods, rather than from pre 

dominantly minority areas alone. They 

may receive a relatively large pro 

portion of minority applications as 

a result of aggressive promotion and 

product development. Although such 

institutions may have a relatively high 

minority-to-white denial ratio, actu 

ally they may be community leaders 

in credit originations to minority 

applicants. The Community Reinvest 

ment Act, the authors emphasize, 

requires lenders to do more than sim 

ply grant credit on equal terms to 

similarly situated applicants. The law 

encourages banks to seek out lending 

opportunities throughout their com 

munity, and to develop products and 

programs that meet the needs of di 

verse groups Of people. Federal Reserve 

Bank of Cleveland: "Cross-Lender Variation in 

Home Mortgage Lending," Working Paper No. 9219, 

55pp., 1'2192; Economic Commentary, 2/12193. 

Are Banks Departing 

"Traditional" Lender 

Role? 

This article, by Jonathan A. Neu

berger, notes that as a result of the 

recent rise in banks1 holdings of gov 

ernment securities, their portfolios now 

hold a larger amount of securities than 

business loans. Since the start of the 

most recent recession in mid-1990, to 

the third quarter of 1992, banks1 loans 

rose less than 3 percent, and business 

loans/^//by over 4 percent, while se 

curities, largely U.S. Government, 

increased by more than 30 percent. 

These developments have led to crit 

icisms that banks have departed from 

their "proper" role of lending to 

consumers and to small and mediumsized businesses. 

Several trends and cyclical move 

ments are seen in the changing com 

position of banks1 assets. In the early 

1950s, securities made up almost half 

of total bank financial assets, and 

by the mid-1970s had fallen to about 

one-quarter. A more gradual decline 

occurred over the next several years 

followed by the more recent uptrend. 

Contrary to an often-heard view, the 

drop in the share of business loans in 

bank portfolios is not solely a recent 

occurrence, having started in the 

1980s. By the third quarter of 1992, 

the share was less than 22 percent. 

The decline has reflected the increas 

ingly competitive market for shortterm business loans, as banks lost 

market share to nonbank financial in 

stitutions, and the rapid growth in the 

markets for commercial paper and 

other forms of "nonintermediated 

debt." Another trend is the steady rise 

in mortgage loans, as mortgages in 

creased from less than 10 percent of 

banks' assets in 1951 to over 25 per 

cent in 1990. 

58 
Recenc Developments 

Business loans as a proportion of 

total bank assets typically decline 

during recessions and rise during ex 

pansions. Compared to earlier postWorld War II business cycles, the 

recent experience differs in that the 

proportion of business loans fell more 

and the share of securities rose more 

than in the previous decades. The 

current weakness in business loans 

appears to be partly a continuation of 

the longer-term decline noted above. 

Among the explanations for the un 

usual weakness in the most recent 

recession are a lower than normal eco 

nomic recovery and concerted effort 

by businesses to restructure their bal 

ance sheets from the debt overhang of 

the 1980s. There is evidence that reg 

ulatory capital standards have become 

more stringent and have had a con 

straining effect on loan growth. Loanloss exposures and high problem-loan 

ratios may have made banks more 

cautious in their lending. A typical 

feature of earlier recessions was disintermediation as deposits left the 

banking system when market interest 

rates rose above Regulation Q ceil 

ings. These ceilings were abolished in 

the early 1980s. In the most recent 

cycle, while banks allowed large 

CDs to run off, so-called core deposits 

stayed in the banking system. Faced 

with extremely weak loan demand, 

banks may have decided to invest these 

funds in safe and relatively lucrative 

government securities. Weekly Letter, 

Federal Reserve Bank ofSan Francisco, March 19, 

1993. 

Licensing ofFinancialServices Institutions 

Proposed 

This paper, by Jane W. D'Arista 

and Tom Schlesinger, proposes a sys 

tem of reforms for the unregulated 

"parallel banking system." The larg 

est single group of unregulated inter 

mediaries, in terms of their assets and 

size of individual companies, are fi 

nance companies. They function like 

banks, but with virtually no regulatory 

costs. Finance companies need not 

comply with capital and reserve re 

quirements, limits on loans to single 

borrowers, or limits on transactions with 

parents and affiliates. They are not 

bound by community investment de 

mands under CRA or the restrictions 

of the Glass Steagall Act, and they can 

operate nationwide. 

By blanketing the parallel banking 

system with fee-generatingguarantees, 

the banks also have exposed the cen 

tral bank to a contingent liability dom 

ino effect of major proportions. Not 

only does the parallel system stretch 

the central bank's lender-of-Iast-re

sort function, it also may compromise 

its ability to implement monetary pol 

icy. A shift in lending from banks to 

the parallel system distorts the distri 

bution of credit. Rising levels of insti 

tutional concentration have made it 

more difficult for the financial system 

to assist the development of small, 

innovative companies and processes 

that will help ease the disruptions 

caused by declining older firms and 

methods. The lack of capital and 

credit for smaller enterprises stems 

not only from growing institutional 

concentration but also from shrinking 

levels of competition in local lending 

markets. 

The authors propose the establish 

ment of a financial industry licensing 

system, under which all parallel-bank 

ing-system firms would be required 

to be licensed and to comply with 

the same major regulations in respect 

to soundness. Uniform licensing re 

quirements would be applied to any 

such entity that directly accepts 

funds from the public for investment, 

makes loans to the public or buys loans 

or securities using funds other than its 

own equity capital and retained earn 

ings, or sells loans or third-party 

securities to financial institutions or 

investors. In respect to direct public 

guarantees, it is recommended that 

the aggregate savings of individuals 

be insured up to a given amount, 

regardless of where they are placed, 

rather than insuring single accounts or 

entire financial firms. 

While the licensing proposal de 

parts from the direction of most recent 

policy debates and initiatives, it has 

a precedent from the not-so-distant 

past. In 1980, responding to a Presi 

dential directive issued under the 

Credit Control Act, the Federal Re 

serve System implemented a credit 

restraint program that went beyond 

the banking system and the usual 

boundaries of its scope of action. The 

program included a special deposit 

requirement of 15 percent on all ex 

tensions of consumer credit through 

credit cards, and certain other loans. 

This deposit requirement applied to 

all consumer lenders, not just deposi 

tory institutions, and it was extended 

to money-market mutual funds. 

The recommended approach to 

regulatory equality could be admin 

istered by a single regulator or reg 

ulators, whose mission is defined by 

industry segments, or by function. 

In addition, enhanced self-regulation 

should become a vital part of any move 

ment toward regulatory equality. The 

elements of the securities industry's 

self-regulating organizations that have 

been proven successful could serve as 

a model. The obligation to self-regulate 

should supplement, not substitute 

for, the supervisory power of indepen 

dent regulators. The■Parallel' BankingSystem, 

Economic Policy Institute, 45 pp., 1993. 

59