Vol. 8 No. 3 - Article I - Published: February, 1996 - Full Article 

Reps and Warranties 

by Penelope Moreland-Gunn, Peter J. Elmer and Timothy J. Curry 

Representations and warranties (R&Ws) are legally binding statements primarily 

made by sellers assuring buyers that certain minimum asset quality requirements 

are met. These minimum quality guarantees are commonly given in all types of 

asset sales, ranging from consumer products to whole loans. The guarantees 

may extend for only a few months or for the life of the asset. 

R&Ws on loan sales are especially interesting because banks and thrifts have 

increased sales dramatically in the 1990s and each sale tends to create new 

R&W liabilities that remain long after the sale is completed. Moreover, these 

liabilities are almost never tracked, recognized in accounting statements, or 

reserved for with specific reserves. As such, they are a largely unacknowledged 

source of risk that remains long after the related assets have disappeared from a 

seller's books. 

R&W risk can be significant for institutions that actively purchase and sell loans, 

because R&W risk exposure increases each time a purchase or sale is made. 

The act of selling loans increases the seller's liability to honor R&W obligations it 

issues as part of the sale. Buyers also increase risk due to the possibility that 

sellers may not honor the R&Ws they issue. Understanding and controlling these 

risks are prerequisites for effective risk management of any institution that actively 

purchases or sells loans. 

The early difficulties of the Resolution Trust Corporation (RTC) in trying to sell 

assets without R&Ws are discussed in the first section of this paper. This is 

followed by a discussion of the "lemons principle" that suggests that the offering 

of R&Ws is likely to be beneficial. R&Ws commonly made by market participants 

are then discussed in detail. This is followed by an analysis of the RTC's claims 

experience with R&Ws, and a comparison of the estimated costs and benefits of 

granting R&Ws. Conclusions and caveats are presented in the final section. 

. 

A $200 Billion Example 

R&Ws, which have been granted for as long as sale contracts have existed, are 

used in all types of sales ranging from toasters to corporations. Sellers are often 

willing to give R&Ws because the risk of loss appears small as long as they are 

confident that they are well-managed and their product is of high quality. Buyers 

demand R&Ws because the potential problems may be difficult or costly to 

research, especially if they are numerous and data are not readily available to 

assess their risk. Buyers may be suspicious of products with no R&Ws due to a 

fear that a seller's unwillingness to offer them signals a higher risk of problems. 

Figure 1 documents the explosion in sales of single-family mortgages that 

occurred during the 1980s. Because R&Ws are given in virtually all sales, 

including those to the Federal Home Loan Mortgage Corporation (FHLMC) and 

the Federal National Mortgage Association (FNMA), it is safe to assume that 

R&W liabilities grew in lockstep with sales activity. The success of the single­
 

 

 

 

 

 

 

 

family market in the 1980s spread to other loan markets in the 1990s, as trading 

increased dramatically for all types of loans ranging from commercial mortgages 

to nonperforming consumer loans. R&Ws have necessarily also increased, 

especially for products that encounter more varied risks than single-family 

mortgages, such as commercial loans. 

The experience of the RTC with R&Ws exemplifies the problems encountered by 

many market participants. The RTC was formed in August of 1989 with no sales 

experience and no policy for giving R&Ws. Initially, the RTC made several efforts 

to limit R&W liabilities created from the sales of loans and servicing rights. One 

approach granted R&Ws only from the receiverships created from the dissolved 

savings-and-loan associations (S&Ls), thereby limiting R&W liabilities to the 

receiverships. Other approaches included the granting of only very limited R&Ws 

and replacing R&Ws with rights to put back assets to the RTC in the event of 

problems. 

Under the initial R&W policy, the RTC experienced great difficulty in selling its 

assets. The process was slow, prices were low, and buyers often resisted doing 

business with the RTC based on the terms it tried to dictate to the market. Buyers 

were highly suspicious of the credit quality of receiverships. In some cases, 

buyers required a portion of the sale proceeds to be placed in escrow to ensure 

that R&Ws issued by insolvent S&Ls could be honored. The limiting of R&Ws 

caused buyers to demand extensive reviews of loan and servicing files ("due 

diligence"), which were costly, time-consuming, and cumbersome to administer. 

The RTC experimented with the sale of whole institutions and giving buyers rights 

to put back assets to the RTC after the sale and after they had been given a 

chance to research the loans. However, bidder interest showed little improvement 

and assets were often returned to the RTC. Also, the buyers of S&Ls and banks 

began teaming with Wall Street experts to buy whole S&Ls, then "flipping" 

(immediately reselling) the loans to the Wall Street partners, who in turn either 

securitized or otherwise resold the loans with R&Ws for a profit. 

The RTC researched the costs and benefits of adopting more common sales 

practices, that is, performing due diligence prior to a sale and giving R&Ws. In 

May 1990, the RTC's Board of Directors approved the first policy permitting the 

use of R&Ws in loan and servicing rights sales. This policy expanded the R&Ws 

given and allowed the RTC in its corporate capacity to give R&Ws instead of only 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

giving them from receiverships. However, the policy established several key 

restrictions, such as limiting R&Ws to a maximum of five years and indemnifying 

investors only in the event of an actual loss. As will be discussed later, these 

restrictions are more than is customary in the market because many situations 

require long-term indemnification and/or the repurchase of assets. Therefore, 

investors remained concerned about the risk of buying assets from the RTC. 

In August 1990, the RTC's Board of Directors responded to market pressures by 

expanding its R&Ws to those customary or normal in the marketplace. In 

particular, R&W coverage was extended to cover the life of the loan and the RTC 

was permitted to resolve problems by repurchasing assets and/or substituting 

replacement loans. These revisions conformed RTC policy with market practices, 

thereby clearing the path for high-volume loan sales that competed directly with 

other loan sales in the market. It also helped to open the door to the development 

of securitization, a process that aimed to sell loans for higher prices than those 

achieved by selling loans directly to buyers as whole loans. 1 Indeed, R&Ws have 

since facilitated the sale of over $200 billion of loans and loan servicing for a vast 

array of loan types, many of which had never been sold in volume. 

Although the expansion of R&Ws cleared the path for high-volume loan sales, it 

also increased the RTC's exposure to the risk of losses on R&W claims. 

Therefore, a R&W claims administration department was created to oversee 

related issues and to establish reserves to cover R&W claims costs. As will be 

discussed later, the experience of the RTC provides a rare example of the 

likelihood and magnitude of R&W claims and costs. 

The Lemons Principle 

Analysts unfamiliar with the whole-loan market occasionally claim that market 

efficiency will cause the financial benefit of higher prices on the sales of loans with 

R&Ws to equal the cost of granting R&Ws. This theory suggests that buyer 

competition will cause the price of loans with R&Ws to exceed the price of loans 

without R&Ws by an amount equal to the sellers' expected cost of granting the 

R&Ws. However, a classic principle of economics, known as the "lemons 

principle," suggests an alternative view, that the value of granting R&Ws should 

be greater than their cost. 

The lemons principle is a response by Akerloff (1970) to the observation that the 

value of a new automobile declines significantly as soon as it is driven off the 

showroom floor. Akerloff explained this as a result of the fact that information 

relating to the quality of the automobile is not the same for the buyer as it is for 

the seller. That is, information is asymmetric in the sense that the seller is more 

likely than the buyer to be aware of the auto's problems and limitations, that is, 

better able to identify the auto as a "lemon." In the absence of complete 

information, buyers assume the worst and price the auto as if it were a lemon, 

even though it may in fact be in perfect running condition. 

Information on the quality of a loan is as difficult (costly) to assess as information 

on the quality of an automobile. While recent payment history and loan 

characteristics are typically available from the servicer on, for example, a 

magnetic tape, it is always possible that the tape information is incorrect. More 

importantly, the tape will normally not show information about a host of potential 

problems such as underwriting equirements, policies used to obtain appraisals, 

sources of credit histories, mistakes made in originating or servicing the loans, 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

and legal problems that either have or have not been identified. Fraud in any of 

these areas is always a possibility as well. 

Buyers are acutely aware of the risks arising from the lack of information in a pool 

of loans. They control the risks by either: 1) requesting that the seller give R&Ws, 

2) requesting that the seller perform extensive due diligence and make it available 

to bidders prior to the sale, or 3) bearing the cost of performing their own due 

diligence. 

The experience of the RTC was that many whole-loan buyers would not even 

consider buying loans that did not have R&Ws customarily given in the market. 

Some buyers would consider loans with limited R&Ws, but only after performing 

extensive due diligence. Many buyers did not wish to bear the cost of their own 

due diligence and they were fearful that it would not address all risks. The final 

result was that the offering of loans with either no or limited R&Ws reduced the 

number of potential buyers significantly and complicated the sale with due 

diligence-related issues. Buyers that took the added risk and participated in the 

sales consequently discounted prices heavily based on the presumption of 

problems. 

Discussions with financial advisors suggested that limiting R&Ws can cause price 

reductions of two percent to three percent for relatively clean portfolios of singlefamily mortgages. Higher discounts are likely for loans that are not as widely 

traded as single-family mortgages and for loans with documentation, underwriting, 

or servicing problems. The lemons principle suggests that these price discounts 

should exceed the cost of granting R&Ws and the payment of related claims. 

Actual RTC R&W claim costs shown below are consistent with this view. 

However, a comparison of R&W costs and benefits is reserved for later in this 

study, following a more detailed discussion of the nature of common loan-related 

R&Ws. 

Common Representations and Warranties 

R&Ws fall into two categories: 1) institutional, which deal with the legal authority 

of a firm to sell loans, and 2) loan-related, which deal with risks arising directly 

from the loans being sold. Most R&Ws are loan-related because the most likely 

source of problems are loan characteristics such as documentation, underwriting 

standards, and delinquency status. R&Ws cover a wide range of issues, from 

innocuous guarantees given in almost every sale to specialized guarantees used 

only for unique circumstances. 

Institutional R&Ws are small in number and can often be used for many types of 

loan sales. As shown in section A of Table 1, these R&Ws focus on the nature of 

the institutional seller and its right to sell the assets. While they are found in many 

types of sale agreements, claims on institutional R&Ws are rare because sellers 

normally have full authority to execute sales and their obligations are valid and 

binding. Nevertheless, buyers consider them indispensable because a violation 

can result in extensive losses and/or litigation. For example, a buyer can seek to 

return all assets, and sue for return of its funds, if a seller does not have legal 

authority to sell a package of loans. 

Loan R&Ws are used in many types of loan sales, but many must either be 

tailored, or written precisely, to meet the needs of each type of loan. Section B of 

Table 1 lists a number of R&Ws common to sales of most types of mortgages. 
 

 

 

 

 

 

 

 

 

 

Items B-1 and B-2 are seemingly obvious guarantees that may be given by most 

sellers with little risk of subsequent claims. In fact, they are found in almost all 

contracts and result in claims only in unusual situations. For example, they 

became an issue in the RTC's sale of "participation" loans, that is, loans owned by 

two or more participants. Documentation on joint ownership for these loans was 

not always complete or available. Ownership guarantees greatly enhanced the 

ability to sell the loans because they relieved all parties of the need to find all 

documentation and resolve all ownership issues prior to sale. 

Servicing-related issues, such as items B-3 and B-6 are most likely to result in 

claims. Because a host of loan characteristics change each month, incorrect 

information can be easily transmitted to a buyer. The loan balance or coupon 

could be incorrectly recorded on the seller's computer system or not received prior 

to transfer. The rate on an adjustable-rate loan may be tied to the wrong index or 

otherwise reset incorrectly. Mortgage insurance coverage may have lapsed due to 

failure to make timely payments. Real-estate taxes may not have been paid. 

Table 1 

Sample of Common Loan Reps and Warranties 

A. Institutional 

1. Seller has taken action to authorize the execution, delivery, and 

performance of the sale agreement. 

2. All obligations of the seller are legal, valid, and binding. 

3. Obligations will not conflict with any provisions of any law. 

4. No action, suit or proceeding is pending against the seller that would 

materially affect the ability of the seller to carry out the transaction. 

B. Found in Many Types of Mortgage Sales 

1. Seller is sole owner and holder of the mortgage loan. 

2. Seller has full right and authority to sell mortgage loan. 

3. Mortgage loan schedule information is correct in all material respects. 

4. The related note, mortgage and other agreements executed in 

connection therewith are genuine and each is a legal, valid and binding 

obligation of the maker enforceable except by limitations of bankruptcy, 

insolvency, reorganization or other similar laws. 

5. Seller is transferring the loan free and clear of any and all liens, 

pledges, charges or security interests of any nature encumbering the 

loan. 

6. All taxes, governmental assessments, insurance and utilities that came 

due prior to the closing date have been paid or an escrow account has 

been established. 

7. The related mortgaged property is free of mechanics' and 

materialmen's liens. 

8. There are no proceedings pending related to the property, and property 

is in good repair and free and clear of any damage. 

C. Single-Family Mortgage Sales 

1. Mortgage loan is secured by a mortgage on a 1-4 family residential real 

property or a condominium unit or a unit in a planned unit development or 

is a co-op loan. 

2. Each mortgage loan was underwritten generally in accordance with 

FNMA or Federal Home Loan Mortgage Corporation (FHLMC) standards 

in effect at the time of origination except that 1) the original principal 

balance may exceed FNMA/FHLMC limits. 

3. Each mortgage loan with a loan-to-value ratio (LTV) greater than 80 

percent is covered by a primary mortgage, FHA, or VA insurance policy. 
 

 

 

 

 

 

 

 

 

 

 

Such policy is in full force and effect and insures the excess over a 75 

percent LTV, and such policy shall remain in effect until the unpaid 

principal balance is reduced below 80 percent LTV. 

4. Loan is serviced in accordance with the terms of the note. 

D. Commercial Mortgage Sales 

1. Borrower possesses all valid licenses, permits and other authorizations 

necessary to conduct business. 

2. If required, seller has inspected or caused to be inspected property 

within the past 12 months. 

3. Credit file includes environmental assessment that does not disclose 

any disqualifying conditions. If a disqualifying condition exists, remediated 

cost should be equal to or less than $10,000. 

4. Seller represents that, as of the sale closing date, property does not 

contain hazardous materials such that the mortgage loan would be 

ineligible for purchase by FNMA (assuming that the loan were otherwise 

eligible for purchase). In the event of a breach of this representation, the 

seller will cure such breach or repurchase the affected mortgage loan. 

E. Vehicle Loan Sales 

1. Seller has not and does not make any representations, warrants or 

covenants regarding financial condition or status of obligor. 

2. Seller has not transferred its interest in and to the vehicles to any other 

person. Seller has the right to sell its interest in and to the vehicles in 

accordance with the terms of the contract and free of liens. 

3. Purchaser waives any claims or cause of action it might have against 

the seller for any loss, damage or expense caused by or to any vehicle. 

4. Purchaser is a sophisticated buyer of contracts and loans similar to 

loans in package. 

The wide variety of servicing problems implies that there is no single rule or 

procedure for dealing with them. Some can be easily identified and resolved soon 

after the sale is completed, either as a result of servicing the loans or a post-sale 

audit or reconciliation. Claims generated at this stage tend to relate to performing 

loans for which delinquency and default-related losses are not an issue. Claims 

generated at later stages are more likely to arise after a loan defaults and a 

careful check is made of the loan file. Incorrect real-estate tax payments and title 

problems are often caught at this point because back taxes must be paid and a 

title check made in order to complete the foreclosure process. Because 

delinquency and foreclosure may not occur until many years following a sale, 

R&W claims may not be made for a similar period. Thus, it is not surprising that 

buyers often require R&Ws for the life of the loan. 

Section C of Table 1 contains a sample of R&Ws specific to single-family 

mortgage sales. This loan market is made unique by the widespread influence of 

the FHLMC and the FNMA. Firms that sell directly to the FHLMC and the FNMA 

must agree to voluminous R&W origination and servicing requirements stated in 

lengthy volumes published by the two agencies. Aside from these requirements 

providing the agencies with R&W protection, their wide publication and 

acceptance enable other mortgage market participants to adopt similar R&W 

requirements easily. As shown in item C-2, a simple R&W extends FHLMC and 

FNMA underwriting requirements to mortgage sales that do not involve either 

agency. Item C-3 is also a FHLMC and FNMA requirement even though it does 

not directly reference them by name. 

Commercial-mortgage R&Ws differ significantly from those of single-family 

mortgages because the loan and underwriting characteristics are different and 
 

 

 

 

 

 

 

 

 

there is far less standardization of the origination and servicing functions. Also, 

the FHLMC and the FNMA are not permitted by their charters to purchase 

commercial mortgages, so standardized R&W guidelines and benchmarks are not 

as common as for single-family mortgages. 

The unique aspects of commercial mortgages are evident in the four R&Ws listed 

in Section D of Table 1. Because commercial-mortgage borrowers are usually 

corporations, they may be required to have and maintain various licenses and 

authorizations required to conduct business. Servicers are often required to 

inspect periodically commercial properties and monitor the borrower's financial 

health by reviewing financial records. Environmental problems are a major issue, 

as suggested by items D-3 and D-4. Item D-4 is especially important because the 

cost of environmental clean-up can be very high and the requirement places this 

cost on the seller, even if the problem is unknown to anyone at the time of sale. In 

some cases the environmental clean-up costs exceed the value of the loan and 

may involve years of litigation to resolve. 

The final sample of R&Ws applies to a group of loans unrelated to mortgages, 

namely, vehicle loans. Because these loans have relatively low balances and are 

collateralized by automobiles, lenders place much less reliance on the security 

gained from foreclosure and the subsequent sale of the underlying collateral. 

Extended or costly litigation between the borrower and the lender is unusual. 

These attributes combine to greatly simplify the types of R&Ws given. For 

example, one requirement might be that the seller guarantees its ownership or 

right to sell the loans (item E-2) in order to prevent fraud. Given the changed 

nature of product risk, sellers may be as likely as buyers to request R&Ws. 

Specifically, sellers may ask buyers to give R&Ws to the effect that they are 

sophisticated and capable of understanding the risks of the loans being sold 

(items E-3 and E-4). 

Claims Trends 

A consequence of the RTC's unprecedented sales volume is that it provides the 

large-scale R&W claims experience needed to gauge the likelihood of problems 

that normally have only a low likelihood of occurrence. The large program size 

also caused the creation of a claims administration department and a database of 

claims losses. These data provide one of the largest records of R&W claims costs 

and trends ever created. 

Many interesting characteristics of the data can be observed by examining the 

claims experience of a sample of deals. Tables 2a and 2b provide such a sample 

for fixed-rate and adjustable-rate mortgage sales that occurred relatively early in 

the RTC's history (1991). 2 The sales chosen were five securitizations, three 

containing single-family mortgages (1991-11, -12, and -14) and two with multifamily mortgages (1991-M1 and -M5). Early securitizations provide convenient 

examples because their collateral characteristics are well-documented and claims 

experience is seasoned. A review of other sales around the same time found that 

the sample chosen was reasonably representative. 

Table 2a 

Rep and Warranty Claims Statistics For a Sample of RTC Sales 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repurchased Total 

Initial Sale Data Cured Claims 

Claims Approved Claims

Mortgage Sale UPB Number Average

Average Average

Sale Date $Mil Loans Type Number $000s 

Number $000s Number 

$000s 

(Security) (1) (2) (3) (4) (5) (6)

(7) (8) (9) (10) 

Single-Family 

1991-11 10/91 $888 16,826 FX 28 $2 

1 $ 32 29 $ 3 

1991-12 10/91 527 2,330 ARM 9 2 

0 0 9 2 

1991-14 11/91 545 7,126 ARM 176 2 

0 0 176 2 

Multi-Family 

1991-M1 8/91 373 218 ARM 0 0 

6 5,960 6 5,960

1991-M5 11/91 386 548 FX 0 0 

1 1,536 1 1,536 

Note: Data reflect all RTC R&W claims filed as of December 31, 1994, for all 

R&Ws contracted by the RTC at the corporate level. The UPB in column 2 is 

unpaid principal balance of collateral placed in trust as of the starting date of the 

security. The average claims figures in columns 6, 8, and 10 are computed by 

dividing total claims costs by the number of claims shown in columns 5, 7, and 9, 

respectively (rounded to $000s). 

The initial sale data in columns 1-4 of Table 2a provide a snapshot of the sample. 

The loans were sold into security trusts between August and November 1991. 

These start dates imply three to four years of R&W claims experience prior to the 

1994 database cutoff used for this study. The securities were mid-sized offerings 

in the $300-900 million range that contained considerable collateral variation. 

Columns 5-10 of Table 2a break total approved claims into two components, 

cured and repurchased. A limitation of the data is that the costs of cured claims 

are recorded as the actual cost of curing the claims, whereas the cost of 

repurchases is recorded as the entire unpaid principal balance (UPB) of the 

repurchased loan. 3 The cost of curing a repurchase is not tracked because 

repurchased loans may be resold in a number of ways that create problems for 

tracking losses. For example, a repurchased delinquent loan might later have the 

delinquency cured and be included in a package of several thousand loans, none 

of which are priced separately when the securitization is completed. The 

important point is that the recorded cost of repurchases is many times larger than 

the cost of cures, and the two numbers should not be compared directly as a 

measure of claims costs. 

In spite of data limitations, several points can be noted from the approved claims 

data in Table 2a. First, on the single-family mortgage side, the average claim for 

all three sales shown was only $2,000. This is because R&W problems for singlefamily mortgages tend to relate to relatively solvable and inexpensive problems 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

such as tax penalties and incorrect payment adjustments. Second, on the multifamily mortgage side, all claims are repurchases. 4 Multi-family claims are more 

likely to relate to environmental or other problems that are not as easily solved as 

single-family problems. Repurchase may be required because the problems are 

either too costly or troublesome to resolve. Multi-family problems are aggravated 

further by large loan balances ($5,960,000 average balance for the six claims in 

1991-M1 and $1,536,000 for the one claim in 1991-M5). 

Table 2b 

Rep and Warranty Claims Statistics For a Sample of RTC Sales (continued) 

Total Claims Claim Filing

Date Claim Processing Time

Approved Claims Denied/Other Claims

Mortgage Average Average

Sale Number $000 Number $000 0-1 Yr 1-2 Yr 

>2 Yrs 0-2 Mo 2-4 Mo >4 Mo

(Security) (1) (2) (3) (4) (5) (6)

(7) (8) (9) (10)

Single-Family 

1991-11 29 $3 133 $15 1 26 

135 65 29 68 

1991-12 9 2 8 23 7 4 

6 15 2 0 

1991-14 176 2 165 25 44 57 

240 44 108 189 

Multi-Family 

1991-M1 6 $5,960 8 429 4 4 

6 1 0 13 

1991-M5 1 $1,536 6 3,090 2 1 

4 6 1 0 

Note: Data reflect all RTC R&W claims filed as of December 31, 1994, for all 

R&Ws contracted by the RTC at the corporate level for the five securities listed. 

Table 2b begins by comparing approved claims to those either denied or subject 

to some other resolution status. 5 Relatively large percentages of the claims were 

denied or otherwise not approved. For example, in three sales (1991-12, 1991-14, 

and 1991-M1) approximately 50 percent of all claims were denied, while the 

remaining two sales had approximately 80 percent of all claims denied. Moreover, 

the average approved claim tended to cost considerably less than the average 

denied claim. Combining these statistics suggests that substantial savings accrue 

to reviewing claims carefully. 

The remainder of Table 2b deals with the time required to file and process claims. 

The most interesting points are that large numbers of claims may be made 

several years after the loans are sold and a review of these claims may take 

considerable time and/or resources. In all of the cases shown the largest number 

of claims occurred in the longest filing date category (over two years) while the 

shortest category (up to one year) contained either the lowest or almost the 

lowest number of claims. This trend primarily results from the fact that RTC 

securities provide an indemnity against loss, which implies that claims are more 

likely to occur several years after the securities are created and after the loans 

have had time to default. In contrast, the RTC's non-securities sales generally did 

not indemnify against losses and their claims tended to occur in the first year 

following sale. This trend can be seen in Figure 2, which shows that R&W claims 
 

 

 

 

 

 

 

 

 

 

for sales consummated in 1991 peaked in 1992 and declined thereafter for every 

class of RTC sales except securities. Therefore, the likelihood of 1991 sales 

claims occurring in 1995 or later is low for all of the classes of RTC assets shown 

in Figure 2, with the exception of securities. 

Compounding the filing time problems is the fact that substantial numbers of 

claims required a long period (over four months) to process, that is, to approve, 

deny, or otherwise conclude. The long processing times reinforce the notion that 

significant resources and costs may be required to administer claims even apart 

from the direct cost of curing claims and repurchasing loans. 

Table 3 RTC Claims Losses by Product Type 

Estimated Estimated 

Claims Claims UPB 

Losses Losses Estimated 

Estimated 

UPB Losses Losses Repurchased

Repurchases Reperchases Total 

Total 

Product $Bil $Mil as % UPB $ Mil $ Mil 

as % UPB $ Mil as % UPB 

(1) (2) (3) (4) (5)

(6) (7) (8)

Servicing Rights $ 139 B $ 69 M 0.05% $ 44 M $ 0-7 

M 0-0.01% $69-76 M 0.05-0.06% 

Single-Family

Securitizations 23 27 0.12 83 0-13 

0-0.06 27-40 0.12-0.18 

Multi/Commercial/Other

Securitizations 20 40 0.20 134 0-33 

0-0.17 40-73 0.20-0.37 

Whole Loans 25 12 0.05 178 0-27 

0-0.11 12-39 0.05-0.16 

Other 19 17 0.09 64 0-10 

0-0.05 17-27 0.09-0.14 
 

 

 

 

 

 

Total $ / Average % $226 B $165 M 0.07% $503 M $ 0-90 

M 0-0.04% $165-255 M 0.07-0.11% 

Note: Data reflect all RTC R&W claims paid as of December 31, 1994, for all 

R&Ws contracted by the RTC at the corporate level. Estimated losses in columns 

5 and 6 are calculated as the likely range of losses on loans repurchased by the 

RTC to cure R&W deficiencies. These ranges assume a minimum loss of zero for 

all categories of loans. The maximum loss is 15 percent of UPB repurchased for 

all categories of loans except multi/commercial/other securitizations, and 25 

percent of UPB repurchased for multi/commercial/other securitizations. 

Costs vs. Benefits 

An advantage of the RTC's experience is that its claims and sales data may be 

combined to compare the financial costs and benefits of granting R&Ws. That is, 

the data may be used to perform a cost/benefit analysis of the economic 

efficiency of granting R&Ws. 

The cumulative claims loss experience for the RTC's R&Ws is shown in Table 3. 

These data include claims paid for all R&W agreements made by the RTC in its 

corporate capacity as of December 31, 1994. As such, they include the seasoned 

claims experience arising from sales completed in 1990 and 1991, as well as only 

recent claims experience from sales completed in 1994. 

Column 1 of Table 3 displays the RTC's R&Ws by type of sale. Of the total $226 

billion UPB covered by R&Ws, the largest component, $139 billion, or 

approximately 62 percent of the total, was given on sales of servicing rights. 6 

The remaining 38 percent were from four similar-sized categories of loan sales: 

single-family securitizations, multi-family/commercial securitizations, whole loans, 

and "other" loan sales. 

Claims losses for each sale type are shown in columns 2-8 of Table 3. The UPB 

of all loans covered by RTC corporate R&Ws is shown in column 1 in order to 

provide a benchmark for gauging the magnitude of the losses. The UPB is a 

useful benchmark because it reflects the maximum potential R&W loss in most 

circumstances. Losses are normally below the UPB because lenders may opt not 

to foreclose on properties with projected losses greater than the UPB. While it is 

possible for legal or environmental problems to cause losses to exceed the UPB, 

these situations are rare. 

The most easily tracked costs are for cures, which equaled $165 million, or 0.07 

percent (seven basis points) of the $226 billion UPB benchmark. The claims loss 

rate in column 3 was highest for multi-family/commercial securitizations (20 basis 

points) due to a higher likelihood of complicating factors such as environmental 

problems. The remaining claims loss rates ranged from five basis points for whole 

loans and servicing rights to 12 basis points for single-family securitizations. 

Whole-loan loss rates were the lowest because most RTC whole-loan sales were 

limited to either unusually clean packages of loans or loans with extensive due 

diligence. 

As noted earlier, the cost of R&W claims resulting in repurchases was not tracked 

by the RTC. The fact that many repurchases cause either no or only small losses 

complicates matters. For example, a repurchase of high-quality adjustable-rate 

mortgages may be required because they were sold into a security containing 
 

 

 

 

 

 

 

 

only fixed-rate mortgages. 

The problems of calculating losses on repurchases are dealt with by estimating 

potential losses as ranges (see columns 5 and 6) based on the UPB of loans 

repurchased, as shown in column 4. The range for each product has a lower limit 

of zero and an upper limit of 15 percent of the UPB of loans repurchased for all 

types of loans except multi-family and commercial loans. A 25 percent upper 

bound is used for multi-family and commercial loans due to their higher risk. The 

15 percent and 25 percent upper bounds are chosen based on the authors' best 

estimates of higher-than-expected or "conservative" estimates of the average loss 

on repurchases. 7 Given the range estimates in column 5, column 6 estimates 

that repurchases add an upper limit of between one basis point and 17 basis 

points to the estimated R&W losses of the various product classes. The average 

upper limit loss across all products is four basis points. 

The costs of granting R&Ws can now be directly compared to the benefits for a 

key asset class, single-family mortgages. As noted, financial advisers and early 

RTC experience estimated the benefit of granting R&Ws on single-family 

mortgages in the range of two percent to three percent (200 to 300 basis points) 

of the UPB sold. That is, single-family mortgages sold with R&Ws can be 

expected to sell for 200 to 300 basis points more than if they are sold without 

R&Ws. 

A 200-to-300 basis point financial benefit for single-family mortgages compares 

very favorably with total R&W costs in columns 7 and 8 of Table 3. The cost 

category most directly applicable to single-family sales is single-family 

securitizations. Column 8 shows the cost of single-family securitizations as 12 to 

18 basis points. However, because Figure 2 suggests that securitization claims 

may continue in the future, an adjustment needs to be made to recognize the 

possibility of future claims. If we project future single-family securitization R&W 

claims costs to equal all costs incurred through December 31, 1994, then the 

projected R&W cost implied by past securitization claims equals 24 to 36 basis 

points. 8 Thus, the cost of single-family mortgage R&Ws is only a small fraction of 

the 200-to-300 basis point benefit that accrues from granting them in single-family 

mortgage sales. 

The dramatic excess of financial benefits over costs suggests that sellers of 

single-family mortgages are well-advised to grant R&Ws in spite of the 

expectation of some claims-related costs. Indeed, the excess may help to explain 

the RTC's experience that it is customary for sellers to grant R&Ws, and why 

sellers who do not grant R&Ws are viewed with suspicion by buyers who willingly 

pay a price premium to avoid the risk of purchasing a "lemon." 

But does the cost/benefit analysis of the the RTC's single-family mortgage 

experience extend to sales of other types of financial assets, such as commercial 

mortgages or "other" loans? Three points suggest that the RTC's experience 

applies to many other types of assets. First, the R&W cost statistics in Table 3 are 

of the same order of magnitude for all types of assets. While the costs vary by 

product, all column 8 estimates are far below the 200-to-300 basis point range 

found for single-family mortgages. 9 Second, all types of loans are characterized 

by information problems similar to those of single-family mortgages. Moreover, 

the RTC's initial policy of limiting R&Ws resulted in the same liquidity and bidder 

interest problems regardless of the types of loan-related assets sold. Finally, it is 

a widespread market practice for sellers to give, and for buyers to request, R&Ws 
 

 

 

 

 

 

for all types of financial assets. 

The weight of evidence points to the conclusion that it is cost-effective to grant 

R&Ws in many types of loan sales. Given the lemons principle, we expect that the 

excess of benefits over costs increases as the quality or availability of risk-related 

information declines. 

Conclusions 

A number of interesting lessons may be drawn from the RTC's extensive R&W 

experience. First, R&Ws may represent significant risk because considerable 

expense may be required to cover claims costs and claims may continue for 

several years after the loans are sold. The risk may be a problem especially for 

firms that actively sell loans to the secondary markets because R&W liabilities 

grow with each sale. Second, administrative costs exacerbate the risk because 

claims may require additional expenses in the form of file reviews, the repurchase 

of assets, legal advice, and other problems. Finally, in spite of the likely costs and 

administrative problems, the experience of the RTC suggests that it is financially 

efficient for firms to grant R&Ws. R&W claims costs for single-family mortgages 

sold by the RTC were dramatically less than the financial benefits estimated to 

accrue from higher market prices on loans sold with R&Ws. The evidence points 

to a similar conclusion for many other types of assets as well. 

Two caveats should be kept in mind regarding the RTC's experience relative to 

that of other institutions. First, the bulk of the RTC's claims experience occurred in 

a relatively favorable economic environment between 1992 and 1994. If this had 

been an extended period of unfavorable economic conditions, then claims-related 

losses could have been higher, especially for the default-sensitive portion of 

claims found in RTC securitizations. Similarly, an economic downturn could cause 

future claims experience, for the default-sensitive portion of the claims, to 

compare unfavorably from that documented in this paper. Second, the RTC's 

experience is made distinct by the fact that the S&Ls it took over, and whose 

assets it sold, were highly distressed. Therefore, the RTC may have been more 

likely to encounter R&W claims problems than, for example, healthy firms, and 

this may have affected both the benefits and the costs of granting R&Ws. While 

the net effect of these factors is difficult to quantify, the RTC's R&W claims 

experience nevertheless seems to provide a useful guide to projecting potential 

claims costs and trends, especially for firms that actively sell loans to the 

secondary markets. 

REFERENCES Akerloff, George. "The Market for Lemons: Quality Uncertainty 

and the Market Mechanism." Quarterly Journal of Economics (August 1970): 488­

500. 

Resolution Trust Corporation. Sketchbook of RTC Securities. Washington, DC: 

Resolution Trust Corporation, December 1994. 
 

 

 

 

 

 

 

 

Vol. 8 No. 3 - Article II - Published: February, 1996 - Full Article 

Banks and Mutual Funds 

by Jay W. Golter 

Mutual funds are the fastest-growing segment of the financial-services industry. 

Assets under management by mutual funds have grown from $134.8 billion in 

1980, to $1,066.8 billion in 1990, to $2,161.5 billion at year-end 1994. In 

comparison to deposits at commercial banks and savings banks during those 

years, mutual fund investments equaled 8.3 percent of deposits in 1980, 37.3 

percent of deposits in 1990, and 75.2 percent of deposits in 1994. 

This paper first traces the growth of mutual funds. The next section describes the 

major functionaries employed by a mutual fund and the extent to which banks or 

bank affiliates have provided these services for mutual funds. The paper 

concludes with an examination of the ways that banks have entered the 

distribution channel by selling mutual funds to their customers. 

History of Mutual Funds 

A mutual fund offers shares to investors. The proceeds from the sale of shares 

are used to purchase a portfolio of investment assets, generally financial 

securities. In an open-ended mutual fund, investors may redeem shares 

previously purchased, or purchase new shares, at a price called the "net asset 

value," or NAV. The NAV is calculated at least daily, usually at the close of 

financial markets, to reflect the marked-to-market value of the pro rata portion of 

the portfolio represented by each share. As more fund shares are purchased 

(redeemed) by investors, the investment portfolio increases (decreases) in size. 

As the market value of the securities held in the portfolio increases (declines), the 

NAV increases (decreases). Portfolio earnings and losses are thus passed on 

directly to the investors. 

Mutual funds in the United States can trace their origins to investment trusts 

established in England and Scotland in the early 19th century. 1 Those trusts 

actively provided capital to American businesses that emerged after the Civil War. 

The first American mutual funds were formed in 1924 in Boston and New York. 

Many closed-end 2 investment companies were formed during the years 

preceding the stock market crash of 1929. These companies tended to hold highly 

speculative portfolios and performed poorly during the crash. Investor confidence 

in all forms of mutual funds was further shaken by unscrupulous practices in some 

closed-end companies. 3 

Congress sought to address this problem in 1935 by ordering the Securities and 

Exchange Commission (SEC) to study the industry. The SEC'S report formed the 

foundation for the Investment Company Act of 1940, the primary statute that 

regulates mutual funds. In addition, a myriad of other statutes govern the 

management of mutual funds. Since the passage of the 1940 Act, the mutual fund 

industry has grown substantially in both absolute size and in terms of market 

share among financial-services providers. 

Mutual fund portfolios are generally constructed in order to achieve specific 

investment objectives. Among the broad classification schemes are short-term 

(taxable and tax-exempt money-market funds) versus long-term (bond and equity) 
 

 

 

 

 

 

 

 

 

 

 

 

funds. Individual short-term funds may hold specialized portfolios; for example, 

some money-market funds invest entirely in U.S. Government instruments. Longterm funds are usually characterized by their investment strategies. Examples 

include funds that invest primarily in equities of small companies (small cap 

funds); equities with high dividend yields (income funds); bonds below investment 

grade (high-yield funds); securities issued by firms in particular industries (sector 

funds); securities issued in developing countries (emerging market funds); and 

balanced funds, which hold both equities and debt securities. In the 1994 Mutual 

Fund Fact Book, the Investment Company Institute classified all mutual funds by 

21 separate investment objectives. 

Mutual fund sponsors often offer a variety of funds in which to invest. This 

enables investors to match their own investment needs and objectives with the 

strategy of a particular fund or combination of funds. The largest fund complex, 

Fidelity, offered 171 funds as of year-end 1993. 4 Only one other fund group, 

Merrill Lynch, offered more than 100 separate funds. Among the 34 fund groups 

that each sponsored funds with aggregate assets exceeding $10 billion, the 

average number of funds offered was 47. Two fund groups with historical ties to 

bank holding companies are included on this list. 5 Pacific Horizon Funds, which 

ranked 30th on the list with 19 funds and had a combined $11.5 billion in assets 

under management, was associated with Security Pacific National Bank and now 

performs many services for the mutual fund complex that was formed in the 

aftermath of that bank's merger with BankAmerica. Nations Funds, which is 

associated with NationsBank, ranked 33rd in size, encompassing 47 funds with a 

total of $10.5 billion in assets under management. As of year-end 1993, 93.6 

percent of the assets managed by Pacific Horizon Funds and 72 percent of the 

assets managed by Nations Funds were in money-market funds. Thus, while the 

combined assets of the two fund families totaled slightly more than one percent of 

the industry's total, the $18.4 billion of money-market funds that the two 

complexes managed represented 3.3 percent of the short-term fund market. 

In contrast, at year-end 1993, the Fidelity group had $219 billion in assets under 

management, or 10.6 percent of the total industry. The top five fund groups had 

$629.7 billion in assets under management, or 29.9 percent of the total industry. 

One group of note is Federated Funds, the 13th largest group at year-end 1993, 

with $29.3 billion in assets under management. Although Federated is not 

associated with any single bank holding company, the firm assists banks in 

establishing mutual fund sales programs and performs all necessary functions for 

banks that create their own mutual funds. It has been estimated 6 that 80 percent 

of Federated's sales occurred in banks. 

Regulation 

Mutual funds are governed by the Securities Act of 1933 (the 1933 Act), the 

Securities Exchange Act of 1934 (the 1934 Act), the Investment Company Act of 

1940 (the 1940 Act), the Investment Advisers Act of 1940, relevant sections of the 

Internal Revenue Act and Blue Sky laws of each state in which a fund operates. 

The success of these statutes in creating a climate of investor confidence is 

evidenced by the extraordinary growth of the mutual fund industry over the past 

decades. 

The Securities Act of 1933 and Securities Exchange Act of 1934. The 1933 

Act requires mutual funds to file registration statements with the SEC. All 

purchasers of "securities" (the definition of which includes mutual fund shares) 

must be provided with a prospectus. The 1934 Act, among other provisions, 

requires that broker/dealers who sell mutual funds must register with the SEC. 
 

 

 

 

Bank employees are exempt from this requirement as long as they do not receive 

transaction-related compensation (commissions). 

The Investment Company Act of 1940. The 1940 Act requires that investment 

companies register with the SEC. The registration statements must include 

information about the investment objectives and strategies of the fund. These 

policies can not be changed without approval of the majority of investors in the 

fund. The Act also imposes restrictions on the amount of leverage that a fund may 

employ. Among other major provisions, the 1940 Act empowers the National 

Association of Securities Dealers (NASD) to regulate sales charges (loads) on 

mutual funds. 

A fund's board of directors will determine which firms should be awarded 

contracts, and at what levels of compensation, for providing the services needed 

to maintain operations. Because a fund's sponsor may perform many of those 

services, and would have selected the original board, "there is obvious potential 

for conflict between the interests of the investment company sponsors and 

managers and the interests of the investment company shareholders." 7 The 

1940 Act addresses this problem by establishing that the investment advisers and 

the board of directors of a fund have a fiduciary obligation to the investors of the 

fund. The composition of the board is further restricted by the 1940 Act to 

enhance its independence from sponsoring organizations or other "interested 

parties." Furthermore, shareholders must approve all management contracts. The 

1940 Act also requires investment companies to provide semiannual statements 

to investors and empowers the SEC to establish appropriate accounting 

standards. The SEC is authorized to regulate all sales literature and 

advertisements of investment companies. 

The Investment Advisers Act of 1940 . The investment adviser is the key 

provider of services to a mutual fund. The Advisers Act requires that investment 

advisers register with the SEC. However, banks (though not bank affiliates) acting 

as investment advisers to mutual funds are explicitly exempted from these 

provisions. The Advisers Act also imposes restrictions on the contracts that 

mutual funds enter into with their advisers. These provisions, which apply to 

banks as well as nonbank advisers, require that the terms of the agreement not 

exceed two years, that a majority of outside directors approve all renewals, and 

that the contract may be terminated, without penalty, by the fund at any time with 

60 days' notice. 

The Internal Revenue Act. Mutual funds can avoid a direct income tax 

assessment and pass taxable income and capital gains through to the fund's 

investors. Subchapter M of the Internal Revenue Code defines a series of tests 

that a mutual fund must pass in order to qualify as a "regulated investment 

company" (RIC). The failure of a mutual fund to meet all of the following 

requirements would result in an onerous tax obligation: 

•	 The mutual fund must be registered under the 1940 Act for the entire 

taxable year. 

•	 At least 90 percent of the RIC's gross income must be derived from 

dividends, interest, gains on sales of securities, and other qualifying 

income from investments in securities. Examples of non-qualifying 

income would include income derived from partnerships investing in real 

estate or oil drilling leases. 

•	 Less than 30 percent of a RIC's gross income may be derived from the 
 

 

 

 

 

 

 

 

 

sale of instruments held less than three months. 

•	 At the end of each quarter, at least 50 percent of the RIC's portfolio must 

consist of cash, cash items, U.S. Government securities, securities of 

other RICs and other securities in which no one issuer's securities will 

exceed five percent of the RIC's assets and no more than ten percent of 

any issuer's outstanding voting securities are held by the RIC. 

•	 At least 90 percent of the RIC's income must be distributed to the 

investors.
 

Blue Sky Laws. States have authority, subject to the primacy of federal laws, to 

regulate the securities activities that occur within their respective borders. Mutual 

funds must register, and pay filing fees, with the state securities agency in each of 

the 50 states, Puerto Rico and the District of Columbia, in which the fund will be 

distributed. Because there are variances in the procedures followed by each of 

the 52 jurisdictions, Blue Sky law compliance can be complicated. 8 

Growth 

When the Investment Company Act of 1940 was enacted, the mutual fund 

industry consisted of 296,000 shareholder accounts investing in portfolios with an 

aggregate asset value of $448 million. 9 In contrast, FDIC-insured commercial 

and savings banks held combined assets of $72.7 billion, 10 or 162 times the 

assets held by the mutual fund industry. By year-end 1994, mutual funds held 

assets of $2.16 trillion, 11 while commercial and savings banks held assets of 

$4.01 trillion. 12 The growth of the two industries is shown in Figures 1A and 1B. 
 

 

As shown in Figures 1A and 1B, the mutual fund industry has grown rapidly 

during the past 15 years. Figure 2 indicates that the intensity of some of the 

periods of growth can be explained by contemporary market conditions. 

The bull market of the 1960s contributed to the run up in mutual fund assets. At 

the start of the 1960s, mutual funds held about $16 billion in assets. By the late 

1960s, mutual fund assets exceeded $47 billion, a threefold increase. Mutual fund 

assets hit a temporary peak of $59.8 billion at year-end 1972. However, the 

effects of a prolonged bear market caught up with the industry, and the value of 

assets under management declined to $34.1 billion by year-end 1974. Although 

traditional (equity and bond) funds gradually began to increase in value the 

following year, they did not regain their asset level of 1972 until 1982. However, 

1974 also marks the first year in which money-market mutual funds, first launched 

in 1971, 13 surpassed $1 billion in assets. 

Money-market mutual funds invest in high-quality, short-term instruments. The 

1940 Act imposes a series of tests on a fund portfolio to assure that standards of 

quality and liquidity are met. Funds that meet the standards are allowed to call 

themselves money-market mutual funds and to use the daily increase in portfolio 

value to issue new shares to investors such that the fund's net asset value is 

maintained at $1.00 per share. Because of the apparent safety of the portfolio, 

many investors view money-market mutual funds as a substitute for bank 
 

 

 

 

 

 

 

deposits. This attitude was reinforced when Merrill Lynch in 1977 introduced its 

"Cash Management Account," which allowed money-market account holders to 

withdraw their funds by writing a check, now a standard feature of retail-oriented 

money-market funds. 

The rapid public acceptance of money-market funds may be explained by the 

previously imposed constraints on the ability of commercial banks and thrifts to 

provide their customers with alternative products that earned a market rate of 

interest. In 1933, the Federal Reserve Board was given authority to restrict the 

interest rates that member banks were permitted to pay depositors. These 

restrictions were codified in Regulation Q of the Federal Reserve Act. Authority to 

impose restrictions on nonmember banks was extended to the FDIC in 1935. 

Until the late 1960s, market interest rates never exceeded the savings rates that 

regulators permitted banks to offer for time deposits. However, when Regulation 

Q became a binding constraint, the market created pressure for an alternative 

savings vehicle to develop. Ironically, the first move to relax Regulation Q helped 

to spur the development of money-market mutual funds. In 1970, the Penn 

Central Railroad became the first major firm to default on its commercial paper. 

Fearful that investors would abandon the market, and that commercial banks 

would not have the liquidity to provide bank loans to firms trying to refinance their 

short-term debt, the Federal Reserve Board removed interest-rate restrictions on 

certificates of deposit greater than $100,000. Although this easing of Regulation Q 

enabled banks to serve institutional and wealthy investors adequately, the retail 

investor was left without any means to earn market rates. 

Figure 3 shows that in their early years of existence, money-market mutual funds 

held a large percentage of their investment portfolios in bank deposits. This 

represented an opportunity on their part to intermediate between banks and bank 

customers, thereby offering the latter the ability to aggregate funds and receive 

market rates. As money-market funds became established, direct investment in 

commercial paper became an increasing proportion of their portfolios, and bank 

instruments became less important. 

As the 1970s ended, interest rates were still rising and money-market funds had 

grown to $45 billion. This movement of funds from the banking sector to the 

mutual fund industry was termed disintermediation, although a more appropriate 

term may have been redesigned-intermediation because depositors were using 
 

 

 

 

 

 

 

 

 

 

alternative channels of intermediation rather than directly financing commercial 

enterprises. Money-market funds function as intermediaries by bringing together 

entities with excess funds and entities in need of funds. Further, liquidity is 

provided to savers through the law of large numbers. That is because on an 

average day the amount of invested funds redeemed by savers is largely offset by 

the amount of additional funds invested by savers with new temporary surpluses. 

As intermediaries, mutual funds differ from banks by passing more risks back to 

investors. In particular, banks shield insured depositors from the credit risk 

associated with lending. Mutual funds, of course, pass on any changes in value, 

whether caused by changes in credit quality or interest-rate movements, directly 

to the investors. 

As vehicles for bringing a class of short-term borrowers (those entities with 

access to the commercial paper market) and short-term investors together, 

money-market funds have certain advantages over banks. Although both 

intermediaries are highly regulated, the regulatory costs imposed on bank 

intermediation include variable costs. Specifically, banks are assessed reserve 

requirements and deposit insurance premiums on each additional dollar of 

deposits. In contrast, each additional dollar invested in a money-market fund can 

be used in full to purchase money-market instruments. 

These efficiencies, combined with a possible increase in investors' willingness to 

bear risk, contributed to the growing acceptance of money-market mutual funds. 

However, a nascent industry faced at least two significant obstacles. The first was 

a need to attain investor confidence; the second was the development cost of the 

systems and infrastructure necessary to support the operations of a moneymarket fund. Regulation Q provided large returns to savers switching from bank 

products. Such returns may have been necessary to overcome depositors' 

concerns about the increased risk of the new intermediation channel. A large 

potential market, consisting of all retail bank depositors, thus existed to justify the 

early development costs incurred by money-market funds. 

Congress responded to the reduction in bank deposits by passing the Depository 

Institutions Deregulation and Monetary Control Act of 1980, which mandated the 

gradual elimination of Regulation Q ceilings. In the interim, money-market fund 

assets grew rapidly. During 1980, money-market funds nearly doubled in size to 

$74.5 billion. In the following year they more than doubled to $181.9 billion. The 

Garn-St Germain Depository Institutions Act of 1982 enabled banks and thrifts to 

offer deposit accounts with attributes similar to money-market funds. However, 

the money-market fund had already become an important component of the 

financial system. Growth in these funds stabilized as banks were able to retain 

their depositors, albeit at a higher cost than prior to deregulation. Subsequent 

growth in assets under management by money-market funds has been related to 

periods characterized by high short-term interest rates, as shown in Figure 4. 
 

 

 

 

 

A new product was introduced in 1976: money-market funds that invest only in 

short-term municipal obligations. The earnings received by investors in such 

accounts are therefore exempt from federal income taxes. These funds, which 

first reached an appreciable asset size in 1979, have grown at a stable pace, with 

one exception. In 1986, the assets held by tax-exempt money-market funds 

increased from $36.3 billion to $63.8 billion. That jump can probably be explained 

by the passage of the Tax Reform Act of 1986, which ended the preferential tax 

treatment conferred on many other types of investments. 

The bull market of the 1980s was favorable to long-term mutual funds. The assets 

of mutual funds and money-market funds totaled $94.5 billion at the start of the 

decade. This equaled 5.1 percent of the $1.839 trillion in assets held by FDICinsured commercial banks and mutual savings banks at that time. By year-end 

1989, total mutual fund assets had grown tenfold to $982 billion, or 27.4 percent 

of the $3.579 trillion in assets held then by the banking industry. During the next 

four years, mutual fund assets more than doubled to $2.075 trillion. This 

represented 56 percent of the $3.706 trillion in assets held by BIF-member 14 

depository institutions at year-end 1993. 

On seven occasions during 1994 the Federal Reserve Board increased short-term 

interest rates. Secondary market prices of previously issued bonds fell, thus 

creating losses for mutual funds that held those instruments. This, in turn, led to 

investor redemptions, which caused assets held by the mutual fund industry to 

decrease even more. The stock market also performed poorly, resulting in losses 

or disappointing returns to investors in mutual funds that held equities. 

Furthermore, the attractiveness of bank deposits relative to mutual fund 

investments improved as CD rates increased and investors experienced the 

riskiness of mutual fund investments. By year-end 1994, mutual fund assets had 

increased by only $86.1 billion, the smallest annual increase since 1983, the last 

year in which assets under management declined. The mutual fund industry 

entered 1995 with a total of $2.162 trillion in assets, or 53.9 percent of the $4.010 

trillion in assets held in BIF-member depository institutions. 

Bank Involvement in the Mutual Fund Industry 

Mutual funds are unusual among business enterprises in that they seldom have 

any direct employees. Instead, a fund is created with a board of directors (or 

trustees) that is responsible for contracting out a variety of functions to other 
 

 

 

 

 

 

 

 

 

 

 

entities. Some of these functions, such as fund attorney, are not appropriate for a 

bank organization to perform. Furthermore, banks are prohibited by GlassSteagall restrictions from performing the functions of the fund underwriter. 15 

However, there are several ways in which banks and bank holding companies are 

able to participate in the mutual fund industry. Banking organizations were first 

authorized by the Federal Reserve Board to become directly involved in mutual 

fund operations in 1972, the year in which mutual fund assets peaked. The 

authorization permitted holding companies to act as transfer agents, custodians, 

and investment advisers for mutual funds, subject to various restrictions. Over 

time, additional interpretations by bank regulators have relaxed many of those 

initial restrictions. 16 As the mutual fund industry developed into a major vehicle 

for financial intermediation, bank involvement with the industry grew. The most 

visible way is through sales of mutual funds to bank customers. Banks have 

become a significant component of the distribution channel. 

Banks as Transfer Agents. Transfer agents maintain the records concerning 

customer accounts. They record purchase and redemption transactions and 

disburse payments of dividends, interest and capital gain distributions. They 

prepare confirmation notices of all investor transactions and report year-end tax 

and withholding information to the Internal Revenue Service. Banks and bank 

holding companies may be transfer agents for mutual funds as well as for other 

incorporated businesses. 

Transfer agents must register with the appropriate regulatory agency as defined in 

the Securities Exchange Act of 1934. 17 Banks and subsidiaries of banks register 

with their primary federal regulator. 18 Transfer agencies that are subsidiaries of 

bank holding companies register with the Federal Reserve Board. All other 

transfer agents, including thrifts and subsidiaries of thrifts, must register with the 

SEC. When a bank is transfer agent for a proprietary fund, 19 the investment 

adviser may not maintain time deposits with affiliated banks and must keep the 

fund's transaction balances with affiliated banks at minimal levels. 

Transfer agents may subcontract a portion of their activities to a shareholder 

servicer. This sub-agent handles the aspects of the service that most closely 

interface with the investor, for example, preparing regular statements or 

answering telephone inquiries. The shareholder servicing agent generally will be 

compensated based on a formula that incorporates the number of shareholders 

serviced and the amount of activity that occurs. 20 In 1986, the Federal Reserve 

Board explicitly permitted bank holding companies to receive fees for shareholder 

servicing. 21 The FDIC permitted state-chartered nonmember banks to conduct 

certain shareholder services in 1989. 22 

A 1994 survey 23 of banks with proprietary funds indicated that approximately 29 

percent were acting as their own transfer agent and an additional five percent 

were planning to do so. This same survey indicated that approximately 58 percent 

of the banks with proprietary funds performed shareholder servicing functions for 

their funds and an additional four percent were planning to do so. However, 

another analysis, which was conducted in March 1994, concluded that 65 of the 

103 banks that offered proprietary funds to retail customers used affiliated transfer 

agents. 24 

Banks as Custodians. Fund custodians execute the portfolio transactions that 

are directed by the investment adviser. They provide safekeeping of securities; 
 

 

 

 

 

monitor events that affect the portfolio's securities such as splits, calls and 

tenders; report on cash balances and provide cash projections for the fund; and 

keep the investment adviser informed about changes in foreign and domestic tax 

laws or market practices that could affect the investment practices of the fund. 

Although the 1940 Act permits funds to use banks, national securities exchange 

members, or the fund itself as custodian, the requirements of SEC rule 17f-1 are 

so strict that most custody is performed by banks. 25 Of the ten largest 

custodians 26 in 1993, only one, Brown Brothers Harriman, is not a bank. The 

eighth largest, Putnam Fiduciary Trust, is a chartered commercial bank, but it 

performs little or no traditional banking activity. The largest custodian, State Street 

Bank and Trust, acted as custodian for 1,704 funds with combined assets under 

management of $407.5 billion. The second-largest custodian, Chase Manhattan 

Bank, was custodian for 154 funds with combined assets of $173.9 billion. 

In 1994, nearly 50 percent of the banks with proprietary funds acted as their own 

custodian and another 25 percent had plans to do so. 27 In March 1995, 53 of the 

103 banks that offered proprietary funds to retail customers used affiliated 

custodians. 28 

Banks as Investment Advisers. The most important functionary of a mutual fund 

is the investment adviser. This is also the function that offers the highest potential 

earnings within a mutual fund. An investment adviser is responsible for managing 

the investment portfolio in order to attain the greatest return consistent with the 

investment strategy established by the board of directors. Investment advisers in 

traditional fund structures would also perform such administrative functions as 

filing all required documents; providing accounting, data processing and clerical 

services; preparing financial statements; and coordinating the relationships 

among the various other entities, for example, transfer agents and legal counsel 

operating the funds. However, bank-sponsored funds often contract out the 

administrative tasks to a third party who acts as fund administrator. 

Investment adviser fees are detailed in a contract that is reviewed annually by the 

board of directors. Generally, fees constitute a percentage of the funds under 

management; however, due to scale economies in portfolio management, 

contracts often will specify diminishing rates as the fund reaches specified levels. 

Performance incentives, and in some cases penalties, are also included in many 

advisory contracts. Bank revenues 29 from investment advisory activities grew 

steadily from $175 million in 1989 to about $450 million in 1993. In just the first 

three quarters of 1994, those revenues doubled to approximately $900 million. 

The growth is accounted for by both the increase in the size of bank proprietary 

funds and an increase in the percentage of such funds that was held in long-term 

funds, which provide higher management fees to the investment adviser. 

Bank Distribution Channel. The most visible way in which banks have 

participated in the growth of mutual funds has been through the sale of mutual 

funds to bank customers and on bank premises. In 1991, 13 percent of all longterm fund sales occurred through banks. The bank share was 12.7 percent in 

1992 and then increased to 14 percent in 1993. In absolute terms, banks sold 

$28.1 billion of long-term mutual funds in 1991, $43.8 billion in 1992, and $67.5 

billion in 1993. 30 (An alternative estimate 31 indicates that bank sales of longterm mutual funds represented four percent of the market in 1992, eight percent in 

1993 and nine percent in 1994.) Banks account for a larger percentage of moneymarket fund sales. In 1991, they accounted for 22.4 percent of all sales of short­
 

 

 

 

 

 

term funds. This market share grew to 26.8 percent in 1992 and 28.7 percent in 

1993. In absolute terms, banks sold $122.8 billion of money-market funds in 1991, 

$149.8 billion in 1992 and $165.9 billion in 1993. This pattern of sales indicates 

that banks are becoming more diverse in the types of funds that they sell. In 1991, 

77 percent of the funds sold through banks were money-market funds; by 1993, 

this percentage had declined to 56 percent. 

There are three basic ways in which a bank can offer mutual funds to its 

customers. The methods, in increasing order of complexity, are to offer third-party 

funds, private label funds, or proprietary funds. In addition, the bank must decide 

who will be making the actual sales presentation. The options are to use bank 

employees, employees of a broker/dealer affiliate or subsidiary, employees of an 

outside broker/dealer, or some combination thereof. 

When a bank offers third-party funds, for example, funds sponsored by Fidelity, it 

receives a fee or commission. However, the bank may sacrifice any ongoing 

benefits from that customer's savings. In fact, the fund will communicate directly 

with the investor, potentially eroding the customer's ties with the bank. 

A bank that wishes to maintain an identity with the customers buying funds may 

choose to establish a private label arrangement. In these arrangements, the 

sponsor creates a fund (or a group of funds) with a name that may be associated 

with the bank that will be selling the fund's shares. The bank, depending on its 

operational capacity, may perform some of the functions required of the fund, 

such as transfer agent or shareholder servicing agent. Communications between 

the fund and the customer may be tailored to enhance the connection between 

the bank and the customer. While this type of arrangement maintains the bank's 

relationship with its customers, it limits the financial benefits that the bank could 

reap from providing full services to the fund. 

The establishment of a proprietary fund is an option available to banks that wish 

to retain the maximum benefit of providing mutual funds to their customers. In 

these arrangements, the bank, or an affiliate, becomes the investment adviser. 

Depending on the extent to which the bank felt it could perform specialized 

functions, the bank or its affiliates could also become fund administrator, 

custodian or transfer agent. 

However, the formation of a new mutual fund involves considerable expense. 

According to one estimate 32 of the start-up costs, legal fees alone can range 

from $25,000 to $350,000 for a single bank-sponsored fund. In addition, the SEC 

and state securities commissions charge filing fees for registering the fund and its 

securities. A standard rule of thumb has been that a bond or equity fund had to 

exceed $100 million in assets in order to attain the economies of scale necessary 

to compete with other funds. Many observers believe that this threshold has 

increased during the past few years; however, there is no general consensus on 

what the new minimum level should be. 33 

In order to attain the threshold level quickly, many banks have looked to their trust 

departments. Trust departments manage funds for individuals and institutional 

customers. Some of the investments are placed in collective investment funds 

(CIFs), which are managed in a manner similar to a mutual fund. Many banks 

have converted CIFs into proprietary mutual funds. Most of these conversions 

have occurred with CIFs holding funds for employee benefit plans because, in 
 

 

 

 

 

 

 

these cases only, there is no capital gains tax consequence. 

Banks have been willing to incur the administrative costs of converting CIFs for 

several reasons. 34 First, trust departments are restricted from assessing fees on 

CIFs. However, mutual funds generate a variety of fees, including fees paid to the 

investment advisers, transfer agents, and custodians, some or all of whom may 

be affiliated with the bank. Second, mutual funds may advertise, subject to 

regulations of the NASD. CIFs, except for those restricted to employee benefit 

accounts, are prohibited from advertising performance results. Finally, mutual 

funds may receive investment funds from the public as well as from trust 

department customers. A fund may even issue a variety of "classes" of shares 

with different fee structures and balance and transaction minimums which are 

each targeted to different groups of potential customers. CIFs, however, are 

restricted from receiving personal funds that are not part of a fiduciary trust 

account. Furthermore, each CIF is restricted to investing funds from personal 

trusts or from agency accounts, increasing the difficulty of growing to take 

advantage of scale economies. 

Trust department customers may also benefit from having funds invested in 

mutual funds rather than CIFs. First, the customer will be able to track the 

performance of the fund in the daily newspaper, and be better able to compare 

the performance with alternative funds. Also, distributions to beneficiaries of the 

trust funds in CIFs must be made in cash. Trust funds invested in mutual funds 

may make "in kind" distributions with mutual fund shares. In some cases, the 

recipients of these distributions will have more flexibility to time the realization of 

capital gains. 

A 1995 study 35 estimates that, excluding the Dreyfus funds now managed by 

Mellon Bank, 60 percent of the bank-managed fund assets (75 percent of the 

assets managed by the ten banks with the largest portfolios) originated as trust 

department conversions. The U.S. General Accounting Office derived a different 

estimate of the level of trust conversions by assuming that any time a bank 

proprietary fund was launched with a large amount of assets, the funds came 

from converted trust accounts. Although this method fails to capture conversions 

of trust assets into already existing proprietary funds, trends can be discerned 

from Table 1. 

Table 1 

Estimated Trust Conversions ($ Millions) 

Long-Term 

Fund 

Conversions 

Money- as a Percent 

of 

Market Long-Term Total Total 

Year Funds Funds Conversions 

Conversions 

1985 $ 178 $ 0 $ 178 0% 

1986 915 20 935 2 

1987 2,128 55 2,183 3 

1988 2,552 1,340 3,892 34 

1989 2,056 1,024 3,080 33 

1990 773 640 1,413 45 
 

 

 

 

 

 

 

 

 

 

 

1991 802 2,123 2,925 73 

1992 2,696 6,624 9,320 71 

TOTAL $12,100 $11,826 $23,926 49% 

Source: Lipper Analytical Services as reported by U.S. General Accounting Office 

Trust Assets: Investment of Trust Assets in Bank Proprietary Mutual Funds. 

By 1988, as banks started to expand their fund offerings, bond and equity 

portfolios in trust departments became significant sources of assets for 

conversion into mutual funds. According to one 1994 study of proprietary funds, 

36 trust conversions accounted for approximately 30 percent of the new money 

that flowed into bank proprietary funds in 1992. The following year, trust 

conversions accounted for only about 15 percent of the total. Proprietary funds 

represent a growing proportion of mutual fund sales at banks. By 1985, 25 banks 

37 had established proprietary mutual funds. At year-end 1994, 119 banks were 

offering proprietary funds. 38 One survey 39 indicated that in 1991, 44.7 percent 

of bank mutual fund sales involved proprietary funds. This percentage dipped to 

40.6 percent in 1992, but grew to 48.7 percent in 1993. The drop in 1992 may 

have been due to the relatively modest growth industry-wide in money-market 

mutual funds at a time when long-term funds were growing quickly. At that time, 

bank proprietary funds were mostly represented by short-term funds. 

In 1990, banks sponsored 517 mutual funds 40 (16 percent of the funds offered 

industry-wide), of which 252 (49 percent) were money-market funds. These 517 

funds held $85.9 billion in assets (eight percent of the industry total), of which $73 

billion, or 85 percent, were in money-market funds. By 1992, banks sponsored 

892 funds (20 percent of the industry total), of which 377 (42 percent) were 

money-market funds. These 892 funds held $158.8 billion (ten percent of the 

industry), of which $111 billion, or 70 percent, were in money-market funds. As of 

March 1995, banks sponsored 2,208 funds (28 percent of the industry), of which 

578 (26 percent) were money-market funds. These 2,208 funds held $327.7 

billion in assets (15 percent of the industry), of which $189.2 billion, or 58 percent, 

were money-market funds. Not only are bank proprietary funds a growing 

segment of the mutual fund industry, but banks also are sponsoring a growing 

variety of fund types, and managing increasingly-diverse portfolios. 

It is too soon to evaluate the long-term importance and profitability to the banking 

industry of the sale of mutual funds. The outcome will depend on how efficiently 

banks are able to provide services and products relative to alternative sources. In 

order to thrive, individual banks may need to establish a national presence for 

their mutual fund programs so that they can better realize scale economies. 

Opportunities to consolidate mutual fund operations will act as an additional 

incentive to the consolidation that is occurring within the banking industry and that 

is expected to continue as full interstate banking becomes a reality. In addition, 

further innovations in the structure and administration of bank proprietary mutual 

funds should occur as each firm finds its place in the mutual fund world. 

Market Share by the Numbers 

A review of the literature on bank involvement in the mutual fund industry quickly 

reveals a lack of agreement on the extent of bank penetration of the market. The 

apparent discrepancies are caused by differing methodologies and different 
 

 

 

 

 

 

 

definitions of bank sales. 

Since 1994, all banks and savings-and-loan associations have been required to 

report the volumes of mutual fund and annuity sales as part of the quarterly 

Report of Condition and Income (Call Reports). A comparison of some of the 

definitions described in the Call Report instruction manual 1 with the definitions 

used in other studies explains some of the variations in reported results. 

Call Report totals differ from many other data sources because participation is 

compulsory. Many figures cited in the accompanying article are derived from 

surveys taken among willing participants. As such, they necessarily represent less 

than the full universe of banks participating in the market. Mutual funds are 

similarly compelled to file regular reports with the SEC on portfolio size and 

composition. 

Classification 

Some analysts classify all funds in which the investment adviser is a bank or bank 

affiliate as "bank related." Although this method yields useful results, some 

sources of conflict with other estimates will occur. First, sales at banks of thirdparty funds are not included in the analysis. Similarly, sales of bank-related funds 

that take place through other channels, such as third-party distributors, are 

included. In addition, the fund sponsor is not always clearly identified. For 

example, if an independent mutual fund sponsor offered a fund that only held 

municipal bonds issued within one state (so that investor income would be taxexempt at both the federal level and state level for residents of that state), it might 

utilize a leading local bank's specialized knowledge of the area by selecting it to 

be the investment adviser. 2 

Unfortunately, some classification problems exist among the banks filing Call 

Reports. For example, an informal survey of several banks with proprietary funds 

determined that Mellon Bank has included all of the fund sales made by its 

Dreyfus affiliate in the sales total. 3 However, Chase Manhattan Bank and other 

banks with proprietary funds that are sold outside of the bank's own channel 

reported only the portion of the fund's sales that occurred on the bank's premises 

or to the bank's customers. As inconsistencies across reporting banks are 

discovered, the Call Report instructions may be modified to ensure uniformity. 

However, as bank involvement in the mutual fund industry develops, innovations 

and changes in fund structures and distribution systems may make it increasingly 

difficult to precisely define banks' sales volume. 

Flows vs. Stocks 

The Call Report requires quarterly data on the level of fund sales (a flow). 

However, banks do not report on the volume of funds under management (a 

stock). The SEC filings report asset levels. Changes in portfolio size across 

reporting periods can be attributed to several factors, including: sales; 

redemptions; fund performance; expenses; levels of investor reinvestment of 

earnings; and the purchase of, or merger with, another fund. Measurements of 

bank involvement in the mutual fund industry based on market share of new sales 

will not necessarily move in tandem with measurements of the percentage of 

mutual fund assets managed by bank-related entities. 
 

 

 

 

 

 

 

 

 

 

 

 

Sales Charges 

Many mutual funds, and most of the funds sold through banks, are sold with an 

associated sales charge or "load." In the case of "front loaded" funds, the charge, 

which is used to pay sales commissions and marketing expenses, is taken at the 

time of sale. In the case of "back loads" (contingent deferred sales charges), 

charges are taken out of the fund over time and when the funds are withdrawn. 

The Investment Company Institute (ICI) requires that its members report sales 

figures net of front loads, but without adjustment for back loads. The Call Report 

instructions are silent on whether to report sales net of charges. Large institutions 

that have proprietary funds that have been reporting to the ICI appear to have 

applied the same method when reporting on the Call Report. However, it is not 

clear whether all banks are calculating sales in the same manner. 

Exchanges and Reinvestments 

Many mutual fund families permit investors to open several funds with differing 

investment strategies. The investor is then permitted to transfer money among 

these funds without incurring new sales charges. Also, most mutual funds permit 

investors to automatically reinvest earnings and capital gains distributions. Mutual 

fund companies provide the ICI with separate figures for sales, redemptions, 

exchanges, and reinvested earnings. However, banks are instructed to include 

reinvestments and exchanges in the Call Report sales totals. 

Money-Market Sales 

It is more difficult to define a money-market sale than to define the sale of a longterm fund. Many investors treat money-market funds like a transaction account, 

increasing and decreasing the balance frequently during reporting periods. This is 

especially true in the commercial bank environment where many commercial 

customers have arrangements with the bank to sweep excess funds from a noninterest-bearing transaction account into a money-market fund at the end of each 

day. The funds are then restored to the transaction account the next morning. 

Banks are instructed to report the daily average of these sweeps during the 

quarter, rather than the aggregate amount of all funds swept during the quarter. 

This procedure, if correctly followed, would reflect fairly the activity over a 

reporting period. However, the same activity would also be reported in each 

subsequent quarter, thus producing an inflated impression of the sales volume 

over a year. 

Reported Sales Volume 

The Call Report requires that banks report separate sales volumes for moneymarket mutual funds, equity mutual funds, bond mutual funds, all other mutual 

funds (for example, balanced funds that include debt instruments and equities), 

and annuities. As of 1995, banks must report the aggregated total of sales of 

proprietary products among those sales. Results are as follows: 

Bank and Thrift Sales of Mutual Funds ($ in Thousands) 

Money-Market 

Quarter Funds Equity

Proprietary 4 

Q1, 94 $109,731,971 $4,576,083

N/A 

Bond 

$ 3,361,389 

Other 

$1,457,198 
 

 

 

 

 

 

 

Q2, 94

N/A

Q3, 94

N/A

Q4, 94

N/A

Q1, 95

$117,087,618

Q2, 95

146,443,097 

BIBLIOGRAPHY 

93,392,669 

131,191,366 

146,237,577 

140,154,679 

164,355,672 

3,185,274 

4,975,811 

3,923,607 

4,156,618 

5,354,626 

3,486,109 

3,085,619 

3,733,798 

3,401,001 

3,183,745 

1,484,284 

3,464,703 

3,066,925 

1,470,019 

1,109,702 

American Bankers Association. "Banks and Mutual Funds: The Who, What, and 

Why of It All." Trends (January/February 1992): 14-20. 

American Institute of Certified Public Accountants. Audits of Investment 

Companies . 1994. 

Bank Securities Association. "Results of the BSA Survey of Bank Proprietary 

Funds." Bank Securities Journal 3 (September-October 1994): 40-42. 

Baris, Jay G. "Mutual Fund Activities of Banks." The Review of Banking and 

Financial Services (July 1994): 41-53. 

Cerulli Associates, Inc. The Cerulli Report: The State of the Bank Securities 

Industry. 1995. 

Clark, Michele A. "Banks and Investment Funds: No Longer Mutually Exclusive." 

Federal Reserve Bank of St. Louis , The Regional Economist (October 1993): 4-9. 

Crockett, Barton. "Lawyers Predicting a Boom in Fund Suits Against Banks." 

American Banker . 18 July 1994. 

Federal Deposit Insurance Corporation. Historical Statistics on Banking, 1934­

1992 . Washington, DC: Federal Deposit Insurance Corporation, 1993. 

___________. Quarterly Banking Profile, Fourth Quarter, 1994 . 1995. 

Fein, Melanie L. Securities Activities of Banks . Englewood Cliffs, NJ: PrenticeHall, 1992. 

Fein, Melanie L., Victoria E. Schonfeld, and David E. Freeman, Jr. Mutual Fund 

Activities of Banks . Englewood Cliffs, NJ: Prentice-Hall, 1993. 

Holliday, Kalen. "Profits Come With Size, But Just How Big Is Big Enough?" 

American Banker . 13 February 1995. 

Investment Company Institute. Mutual Fund Statistics for the Bank Distribution 

Channel . FUNDamentals, November 1994. 

__________. 1994 Mutual Fund Fact Book . 1994. 
 

 

 

 

__________. 1994 Mutual Fund Training Conference Workbook . 1994. 

Lappen, Alyssa A. "Fund Follies." Institutional Investor (October 1993): 39-48. 

Mack, Philip R. "Recent Trends in the Mutual Fund Industry." Federal Reserve 

Bulletin (November 1993): 1001-1012. 

Plasencia, William. "New Play in Mutual Funds: Helping Smaller Banks Limp Off 

the Field." American Banker . 31 May 1995. 

Securities and Exchange Commission. Protecting Investors: A Half Century of 

Investment Company Regulation . Washington, DC: Securities and Exchange 

Commission, 1992. 

Sellon, Gordon H. Jr. "Changes in Financial Intermediation: The Role of Pension 

and Mutual Funds." Federal Reserve Bank of Kansas City, Economic Review 

(Third Quarter 1992): 53-70. 

Talley, Karen. "Settle with Fund Complainants, Lawyer Advises." American 

Banker . 28 June 1994. 

U.S. General Accounting Office. Trust Assets: Investment of Trust Assets in Bank 

Proprietary Mutual Funds . Washington, DC: U.S. General Accounting Office, 

March 1995. 
 

 

 

 

 

 

 

 

 

 

 

 

Vol. 8 No. 3 - Article III - Published: February, 1996 - Full Article 

Recent Developments Affecting Depository Institutions 

by Benjamin B. Christopher 

(a financial economist in the FDIC's Division of Research and Statistics.) 

Reference sources:
 

American Banker (AB);
 

Wall Street Journal (WSJ);
 

BNA's Banking Report (BBR); and 

Federal Register (FR).
 

REGULATORY AGENCY ACTIONS 

Inter-Agency Actions 

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

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

capital standards, safety-and-soundness standards, supervision of U.S. operations of foreign banks, CRA 

regulations, single-borrower lending limits, affordable housing loan appraisals, and HMDA reporting 

requirements. For full information on the inter-agency actions included in this issue, reference is 

necessary to the pages devoted to each of the agencies and the Federal Financial Institutions 

Examination Council. 

Federal Deposit Insurance Corporation 

Assessments to Be Reduced For Most BIF-Insured Banks 

The FDIC Board of Directors voted to reduce significantly the deposit insurance premiums paid by most 

banks but to keep existing assessment rates intact for savings associations. The decision closely 

resembles a proposal issued for public comment earlier this year (see this Review, Spring 1995, p. 25). 

The reduction in premium rates for banks is required by current law based on the anticipated 

recapitalization of the Bank Insurance Fund (BIF). Under the new rate structure, the best-rated institutions 

insured by the BIF will pay four cents per $100 of domestic deposits, down from the current rate of 23 

cents per $100. The weakest institutions will continue to pay 31 cents per $100. Approximately 92 percent 

of the nearly 11,000 BIF-insured institutions would pay the lowest rate. The reductions in premiums will 

decrease the expenses of BIF members by approximately $4.4 billion annually. 

Chairman Ricki Helfer said that widening the spread between the rates paid by the strongest and the 

weakest BIF-insured institutions (eight basis points under the current system, and 27 basis points under 

the new one) promotes the fundamental goals of a risk-related insurance system. "The wider range of 

insurance rates gives weak banks a big incentive to get healthy and encourages all banks to avoid 

unnecessary risk-taking," she said. 

The latest FDIC projections indicate that the BIF likely was recapitalized, with reserves of $1.25 for every 

$100 of estimated insured deposits (or a reserve ratio of 1.25 percent), during the second quarter of 

1995. The new BIF assessment rates will apply from the first day of the month after the BIF is 

recapitalized. The soonest the recapitalization of the BIF can be confirmed is in early September, when 

the agency finishes processing banks' "Call Reports" for the period ended June 30, 1995. Assuming that 

the BIF recapitalized during the second quarter, BIF members that have overpaid their assessments 

based on the newly-adopted premium rate schedule can expect to receive a refund of any overpayment 

plus interest. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In connection with the new rate schedule, the FDIC Board established a process for quickly raising or 

lowering all rates for BIF-insured institutions if changing conditions warrant a timely change. Under this 

new system, the Board would have the flexibility to adjust the entire BIF assessment rate schedule twice 

a year without having to seek public comment first, but only within a range of no more than five cents per 

$100 above or below the premium schedule adopted. PR-50-95, FDIC, 8/8/95. 

The BIF Increased to 1.22 Percent of Insured Deposits in First Quarter 

During the first quarter of 1995, the BIF rose by $1.3 billion to $23.2 billion. This growth reflects continuing 

high levels of assessment income, increased investment income, and continuing minimal bank failures. 

The fund balance amounted to 1.22 percent of estimated insured deposits at year-end 1994, about $516 

million below the legislatively mandated level of 1.25 percent. Total revenues to the BIF in the first quarter 

were $1.65 billion, which included net assessment revenues of $1.4 billion and interest income on fund 

investments of $221 million. Non-assessment income amounted to 80 percent of the first quarter's 

expenses and losses. The fund's liquid assets comprise 79 percent of the fund balance. 

The Savings Association Insurance Fund (SAIF) continued to grow slowly in the first quarter of 1995. 

Total revenues amounted to $283 million, and operating expenses were $4 million, resulting in the net 

income added to the fund of $279 million. The SAIF balance increased to $2.2 billion, or 0.32 percent of 

estimated insured deposits, from $1.9 billion and 0.28 percent at year-end 1994. First Quarter 1995 

Financial Management Report, FDIC, 5/30/95. 

Recapitalization of the SAIF 

In testimony in late July, Chairman Ricki Helfer described the difficulties facing the SAIF, and discussed 

recommendations, which reflect discussions and analyses by the Department of the Treasury, the OTS, 

and the FDIC, for resolving those difficulties. At the current pace, and under reasonably optimistic 

assumptions, the SAIF is unlikely to reach the minimum designated reserve ratio of 1.25 percent until the 

year 2002. 

A principal reason the SAIF is undercapitalized is that SAIF assessments have been diverted to purposes 

other than building the fund. Since 1989, $7.4 billion --- approximately three-quarters of SAIF 

assessments --- have been diverted from the fund to pay off obligations arising from the government's 

efforts to handle the thrift failures of the 1980s. The Resolution Funding Corporation (REFCORP) 

received $1.1 billion, the Federal Savings and Loan Insurance Corporation Resolution Fund (FRF) 

received $2 billion, and the Financing Corporation (FICO) has received $4.3 billion. Without these 

diversions, the SAIF would have reached its designated reserve ratio of 1.25 percent last year. Only the 

FICO obligation remains, but under current law it has an annual call of up to the first $793 million in SAIF 

assessments until the year 2017, with decreasing calls for two additional years thereafter. In 1995, the 

FICO draw is expected to amount to approximately 45 percent of all SAIF assessments. On July 1, 1995, 

the SAIF's potential obligations increased when it assumed responsibility from the RTC for resolving all 

new failures of SAIF-insured thrifts. 

The FDIC strongly supports a proposal developed on an inter-agency basis for resolving the problems of 

the SAIF. Under this proposal, briefly summarized, the SAIF would be capitalized through a special upfront cash assesssment on SAIF-assessable deposits. The special assessment would amount to 

approximately 85 to 90 basis points, or 85 to 90 cents for every $100 of assessable deposits. A special 

assessment of this magnitude would produce approximately $6.6 billion, increasing the SAIF's balance to 

$8.8 billion and the reserve ratio to 1.25 percent. The special assessment would be based on SAIFassessable deposits held as of March 31, 1995, and would be due on January 1, 1996. After the SAIF is 

capitalized, it's risk-related assessment schedule would be similar to the final schedule adopted for the 

BIF. Among other elements of the proposal are: the responsibility for the FICO payments would be 

spread proportionally over all FDIC-insured institutions; the BIF and the SAIF would be merged as soon 

as practicable, after a number of additional issues related to the merger are resolved. The FDIC and the 
 

 

 

 

 

 

 

 

 

 

OTS also recommended making unspent RTC funds available as a kind of reinsurance policy against 

extraordinary, unanticipated SAIF losses to limit the potential future costs to taxpayers from the existing 

full faith and credit guarantee of the U.S. Government that the SAIF enjoys. Testimony, Chairman Ricki 

Helfer, Committee on Banking, Housing and Urban Affairs, U.S. Senate, 7/28/95. 

GAO Audits 

The U.S. General Accounting Office, reporting on its audits of the financial statements of the BIF, the 

SAIF, and the FRF on December 31, 1993 and 1994, said the statements, taken as a whole, were reliable 

in all material respects. FDIC management fairly stated that internal controls in place on December 31, 

1994, were effective in safeguarding assets against unauthorized acquisition, use or disposition. There 

was no reportable noncompliance with laws and regulations that were tested. 

The report presents the GAO's recommendations to improve the FDIC's internal controls, discusses the 

improvements in the banking and savings association industries that have significantlyaccelerated the 

recapitalization of the BIF, and discusses the agency's concerns about the capitalization of the SAIF. 

Financial Audit Federal Deposit Insurance Corporation's 1994 and 1993 Financial Statements, U.S. 

General Accounting Office, March 1995. 

Bank Exposure to Interest-Rate Risk 

The FDIC is amending its risk-based capital standards to include a bank's exposure to changes in interest 

rates as a factor in evaluating the institution's capital adequacy, implementing Section 305 of the FDIC 

Improvement Act of 1991. The revised rule is scheduled to take effect 30 days after it appears in the 

Federal Register. The FDIC's rule applies only to state-chartered commercial banks that are not members 

of the Federal Reserve System and FDIC-supervised savings banks. The Board of Governors (FRB) and 

the Office of the Comptroller of the Currency (OCC) are expected to issue similar revisions to their capital 

standards for the commercial banks they supervise. A policy statement is being proposed that would 

serve as the basis for measuring and monitoring interest-rate risk. After an evaluation of the reliability and 

the accuracy of this framework, the regulators will consider proposing a regulation that would set 

definitive capital requirements. To avoid unnecessary regulatory burden, low-risk institutions, primarily 

small banks, would be exempted from having to complete the additional paperwork required to monitor 

interest-rate exposure. The FDIC estimates that approximately 7,025 out of the 10,847 commercial banks 

and FDIC-supervised savings banks nationwide would be exempt from additional reports. PR-42-95, 

FDIC, 6/27/95. 

Capital Maintenance 

The FDIC is amending its risk-based capital standards for insured state nonmember banks to implement 

a provision of the Riegle Community Development and Regulatory Improvement Act of 1994 (RCDRIA) of 

1994 which states that the amount of risk-based capital required to be maintained by any insured 

depository institution, with respect to assets transferred with recourse, may not exceed the maximum 

amount of recourse for which the institution is contractually liable under the recourse agreement. The 

amendment is effective on April 27, 1995. FR, 3/28/95, p. 15858; 4/10, p. 17986 (OCC). 

Policy Statement on Collateralized Letters of Credit 

The FDIC issued a policy statement assuring the financial markets that certain collateralized letters of 

credit issued by insured banks and thrifts prior to the enactment of FIRREA on August 9, 1989, will 

continue to be treated substantially the same by the agency, as conservator or receiver for an insured 

depository institution, as they are now being treated by the RTC. The policy statement, effective 

immediately, is intended to remove doubts the financial markets may have about the FDIC's treatment of 

these instruments when the agency assumes responsibility for thrift receiverships from the RTC on July 1, 

1995. These letters of credit include those issued by banks and thrifts as collateral for state or municipal 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

bonds that finance low- and moderate-income housing developments and similar projects. The policy 

statement explains the limited circumstances when the FDIC would seek to repudiate a collateralized 

letter of credit issued by an insured institution that fails. PR-36-95, FDIC, 5/19/95, and Policy Statement. 

Management Official Interlocks 

The FDIC is withdrawing a proposed amendment to its regulations that implement the Depository 

Institution Management Interlocks Act. The proposal would have created limited exceptions to the 

prohibition on management official interlocks for depository institutions that control only a small 

percentage of the total deposits in the community or relevant metropolitan statistical area in which the 

institutions are located (see this Review, Winter 1995, p. 33). Section 338 of the RCDRIA modified the 

authority of the federal banking agencies to create regulatory exceptions to the bar on management 

interlocks. The FDIC Board believes the proposed amendment is not consistent with the limited authority 

to create exceptions on a bank-specific and case-by-case basis given the FDIC under the Interlocks Act 

as amended. FR, 2/7/95, p. 7139. 

Limits on "Golden Parachutes" Proposed 

The FDIC issued a proposal under which troubled holding companies, banks and thrifts would be 

prohibited from making "golden parachute" payments, which are typically large cash amounts paid to 

executives who resign just before an institution is closed or sold, subject to certain exceptions. Also, any 

holding company or FDIC-insured institution would be limited in its payments for an employee's or 

director's liabilities or legal expenses when that person is the subject of an enforcement proceeding. The 

proposed regulation would provide guidance to the industry on which payments would be considered 

legitimate and which would be considered abusive or improper. The regulation would implement antifraud legislation enacted in 1990, pursuant to which the FDIC issued an initial proposal in 1991. PR-24­

95, FDIC, 3/21/95. 

Payable Through Accounts 

The FDIC issued guidelines that include more information about "payable through" accounts and 

suggested internal controls and procedures. Also called "pass by" accounts, these generally are checking 

accounts marketed to foreign banks that otherwise would not have the ability to offer their customers 

access to the U.S. banking system. U.S. banking entities that process large numbers of checks on 

accounts where signature cards have been completed abroad and submitted in bulk may have 

undertaken little or no effort independently to obtain or verify information about the individuals and 

businesses who use the accounts. Regulators are concerned that the use of these accounts may 

contribute to unsafe and unsound banking practices and other misconduct, including money laundering 

and related criminal activities. It is noted that the traditional use of "payable through" accounts by financial 

organizations in the U.S., such as by credit unions and investment companies, has not been a cause for 

concern. FIL-30-95, FDIC, 4/7/95. 

FDIC's Right to Revoke Deposit Insurance Upheld 

The U.S. Court of Appeals for the 4th Circuit upheld the FDIC's decision to terminate the deposit 

insurance of Doolin Security Savings Bank, New Martinsville, W. VA., for the bank's refusal to pay its 

insurance premium in full. Doolin protested in 1993 its not being placed in the FDIC's lowest risk-based 

premium category, citing the agency's failure to base its decision on objective criteria. In deciding for the 

FDIC, and upholding the decision of an administrative law judge, the court said the agency's decision was 

not unreasonable "that the subjective supervisory reports of primary regulators are relevant to 

determining whether an institution would cause the insurance fund to incur a loss." Following a 15-day 

period in which Doolin could ask for a rehearing, the bank will have 60 days to pay the remaining $15,000 

on its assessed premium before its deposit insurance would be withdrawn. AB, 5/22/95, p.2. 
 

 

 

 

 

 

 

 

 

 

 

 

 

Recordkeeping For Securities Transactions 

The FDIC amended its regulation that establishes recordkeeping and confirmation requirements for 

securities transactions undertaken by an insured state nonmember bank for its customers. The action 

responds to reports from some banks of practical difficulties in complying with the requirements. The 

amendment, effective February 7, 1995, provides for a waiver of the requirements for good cause, 

affording the FDIC more flexibility in applying its requirements. FR, %-4 2/7/95, p. 7111. 

The FDIC is waiving under certain circumstances its requirement that state nonmember banks carrying 

out securities transactions for customers disclose on the confirmation statement or separately the portion 

of the fee charged to customers represented by the amount of the bank's commission. This action, 

effective immediately, will eliminate a disparity in the rules for state nonmember banks in relation to state 

member and national banks, which are not required to provide the disclosures. Bank customers will 

continue to receive information about their transactions under existing securities industry standards, 

including disclosure of the total fees paid in connection with securities transactions. PR-22-95, FDIC, 

3/21/95. 

Housing Recovery Continuing at Slower Pace 

The FDIC's latest quarterly survey of real-estate markets showed continuing improvement in many areas 

of the country, particularly for commercial properties. While the assessments of local housing markets 

across the country remained favorable overall, some continuing loss of momentum in that sector was 

indicated. 

The national composite index of survey results fell to 61 in April from 62 in January and 72 in July 1994. 

Values of the index above 50 indicate more respondents believed conditions were improving than 

declining, compared to the previous quarter, while values below 50 indicate the opposite. The surveys, 

which began in April 1991, are based on interviews across the country with senior examiners and asset 

managers of federal bank and thrift regulatory agencies. The 401 participants in the latest survey were 

polled in late April. 

The composite index for housing fell in April to 57 from 58 in January, continuing a decline in the index 

that began with the July 1994, survey. The proportion of respondents observing worsening conditions --­

18 percent --- was the highest to date. Thirty-two percent of the respondents reported excess supply of 

residential real estate in April, up from 28 percent in January. Declining from 69 percent in April 1991, this 

percentage reached a low of 27 percent in July 1994. Among other indicators of housing markets, 73 

percent of the respondents in April reported new-home construction at "average" or "above-average" 

levels, down from 1994's average of 76 percent. The proportion of respondents who thought home sales 

were "above-average" --- 19 percent --- has declined in four consecutive surveys. 

For commercial real estate, the composite index in April was 68, unchanged from January, and down by a 

moderate 5 percent from its survey high of 73 in April 1994. This index registered a low of 46 in January 

1992. In April, 38 percent of the respondents thought conditions in their local commercial real-estate 

markets were better than three months earlier, the same percentage as in January, while the three 

percent seeing worsening conditions was down slightly. Fifty-three percent of respondents nationally 

reported excess supply in commercial real-estate markets, up from 52 percent in January, following 

consecutive declines since July 1993, when the figure was 82 percent. 

Regionally, the indexes in April for both residential and commercial real-estate markets were equal to or 

off by not more than one point from the national indexes, except in the Northeast and West. The most 

significant improvement in April occurred in the Midwest, this being the only region where improvements 

were seen in both the commercial and residential real-estate markets. It may be noted that the Midwest's 

indexes had dropped sharply in January from the October 1994, survey. The indexes for the South, which 

were several points above the national data in January, declined to near those figures in April. In the 
 

 

 

 

 

 

 

 

 

 

Northeast, following significant gains in late 1993 and early in 1994, the indexes began a decline that 

continued for commercial markets in April. The proportion of respondents there reporting excess supply 

conditions in both commercial and residential markets continued to be the highest of any region. In 

California, 26 percent of the respondents saw improvements in commercial markets in April, and 18 

percent in residential, representing small increases from January. Excess supply in commercial real 

estate was reported by 93 percent of the respondents. In contrast, for the West outside of California, 61 

percent reported improvement in commercial real estate, compared to 38 percent nationally, and only 29 

percent reported excess supply. Residential markets also were seen as stronger than average in those 

states. Survey of Real Estate Trends; FDIC, April 1995. 

Reorganization and New Division of Insurance 

The FDIC has created a Division of Insurance, whose mission will include identifying and assessing 

existing and emerging risks to the deposit insurance funds. Chairman Ricki Helfer said that "establishing 

this new division as a formal element in the structure of the organization is the next logical step in our 

effort to shift the FDIC from an agency that resolves bank failures to an agency working to keep banks 

open and operating safely and soundly." The new division is one of several organizational changes 

approved by the FDIC Board to enhance the Corporation's decision-making processes and to achieve the 

goals established by the agency's strategic plan which the Board adopted on April 24, 1995. Under the 

revised organizational structure, the Corporation's divisions and offices will generally report to one of the 

three deputies to the Chairman. A number of management changes were also announced, effective June 

18, 1995. PR-30-95, FDIC, 4/24/95; PR-33, 5/17. 

Bankers to Be Surveyed on Ways to Improve Examination Process 

The FDIC will conduct surveys among bankers across the country aimed at improving the quality of 

safety-and-soundness examinations, detecting and changing aspects of the agency's examination 

process that may be inefficient, and reducing regulatory burden. The program, which is expected to run 

for one year, builds on previous informal surveys conducted on a regional basis by the Division of 

Supervision. 

Chairman Ricki Helfer said "the emphasis in this program is on two-way communication, timely analysis 

and effective follow-up ... these elements are essential if the FDIC is to maintain an efficient supervisory 

program and work effectively with bankers to encourage safe and sound banking operations." PR-25-95, 

FDIC, 3/24/95. 

As of early May, the Office of Thrift Supervision (OTS) had begun a similar program for evaluating its 

examiners, and the OCC was planning to start a program in June. AB, 5/9. 

Final Guidelines For Appeals Process 

The FDIC approved final guidelines establishing an appeals process for material supervisory 

determinations made by agency examiners and regional supervisory officials, implementing a 

requirement applicable to the federal banking agencies and the NCUA under the RCDRIA of 1994. Under 

the new guidelines, institutions have 60 days following receipt of written notice of a material supervisory 

determination to appeal that determination to a special Supervision Appeals Review Committee 

established in the Washington office. This Committee will consider and decide the appeal, and notify the 

institution of its decision within 60 days. 

Institutions may appeal a variety of material supervisory determinations, including those relating to: 

examination ratings, such as CAMEL, compliance, and Community Reinvestment Act ratings; the 

adequacy of loan-loss reserve provisions; disputed asset classifications exceeding ten percent of total 

capital; and violations of law or regulations. Decisions to take prompt corrective action pursuant to 

Section 38 of the Federal Deposit Insurance Act, determinations for which other appeals procedures 
 

 

 

 

 

 

 

 

exist, and decisions to initiate formal or informal enforcement actions are not appealable under the new 

guidelines. There are also provisions designed to protect institutions from possible retaliation as a result 

of filing an appeal. PR-21-95, FDIC, 3/21/95; FIL-28-95, 4/4; FR, 3/28, p. 15923. 

Deposit Activities of Foreign Banks 

Pursuant to Section 107 of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, the 

FDIC proposed to amend its regulations to restrict the amount and types of initial deposits of less than 

$100,000 that could be accepted by an uninsured, state-licensed U.S. branch of a foreign bank. The 

proposal is intended to afford equal competitive opportunity to foreign and domestic banks. FIL-48-95, 

FDIC, 7/19/95; FR, 7/13, p. 36074. 

Examinations Workshop For Minority Bankers 

The FDIC will conduct a workshop at the National Bankers Association Annual convention this year on 

how bankers can prepare for examinations and how they can work with examiners in addressing any 

problems they may have. The convention will be held in New York City in September. Announcing the 

FDIC's participation which responded to a request from the NBA, Chairman Ricki Helfer said the 

workshop is an example of how the agency's focus has changed from resolving failed banks to 

concentrating on helping banks and other financial institutions to stay open and operate safely and 

soundly. Section 308 of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 calls 

on the FDIC to provide minority-owned banks with technical assistance and educational programs. PR17-95, FDIC, 3/6/95. 

Deposit Insurance Seminars 

Beginning in May and through August 1995, the FDIC will conduct 22 seminars in 11 cities nationwide for 

bank officers and employees who have oversight responsibilities relating to the dissemination of accurate 

deposit insurance information. Instruction will be presented also on uninsured deposit-like products and 

how to assist employees and customers to distinguish them from insured deposits. FIL-33-95, FDIC, 

4/28/95. 

Information Availability Is Enhanced 

To improve public access to information, the FDIC is now offering a new telephone service, "Action 

Update," which provides a recorded message about the most recent press releases and directives to 

institutions (Financial Institution Letters), as well as brief descriptions of the FDIC Board of Directors' most 

recent actions, a description of new publications, and a list of significant events. Callers can access the 

new service by dialing 202-898-7210, and can obtain copies of the documents referenced by calling 202­

898-6996. FDIC press releases and certain other documents also are available through a fax retrieval 

system. PR-41-95, FDIC, 6/19/95. 

Study of Bidder Competition and Resolution Policies 

This study, by three FDIC staff members, investigates whether the changes in the FDIC's failureresolution policies mandated by the FDIC Improvement Act of 1991 (FDICIA) decreased failure-resolution 

costs. Prior to FDICIA, the winning bid for a failed bank's assets and liabilities was not required to be the 

bid that minimized the FDIC's resolution costs. Generally, bids were divided into three categories 

according to whether the bidder proposed assuming virtually all, some, or few of the failed bank's assets. 

These three types of bids are termed whole-bank bids, purchase-and-assumption (P&A) bids, and 

deposit-transfer bids, respectively. Whole-bank bids were considered first, and if the most competitively 

priced whole-bank bid was less costly than a deposit payoff, that whole-bank bid was selected. If no 

whole-bank bid passed the cost test, the P&A bids were considered. Finally, if no P&A bids passed the 
 

 

 

 

 

 

 

 

 

 

 

 

cost test, the deposit-transfer bids were considered. If no bids passed the cost test, the FDIC conducted a 

deposit payoff. 

FDICIA eliminated the preference to select whole-bank bids over P&A bids and P&A bids over deposittransfer bids. The Act required that the winning bid be chosen solely on the basis of minimizing the 

FDIC's resolution costs. The least-cost resolution rule went into effect immediately upon passage of 

FDICIA on December 19, 1991. Because competition among bidders for failed banks prior to FDICIA was 

based not only on the cost to the FDIC, but also on the type of bid, it is possible that winning bids were 

not always cost minimizing to the FDIC. Based on the FDIC's actual and estimated losses on resolutions 

in the study period, the aggregate resolution costs were found to have decreased substantially after 

enactment of FDICIA. "Acquirer Gains in FDIC-Assisted Bank Mergers: The Influence of Bidder 

Competition and FDIC Resolution Policies," Matthew T. Billett, Jane F. Coburn, and John P. O'Keefe, 

May 1995. 

Resolution Trust Corporation 

Agency on Schedule to Sunset at Year-end 

Established on August 9, 1989, to deal with the failure of much of the U.S. savings-and-loan industry, the 

RTC is completing its mission and is scheduled to terminate on December 31, 1995. The agency was 

created by amendments to the Federal Home Loan Bank Act made by the Financial Institutions Reform, 

Recovery, and Enforcement Act of 1989 (FIRREA). This legislation, as subsequently amended, gives the 

RTC responsibility for resolving savings institutions that were previously FSLIC-insured and that became 

insolvent before July 1, 1995; and liquidating the assets of those institutions. Savings associations that 

become insolvent after July 1, 1995, become the responsibility of the Savings Association Insurance 

Fund (SAIF) administered by the FDIC. 

At sunset, all RTC assets and liabilities will be transferred to the FSLIC Resolution Fund (FRF), a fund 

administered by the FDIC, and the FDIC will succeed the RTC as conservator and receiver for any 

institutions under RTC control at that time. All RTC staff will also be returned to the FDIC, as provided by 

FIRREA. As required under the RTC Completion Act, the FDIC/RTC Transition Task Force was 

established in February of 1994 to effectuate this transfer in a coordinated manner. The Task Force is 

required by statute to resolve differences in the operations of the two corporations; to recommend which 

systems of the RTC should be preserved for use by the FDIC; to recommend procedures that would 

promote an orderly transfer; and to recommend which management enhancement goals and reforms 

applicable to the RTC should apply to the FDIC. 

From its inception on August 9, 1989 to June 16, 1995, the RTC resolved all 747 institutions taken over 

through that date, protecting 25 million deposit accounts and $221 billion in deposits. Through April 30, 

the RTC had disposed of assets with a book value of $445 billion, leaving $20 billion (book value) of 

assets in its inventory. Recoveries from sales and collections totaled $388 billion, averaging 87 percent of 

original book value. The Congress has authorized $105 billion in loss funds for the RTC. The estimated 

total resolution costs, as of June 20, 1995, were $87 billion to $95 billion. = Testimony, Committee on 

Banking, Housing and Urban Affairs, U.S. Senate, June 20, 1995, J.E. Ryan, Acting CEO, RTC; 

FDIC/RTC Transition Task Force. 

Federal Reserve Board 

Evaluating the Risk Management of Derivative Contracts 

The FRB issued a guidance for evaluating the risk-management practices used by banking institutions in 

acquiring and managing securities and off-balance-sheet (OBS) derivative contracts for nontrading 

purposes. It focuses on institutions' investments in cash securities and "end-user" derivatives activities, 

supplementing existing guidances and directives. Nontrading activities in this guidance involve the use of 
 

 

 

 

 

 

 

 

 

 

securities (both available-for-sale and held-to-maturity) and OBS derivative contracts that involve longer 

time periods than typically are associated with trading activities. Nontrading activities involve the full array 

of cash securities (including fixed- and floating-rate notes and bonds, structured notes, mortgage passthrough and other asset-backed securities, and mortgage derivative products), money-market 

instruments, and OBS derivative contracts (including swaps, futures, and options). 

The overview of the guidance identifies basic factors that examiners should consider in evaluating the 

elements of a sound risk-management process, and contains specific guidance for evaluating an 

institution's management of each of the risks involved in these activities, including credit, market, liquidity, 

operating and legal risks. In evaluating an institution's risk-management process, examiners should 

consider the nature and size of its holdings. Examiners should focus particular attention on evaluating an 

institution's understanding of the risks involved in the instruments it holds. Banking organizations should 

ensure that their capital positions are sufficiently strong to support all the risks associated with nontrading 

activities on a fully consolidated basis and should maintain adequate capital in all affiliated entities 

engaged in these activities. In evaluating the adequacy of an institution's capital, examiners should 

consider any unrecognized net depreciation or appreciation in an institution's securities and derivative 

holdings. SR 95-17 (SUP), Division of Banking Supervision and Regulation, FRB, 3/28/95. 

Capital Requirements 

The FRB requested comment on a proposal to amend its risk-based capital requirements to incorporate a 

measure for market risk in foreign-exchange and commodity activities and in the trading of debt and 

equity instruments. The effect of the proposed rules would be that, in addition to existing capital 

requirements for credit risk, certain institutions would be required to hold capital based on the measure of 

their market risk exposure. The proposed rule is based on a proposal issued by the Basle Committee on 

Banking Supervision and would go into effect at the end of 1997. 

The FRB also is requesting comment on a possible approach to setting capital requirements for market 

risk that would require a bank to specify the amount of capital it chose to allocate to support market risks. 

If cumulative losses over some subsequent trading interval exceed the commitment, the bank would be 

subject to regulatory penalties, such as fines, higher capital requirements, or restrictions on trading 

activities. Press Release, FRB, 7/14/95; FR, 7/25, p. 38142; p. 38082 (inter-agency proposal). 

The FRB is amending, effective March 22, 1995, its risk-based capital guidelines for state member banks 

and bank holding companies to implement Section 350 of the RCDRIA. Section 350 states that the 

amount of risk-based capital required to be maintained by any insured depository institution, with respect 

to assets transferred with recourse, may not exceed the maximum amount of recourse for which the 

institution is contractually liable under the recourse agreement. Currently, under the guidelines an 

institution could be required to hold capital in excess of the maximum amount of loss possible under the 

contractual terms of the resource obligation. Press Release, FRB, 2/7/95; FR, 2/13, p. 8177. 

The FRB issued a proposal, implementing Section 208 of the Riegle Act, that would have the effect of 

lowering the capital requirement for small-business loans and leases on personal property that have been 

transferred with recourse by qualifying banking organizations. For the general purpose of calculating riskbased and leverage capital ratios, qualifying institutions that transfer small-business obligations with 

recourse would be required to maintain capital only against the amount of recourse retained, subject to 

certain conditions. Press Release, FRB, 1/26/95; FR, 2/1, p. 6043. 

The FRB, the OCC, the FDIC and the OTS issued an interim final rule, effective August 1, 1995, 

amending the capital adequacy guidelines for banks, bank holding companies, and savings associations 

to treat originated mortgage servicing rights (OMSRs) the same as purchased mortgage servicing rights 

(PMSRs) for regulatory capital purposes. Under the interim rule, which was developed in response to 

Financial Accounting Standards Board Statement No. 122, both OMSRs and PMSRs are included in 

regulatory capital when determining Tier 1 (core) capital for purposes of the agencies' risk-based and 
 

 

 

 

 

 

 

leverage capital standards, and in calculating tangible equity for purposes of prompt corrective action 

subject to the regulatory capital limitations that previously applied only to PMSRs. Press Release, FRB, 

7/27/95; FR, 8/1, p. 39226. 

Safety-and-Soundness Standards 

The FRB issued final guidelines and a final rule, both effective August 9, 1995, regarding safety-andsoundness standards for state member banks as required by Section 132 of the FDICIA. As amended by 

the Community Development Act, Section 132 no longer requires the FRB, the OCC, the FDIC and the 

OTS to prescribe quantitative standards relating to asset quality and earnings but rather, mandates that 

the agencies prescribe standards that they deem appropriate. The agencies are therefore proposing 

asset quality and earnings standards, in guidelines form, that emphasize monitoring, reporting and 

preventive or corrective action. The guidelines set forth broad, principle-based standards that establish 

the objectives that proper operations and management should achieve, while leaving the methods for 

achieving those objectives to each institution. The rule establishes deadlines for submission and review of 

safety-and-soundness compliance plans that the federal bank regulatory agencies may require for 

insured depositories that fail to meet the guidelines. Press Release, FRB, 7/7/95; FR, 7/10, p. 35674 

(inter-agency proposal). 

Supervision of Foreign Banks' U.S. Operations 

The FRB advised the Federal Reserve Banks that the banking supervisory authorities whose 

responsibilities include the U.S. operations of foreign banking organizations have developed a program of 

supervision relating to FBOs. The Board said that Reserve Banks should fully coordinate their FBO 

supervision activities with the appropriate state banking departments and regional offices of the other 

federal agencies in their districts. The FRB will designate a foreign bank's entire U.S. operation a single 

rating, regardless of how many units exist, which will diminish the negative impact on the entire institution 

of a poor rating at a small unit. Greater emphasis will be given to the foreign bank's risk-management, 

internal controls, and compliance activities. The guidelines require foreign banks to be a source of 

strength to their U.S. operations. AB, 4/19/95, p. 3; SR 95-22 (Sup. IB), Div. of Banking Supervision and 

Regulation, FRB, 3/31. 

Tying Restrictions Are Revised 

The FRB is adopting, effective May 26, 1995, a regulatory "safe harbor" from the anti-tying restrictions of 

Section 106 of the Bank Holding Company Act Amendments of 1970 and the Board's Regulation Y. The 

safe harbor permits any bank or nonbank subsidiary of a bank holding company to offer a "combinedbalance discount," which is a discount based on a customer maintaining a combined minimum balance in 

products specified by the company offering the discount. 

The BHC Act Amendments of 1970 generally prohibit a bank from tying a product or service to another 

product or service offered by the bank or any of its affiliates. The Board is authorized to grant exceptions 

to its restrictions by regulation or order. FR, 4/25/95, p. 20186. 

Community Reinvestment Act Revised Regulations 

The FRB issued a revised Regulation BB, and related conforming amendments to its Home Mortgage 

Disclosure Act regulation (Regulation C). Parallel regulations are being issued by the OCC, the FDIC and 

the OTS for institutions they supervise. The new CRA rule emphasizes performance over process and 

documentation. The 12 old CRA assessment factors for large retail banks and thrifts are replaced with 

three tests: for lending, services, and investments. 

Institutions will no longer have to maintain extensive documentation of directors' participation in 

formulating and reviewing CRA policies, will no longer have to prepare a formal CRA statement, and will 

not have to document their efforts to market services in low- and moderate-income communities. Banks 
 

 

 

 

 

 

 

and thrifts will be evaluated based on loans made, services provided and investments in their 

communities. The rule emphasizes direct lending. A streamlined examination process is provided for 

independent banks and thrifts with assets under $250 million, or banks and thrifts with assets under $250 

million that are members of a holding company with assets of under $1 billion. Larger institutions will 

collect and report to regulators aggregated data on their small-business and small-farm loans by census 

tract. They will not collect or report data on race and gender of small-business borrowers. HMDA data 

collection will be expanded for large institutions to include collection and reporting of mortgage loans 

outside the metropolitan statistical areas (MSAs) where the institutions have branch offices. 

Under the final rule, there are no "safe harbors" from CRA protests. Institutions will continue to make their 

CRA ratings public, and the public will have an opportunity to comment on CRA performance before the 

start of a scheduled examination. The FRB, the FDIC, the OCC and the OTS will work together to develop 

and adopt uniform examination procedures. Joint examiner training programs will be developed and 

implemented. The rule becomes effective on July 1, 1995; some provisions become operational on 

January 1, 1996, and July 1, 1997. Press Release, FRB, 4/14/95; NEWS and "CRA Regulation Facts," 

OTS, 4/19; FR, 5/4, pp. 22156, 22223; FIL-35-95, FDIC, 5/17/95. 

Equal Credit Opportunity 

The FRB proposed amending its Regulation B to eliminate the general prohibition on collecting data 

relating to an applicant's race, color, sex, religion, and national origin, giving creditors the option to ask 

applicants to provide the information on a voluntary basis. 

Creditors have expressed a variety of reasons for wanting to collect these data: to better audit their 

lending programs to ensure that they are in compliance with fair lending laws; to respond more effectively 

to CRA protests; and to collect data so that they can better evaluate their community outreach programs 

and the effectiveness of their marketing programs. Some regulatory agencies and community groups say 

the data may increase their ability to detect discrimination. 

The proposal would allow data collection only; consideration of an applicant's race, color, sex, religion, 

and national origin in a credit decision would still be prohibited. FR, 4/26/95, p. 20436; Press Release, 

FRB, 4/21. 

The FRB revised, effective June 5, 1995, the official staff commentary to its Regulation B. The 

commentary applies and interprets the requirements of the Regulation and is a substitute for individual 

staff interpretations. Issues on which the revisions provide guidance include disparate treatment, special 

purpose credit programs, credit scoring systems, and marital status discrimination. FR, 6/7/95, p. 29965. 

Information on Banks' Selling Mutual Funds 

The Federal Reserve will soon begin a nationwide education campaign about the sale of mutual funds 

and annuities at banks. The campaign will begin with a series of seminars for retirees and those planning 

for retirement. The seminars will be hosted by the 12 Federal Reserve Banks and will emphasize that 

mutual funds and annuities, unlike certificates of deposit, are not insured by the FDIC or in any way 

guaranteed by the banks that sell them. The Federal Reserve developed the program in cooperation with 

the American Association of Retired Persons, and conducted pilot seminars in the Boston area in late 

1994. Press Release, FRB, 3/20/95. 

Truth in Lending 

The FRB amended its Regulation Z to implement changes made to the Truth in Lending Act by the 

RCDRIA, which imposes new disclosure requirements and substantive limitations on closed-end homeequity mortgage loans bearing rates or fees above a certain percentage or amount. The law also imposes 

new disclosure requirements to assist consumers in comparing the cost of reverse mortgage transactions, 
 

 

 

 

 

 

 

 

 

 

 

 

 

which provide periodic advances primarily to elderly homeowners and rely principally on the home's value 

for repayment. The rule is effective March 22, 1995, with compliance optional until October 1, 1995. Press 

Release, FRB, 3/16/95; FR, 3/24, p. 15463. 

The FRB revised the official staff commentary to its Regulation Z to clarify regulatory provisions and 

provide further guidance on certain issues of general interest, such as the treatment of various fees and 

taxes associated with real-estate-secured loans and a creditor's responsibilities when investigating a 

claim of the unauthorized use of a credit card. The rule is effective April 1, 1995, with compliance optional 

until October 1, 1995. 

The Truth in Lending Act requires creditors to disclose credit terms and the cost of credit as an annual 

percentage rate (APR). The Act requires additional disclosures for loans secured by a consumer's home, 

and permits consumers to cancel certain transactions that involve their principal dwelling. It also imposes 

limitations on some credit transactions secured by a consumer's principal dwelling. Press Release, FRB, 

3/28/95. 

Pursuant to requirements of the RCDRIA, the FRB requested comment on how rules for credit advertising 

could be modified to increase consumer benefit and decrease creditor costs, and on how current rules 

could be modified, if at all, for radio and television advertisements without diminishing consumer 

protection. Under present law, creditors that state a rate in an advertisement must state the APR. Stating 

the APR or other terms triggers additional disclosure requirements such as annual fees imposed on a 

credit line or the repayment terms for an installment loan. FR, 6/27/95, p. 33151. 

Home Mortgage Disclosure 

The FRB published for comment a staff commentary to its Regulation C. The proposed commentary 

provides guidance on various issues including the treatment under the Regulation of prequalifications, 

participations, refinancings, home-equity lines, mergers, and loan applications received through a broker. 

FR, 6/7/95, p. 30013. 

Loans to Bank Officers 

The FRB is revising, effective immediately, its Regulation O to implement a provision of the RCDRIA that 

eliminates a requirement for prior approval of the board of directors before a member bank may make a 

loan to an executive officer that is secured by a first lien on the officer's residence. FR, 4/7/95, p. 17635. 

Insider Lending Limits 

The National Bank Act and Regulation O establish the limit for single-borrower loans to any insider of a 

member bank and insider of the bank's affiliates to be 15 percent of the bank's unimpaired capital and 

unimpaired surplus for loans that are not fully secured, and an additional ten percent for loans that are 

fully secured by certain readily marketable collateral. The FRB amended its regulation to conform the 

definition of unimpaired capital and unimpaired surplus to the definitions recently adopted by the OCC in 

calculating the limit on loans by a national bank to a single borrower. Under that revised definition, a 

national bank's "capital and surplus" are equal to Tier 1 and Tier 2 capital included in the calculation of 

the bank's risk-based capital together with the amount of the bank's allowance for loan and lease losses 

not included in this calculation. FR, 4/20/95, p. 19689; Press Release, FRB, 6/8. 

Suspicious Activity Reports 

The FRB proposed to revise its regulations on reporting of suspicious activities by the domestic and 

foreign banking organizations supervised by the Federal Reserve, including the reporting of suspected 

violations of the Bank Secrecy Act (BSA). The principal proposed changes to the FRB's current criminal 
 

 

 

 

 

 

 

 

 

 

 

referral reporting rules include: a) simplifying and shortening the referral form; b) raising the mandatory 

reporting thresholds for criminal offenses, thereby reducing banking organizations' reporting burdens; c) 

filing only one form with a single repository, rather than submitting multiple copies to several federal law 

enforcement and banking agencies, thereby further reducing reporting burdens; and d) clarifying the 

criminal referral and suspicious financial transaction reporting requirements of the FRB, the OCC, the 

FDIC, the OTS, and the National Credit Union Administration and the Treasury Department associated 

with suspicious financial transactions. The above supervisory agencies, working with the Treasury's 

Financial Crimes Enforcement Network (FinCEN), are developing computer software to assist financial 

institutions in preparing and filing Suspicious Activity Reports (SARs). FR, 7/3/95, p. 34481; 7/17, p. 

36366 (OTS notice). 

Required Reporting Is Reduced For BHCs 

The FRB adopted several revisions to its FR Y-6 which is an annual report filed by large bank holding 

companies, excluding foreign banking organizations. The report consists of consolidated and parent 

company financial statements in the company's own format, and is the Federal Reserve's principal source 

of internally generated and independently audited financial data on individual bank holding companies 

and their banking and nonbanking subsidiaries. Among the burden-reducing changes are: 1) eliminating 

the requirement to submit consolidated and parent company financial statements; 2) revising the 

requirement for audited financial statements to include only holding companies with assets of $500 million 

or more (raised from $150 million) and 3) eliminating the requirement to submit nonbank subsidiary 

financial statements which, as currently proposed, would be incorporated into an expanded standardized 

FR Y-11 report (financial statement of nonbank subsidiaries). Holding companies must still make 

available their annual reports and their Securities and Exchange Commission reports of financial 

condition. FR, 3/6/95, p. 12215; AB, 3/14, p. 3. 

Establishment of Loan Production Offices 

The FRB issued, effective April 6, 1995, an interpretation of its Regulation H that allows a state member 

bank to establish a back office facility that is not accessible to the public without such a facility being 

considered to be a branch. Loans originated by a loan production office may be approved at a back office 

location, rather than at the main office or a branch of the bank, without the loan production office being 

considered to be a branch, if the proceeds of those loans are received by customers at locations other 

than a loan production office or back office facility. This interpretation is intended to provide parity 

between state member banks and national banks with respect to the establishment of loan production 

offices and back office facilities. FR, 4/6/95, p. 17436. 

Mortgage Unit May Sell Employment Histories 

The FRB granted approval for an Iowa-based mortgage unit of Norwest Corp., Minneapolis, to sell 

employment histories to third-party depository institutions and affiliates for use in their banking activities. 

While the decision is the first of its kind, the expansion of banking powers is said to be small. A 1994 

decision of the Board allowed Comerica Corp. to provide employment information and histories to 

depository institutions in connection with career counseling services. The mortgage firm's release of 

certain information, which it will gather from state employment departments and other sources, will 

depend upon the individual's prior consent. The firm will be subject to the Fair Credit Reporting Act. BBR, 

5/15/95, p. 951. 

Title Abstracting Approved as Banking-Related Activity 

The FRB granted approval for First National Co., Storm Lake, Iowa, to engage in realty title abstracting 

through an acquisition. For the first time this activity as a source of fee income would be available to bank 

holding companies. Normally the realty title abstracting business involves recreating each county's title 
 

 

 

 

 

 

 

 

 

 

 

records, often converting them to electronic form, and then charging a fee for the title search. Permission 

for national banks to acquire title abstractors was granted by the OCC seven years ago. AB, 7/5/95, p. 2. 

Data Processing Limits Under Reg. Y Are Broadened 

The FRB gave approval for BNCCORP Inc. of Bismarck, ND to acquire a data processing firm and to 

include providing non-financial information in its data processing services. Under Regulation Y, bank 

holding companies can provide data processing and transmission services, databases, and access 

facilities, if the data are "financial, banking, or economic" in nature. The FRB said that in this case the 

non-financial information would be provided only as a part of a larger package of data processing 

services to a financial institution, and would not be offered on a stand-alone basis or to customers other 

than financial institutions. BBR, 1/16/95, p. 98. 

Geographic Market Defined For EPT Network Services 

The FRB granted approval for Electronic Payment Services Inc., Wilmington, Delaware, a joint venture 

subsidiary of four large bank holding companies, to acquire the ATM assets and some POS assets of 

National City Corp., a Cleveland-based bank holding company, and also approved National City to 

become a member of the joint venture. EPS provides data processing and transmission services to banks 

and retail merchants who are members of the ATM and POS network MAC. The four members of the joint 

venture are Bank One Corp., Columbus, CoreStates Financial Corp., Philadelphia, PNC Bank Corp., 

Pittsburgh, and KeyCorp, Cleveland. The FRB defined the appropriate geographic market in this case to 

be MAC's Mideast region, consisting of western Pennsylvania, Ohio, Indiana, Kentucky and West 

Virginia. A FRB study suggests that the geographic market for network access is an area significantly 

larger than local markets, and the markets for network services and ATM processing are thought to be at 

least regional. The FRB rejected arguments that the geographic markets should be defined on the basis 

of the boundaries of cities or states. BBR, 3/16/95, p. 517. 

Electronic Fund Transfers 

The FRB amended, effective April 24, 1995, its Regulation E to eliminate the requirement that an 

electronic terminal receipt disclose a number or code that uniquely identifies the consumer, the 

consumer's account, or the access device. This requirement posed a significant security risk to 

consumers and financial institutions by making information accessible to criminals that could be used to 

make fraudulent fund withdrawals. Press Release, FRB, 3/16/95. 

Payments System Risk; Daylight Overdrafts 

The FRB revised the increase in the fee charged to depository institutions for daylight overdrafts incurred 

in their accounts at the Reserve Banks that had been scheduled to take effect on April 13, 1995. The 

current effective daily fee of ten basis points was implemented in April 1994, with scheduled increases to 

20 basis points on April 13, 1995, and to 25 basis points on April 11, 1996. In the aggregate, daylight 

overdrafts in Federal Reserve accounts have fallen by roughly 40 percent in response to the initial tenbasis-point fee. As a result of the sizeable reductions, as well as concerns about the possible effects of 

further rapid fee increases, the Board approved an increase in the fee to an effective daily rate of 15 basis 

points rather than 20 basis points. (The 15-basis-point fee equals an annual rate of 36 basis points, 

quoted on the basis of a 360-day year and a 24-hour day.) The Board will evaluate the desirability of any 

further increases in the daylight overdraft fee, based on the objectives of the payments system risk 

program, two years after the implementation of the 15-basis-point fee. Press Release, FRB, 3/2/95; FR, 

3/7, p. 12559. 

Fed Acts to Cut Costs of Services, Improve Efficiency 
 

 

 

 

 

 

 

 

 

The FRB and the Federal Reserve Banks are undertaking a number of major consolidation and other 

budget-cutting measures. For example, a majority of the Federal Reserve Banks have implemented earlyretirement programs during the last few years. Other recent or ongoing actions include: a) consolidation 

of mainframe data processing from the previous 12 sites to three: a hub in East Rutherford, NJ, with 

backup facilitates at the Dallas and Richmond Federal Reserve Banks; b) consolidation of supervision 

and decision-making on financial services such as check clearing and funds transfer at the St. Louis 

Federal Reserve Bank; and c) replacement of varied software used by the different Federal Reserve 

Banks with standardized systems. Individual Federal Reserve Banks are centralizing a number of 

operations, for example, the Atlanta Bank has brought its check processing sites down to five from 12. 

AB, 5/17/95, p. 1. 

"Purposes and Functions" Is Updated 

The FRB is publishing the eighth edition of Purposes and Functions, a paperback book first published in 

1939 that explains the structure and operations of the Federal Reserve System. The revised and updated 

edition has been designed to appeal to a general audience and can supplement college-level classroom 

texts on the Federal Reserve's role in monetary policy and the global economy. Press Release, FRB, 

3/2/95. 

Office of the Comptroller of the Currency 

Enhancing the Supervision of Bank Lending 

Comptroller of the Currency Eugene Ludwig said that the agency's supervisory activities for safety and 

soundness in the credit area will be strengthened because of warning signs of slippage of credit quality. 

Among the steps being planned, a National Credit Committee, whose members include some of the 

agency's most senior and experienced credit analysts, will work with examiners in charge of supervision 

at larger national banks to ensure that adequate credit quality supervision is in place. Among the warning 

signals noted is a recent decline in the standard minimum payment on credit cards from five percent to 

two percent of the outstanding balance, and significant increases in high loan-to-value second-mortgage 

and home-equity lending. Some of the questions for bank managements and the examiners are the 

extent that the bank: 1) is taking risk into account in the pricing of loans; 2) is making exceptions to credit 

standard policies; 3) has compensation or other policies that encourage lending officers to lower credit 

standards; and 4) has significant credit concentrations in its portfolio. Also, how independent and effective 

is the credit review function; and are stress tests being performed on all or a portion of the credit portfolio 

to determine how loans will be repaid when the customer, the industry and/or the economy turn down. 

News %0 Release, OCC, 4/8/95. 

In February 1995, the OCC decided to include information about concentrations of credit in the reports of 

examination of national banks. Examiners will report such concentrations amounting to over 25 percent of 

the bank's capital structure in the report of examination. Effective May 19, 1995, this reporting was 

extended to federal branches and agencies of foreign banks where credit concentrations exceed ten 

percent of the total assets of the branch or agency. Bulletin No. 95-7, OCC, 2/8/95; Bulletin No. 95-26, 

5/19. 

Interest-Rate Risk 

Reaffirming and updating its statement issued in January 1990, the OCC said that during the past five 

years national bank managers have improved their interest-rate-risk management systems, in particular 

by: 1) advancing from measuring risk in simple repricing ("gap") reports to using simulation models to 

quantify and control the amount of short-term earnings that may be at risk; and 2) developing or 

enhancing ways to measure and control exposures arising from medium- and long-term positions. The 

agency's statement notes that the value of many banks' medium- and long-term instruments are highly 

sensitive to changes in interest rates, particularly those containing option features, such as the possibility 
 

 

 

 

 

 

 

 

 

 

 

 

of loan prepayments or the withdrawal of funds. Financial instruments such as collateralized mortgage 

obligations (CMOs), structured notes, credit-card lines, indexed CDs, and off-balance-sheet derivative 

instruments provide financial institutions with more services to offer customers and more tools for risk 

management, but the complexity of many of these instruments makes it more difficult to determine the 

sensitivity of their values to changes in interest rates. 

Risk measurement systems should be able to identify and quantify the major sources of a bank's interestrate-risk exposure on a timely basis. Where there are significant medium- and long-term positions, 

managers should be able to assess the longer-term impact of changes in interest rates on the earnings 

and capital of the bank. Senior management and the board or a committee thereof should receive reports 

on the bank's interest-rate risk on at least a quarterly basis, but more frequently as appropriate to the 

level of current and potential risk. The board's tolerance for interest-rate-risk exposure should be clearly 

communicated to senior management. Clear lines of responsibility should be established for measuring 

and managing risk exposures. Advisory Letter 95-1, OCC, 2/8/95. 

In June, the agency provided question-and-answer information regarding its guidance issued on February 

8. Bulletin No. 95-28, OCC, 6/20/95. 

More Information Provided on Derivatives Activity 

Bank Call Report data for the first quarter of 1995 include new information that provides a better measure 

of the market size, credit risk exposure, and revenue from bank derivatives activity. The notional amount 

of derivatives in commercial bank portfolios, which is an indicator of the level of derivatives activity, 

increased by 14 percent in the quarter. Nine commercial banks account for 93 percent of the total notional 

amount. First-quarter Call Report data include, for the first time, the gross negative and positive fair 

values of derivative positions, credit risk exposure in the form of "bilaterally netted" current exposure, the 

distribution of derivatives contracts by type, revenue from derivatives transactions and the diversification 

of earnings sources, and information on high-risk mortgage securities and on structured note holdings. 

News Release, OCC, 3/31/95; 6/14. 

OCC and SEC Agree on Joint Examinations 

The OCC and the Securities and Exchange Commission agreed to conduct joint examinations of certain 

entities in which both agencies have regulatory and supervisory interests. These entities are mutual funds 

advised by national banks or their subsidiaries and national banks and national bank subsidiaries 

providing advisory and other investment services to mutual funds. Among the areas of common interest 

to be evaluated are: systems of internal control used to ensure compliance with regulatory requirements, 

including disclosures to investors; risk management systems used by the adviser to monitor and control 

the risks in light of the fund's objectives; and management of conflicts of interest between the adviser and 

the advised funds or other advisory clients and the advised funds. The scope and staffing of particular 

examinations will be determined by both agencies on a case-by-case basis. Documents prepared or 

obtained by either agency in connection with a joint examination will be treated as confidential. 

Coordination of these examinations will enable the agencies to reduce the regulatory burden on banks 

involved in mutual fund activities, minimize government intrusion into bank operations, and also protect 

the interests of bank depositors and investors. Joint Release, OCC and SEC, 6/12/95. 

Lending Limits 

The OCC, effective March 17, 1995, revised its rules governing national bank lending limits, in order to 

eliminate inefficient and unduly burdensome requirements and refocus the lending limit rules on the areas 

of greatest safety-and-soundness concern. The final rule alters the definition of "capital and surplus" upon 

which lending limits are based. The new lending limit calculation draws upon risk-based capital 

components that a bank must already calculate for Call Report purposes. Thus, most national banks 

generally will be required to calculate their lending limit only once every quarter, rather than every time 
 

 

 

 

 

 

 

 

 

 

 

 

 

they propose to make a loan. A new exception to the lending limits will allow a bank to advance funds to 

renew and complete the funding of a qualifying loan where the additional advance will protect the position 

of the bank. The final rule also allows a bank to advance funds to pay taxes, insurance and other 

necessary expenses to protect its interest in the collateral securing a loan, and clarifies when a loan is 

considered "nonconforming." FR, 2/15/95, p. 8526. 

The FRB adopted a conforming amendment to its Regulation O. FR, 6/13/95, p. 31053. 

Court Upholds State Limits on Bank Insurance Activities 

The U.S. Court of Appeals for the Eleventh Circuit denied a petition by Barnett Bank of Marion County, 

N.A. to rehear a ruling that would allow Florida's insurance commissioner to block Barnett's ownership of 

an insurance agency under state law (Barnett Bank of Marion County, N.A. v. Gallagher). A panel of the 

Court, affirming a trial court's decision, ruled in January that the McCarran-Ferguson Act overrides other 

federal laws and gives states the right to regulate bank insurance sales. The denial of the petition 

appears to conflict with a decision of the Sixth Circuit that federal law preempts a Kentucky anti-affiliation 

law (Owensboro National Bank v. Stephens), and a review by the U.S. Supreme Court is expected. 

The Louisiana Court of Appeals upheld a state law that limits bank insurance sales in the state (First 

Advantage Insurance, Inc. v. Green). The court held that McCarran-Ferguson protects a state law that 

prohibits banks from selling insurance (except for credit life, credit health, and accident insurance) from 

preemption by the National Bank Act. AB, 4/12/95, p. 3; BBR, 4/3, p. 693; 3/13, p. 541. 

Courts Rule on Retirement Account 

A federal judge in New Mexico prohibited the state insurance regulator from interfering with a national 

bank's sale of the retirement CD (First National Bank of Santa Fe v. Chavez). The retirement certificate of 

deposit is a FDIC-insured product that is similar to an uninsured annuity. A customer makes one or a 

series of payments into a tax-deferred account and after reaching a designated age receives regular 

lifetime payments from the bank. In January the U.S. Supreme Court ruled in the Valic case (see this 

Review, Spring 1995, p. 39) that selling annuities is "incidental" to banking and a permissible activity 

under the National Bank Act. AB, 2/21/95, p. 2. 

A judge in the U.S. District Court in Illinois ruled that the retirement CD is an annuity, and therefore should 

be regulated as an insurance product. AB, 6/6/95, p. 18. 

Loans to Distributor of Bank's Mutual Funds 

The OCC issued a no-objection letter with respect to a proposed financing arrangement under which 

Crestar Bank, N.A., Washington, DC, would provide loans to the distributor of the bank's mutual funds to 

finance the payment of brokerage commissions to a brokerage affiliate of the bank. The OCC's decision 

was made contingent upon the loans being structured on terms and conditions substantially the same as 

loans and extensions of credit provided to other nonaffiliates, and that any such loan be fully 

collateralized by a cash deposit or an equivalent amount of U.S. Government securities. Letter Regarding 

Proposed Financing Arrangement, OCC, 3/13/95. 

Decision on Bank Officer's Services Not Reviewable 

The U.S. District Court for Kansas ruled (Hammond v. OCC) that it lacked jurisdiction to review an OCC 

decision disapproving a proposed appointment of an executive to serve as president, chief executive 

officer, and a board member of a national bank. The OCC said the individual lacked the necessary 

integrity for the positions, having engaged in a tying violation while president of another bank. BBR, 

4/17/95, p. 795. 
 

 

 

 

 

Tying Restrictions 

The OCC reminded national banks of their obligations under the antitying law, whose purpose is to keep 

banks from using bank credit and other services to coerce customers and reduce competition. The 

guidance includes, among other things, examples of tying arrangements that, unless exempted by the 

Board, are prohibited. For example, a bank may not condition the extension of credit or the reduction of 

the price of credit on the customer purchasing credit-related insurance from the bank. Also included are 

suggested systems and controls, and suggested audit and compliance programs. Bulletin No. 95-20, 

OCC, 4/14/95. 

Bank Reports Do Not Violate Privacy Laws 

A U.S. district court in Texas ruled that Marfa National Bank, Marfa, TX, was not violating financial privacy 

laws, but was complying with the Bank Secrecy Act when it reported two depositors suspected of 

engaging in actions to avoid coverage by the bank's currency transaction reports. AB, 6/22/95, p. 9. 

Community Development Bank Chartered 

The OCC issued a charter to Neighborhood Development Bank, N.A., which will serve the low- and 

moderate-income and minority neighborhoods of southeast San Diego, CA. The institution is the first 

bank focusing on community lending to be federally chartered, and an application has been filed with the 

Federal Reserve to establish a holding company, Neighborhood Bancorp. The bank will seek funding as a 

community development financial institution under the CDFI Fund, which was created by the RCDRIA. 

The OCC has granted approval for Wells Fargo Bank, N.A. to make an equity investment in both the bank 

and the proposed holding company. BBR, 2/13/95, p. 316. 

Appraisals For Affordable Housing Loans 

In a joint policy statement, the OCC, the OTS, the FDIC, and the FRB clarified that federally regulated 

financial institutions should ensure that appraisals of affordable housing projects consider and discuss the 

effect of certain types of financial assistance, such as low-income housing tax credits, subsidies and 

grants on the estimate of market value for such projects. Such financial assistance creates an incentive 

for developers and investors to undertake the project. When the benefits of such financial assistance are 

not appropriately reflected in the project's appraisal, the estimated cash flow of the project is negatively 

affected, resulting in a lower market value, and a loan-to-value ratio that may be too low to meet 

supervisory standards. The apppraisal should discuss the value of the financial assistance that would 

survive sale or foreclosure, and consider the effect of financial assistance that does not necessarily 

transfer to new ownership, when applicable. Joint Release, OCC, FDIC, FRB, OTS, 3/10/95. 

Agency to Request Feedback on Examination Process 

The OCC will begin surveying bankers at the conclusion of each examination to get their immediate 

feedback on how well the agency is doing its job in areas such as the effectiveness of its communications 

with banks, the reasonableness of agency requests for data and information, the quality of examiners' 

decision-making during the exam process, and quality of written exam reports. Completing the survey is 

voluntary; however, bankers will be asked to fill in their name in order to facilitate follow-up work by the 

OCC. The survey forms will be sent directly to the agency's Ombudsman, who will be responsible for 

analyzing and summarizing the responses. News Release, OCC, 4/17/95. 

Approvals For Interstate Branching 

Federal banking law dating from 1886 allows a national bank to move its main office up to 30 miles, even 

across a state line, and the OCC has approved the operation of the former main offices, following the 
 

 

 

 

 

 

 

 

 

 

 

moves, as branches. Among the recent approvals under this authority were: PNC Bank, Northern 

Kentucky, will move from Ft. Mitchell, Kentucky to Cincinnati, Ohio, combining two subsidiaries into a 

single Ohio bank with> ten Kentucky branches and 60 Ohio branches; NationsBank Middle Atlantic will 

move from Bethesda, Maryland to McLean, Virginia, consolidating subsidiaries into a single Virginia bank 

with branches in Virginia, Maryland and the District of Columbia; American National Bank and Trust 

Company of Wisconsin will move its main office from Genoa City, Wisconsin to Libertyville, Illinois, 

merging into an Illinois bank that will have 20 branches in Illinois and Wisconsin. The 30-mile rule has 

been used by about a dozen banks in the past year, and the OCC expects about the same number of 

applications in 1995. In recent approvals the OCC has argued that state laws prohibiting out-of-state 

banks from owning branches violates the U.S. Constitution's commerce clause, and also that these laws 

are preempted by federal law. AB, 3/13/95, p. 2; 3/20, p. 2. 

Interpretive Rulings: Additions, Eliminations, Revisions 

The OCC is proposing to revise the interpretive rulings that appear in part 7 of Title 12 of the Code of 

Federal Regulations. This proposal updates and streamlines OCC regulations and seeks to eliminate 

regulatory requirements that impose ineffective, inefficient and costly regulatory burdens on national 

banks. FR, 3/3/95, p. 11924. 

Comments Sought on Various Issues 

Among the issues on which the OCC is seeking comments are permitting banks to sell their excess data 

processing capacity, whether to prohibit states from barring national banks from engaging in actions 

permitted by federal rules through the use of restrictive licensing laws, and expanding the definition of 

interest rates that national banks may charge by including annual fees, late fees, and other fees. AB, 

3/3/95, p. 1. 

Disclosures of Information 

The OCC proposed clarifications and technical amendments to its rules relating to the availability and 

release of information to update and streamline its regulations and reduce unnecessary regulatory costs 

and other burdens. FR, 3/27/95, p. 15705. 

History Text Reissued 

First published in 1968, The Comptroller and Bank Supervision: A Historical Appraisal has been reissued. 

The updated version includes a discussion of the changes in banking that have occurred over the past 30 

years and the many legislative and regulatory changes that have shaped the current banking 

environment. News Release, OCC, 6/12/95. 

Treasury Shortens Currency Transaction Report 

The Treasury Department has revised the report that banks must file on their currency transactions 

exceeding $10,000, effective October 1 of this year. The new report will be more than one-third shorter 

than the former one. The box item used for reporting suspicious transactions will be eliminated, and 

instead banks will use for this purpose the criminal referral form, which also is being revised. Banks will 

no longer be required to identify the number of $100 bills involved in transactions covered by the report. 

While the old form required the signatures of two employees, in the future only one signature will be 

needed. AB, 5/18/95, p. 9. 

Office of Thrift Supervision 

Simplified Application For New Thrifts 
 

 

 

 

 

The OTS proposed a simplified rule that would reduce the paperwork and administrative costs imposed 

on organizers of new federal savings associations and federal savings banks. The standard initial 

capitalization would formally decrease from $3 million to $2 million, the same as the requirement for 

deposit insurance imposed by the FDIC. The OTS would reserve the right to impose higher or lower initial 

capital requirements on a case-by-case basis. NEWS, OTS, 3/6/95; FR, 3/6/95, p. 12103. 

Calculations For Loan Limits Are Simplified 

The OTS is amending, effective March 28, 1995, its loans-to-one-borrower rule, to reflect recent changes 

to the OCC's lending limits regulation. The Home Owners' Loan Act requires that savings association 

lending limits parallel those applicable to national banks. This interim final rule amends OTS' regulation so 

that thrifts, like national banks, will use regulatory capital as the starting point for determining "unimpaired 

capital and unimpaired surplus" for LTOB purposes. The revised rule allows savings associations to figure 

loan limits by using the same calculations they already make to determine capital adequacy. Thus, thrifts 

avoid having to complete a complex extra worksheet and like national banks will find it substantially 

easier to calculate lending limits. The changes also remove other outdated or redundant provisions. 

NEWS, OTS, 3/28/95; FR, 3/28. p. 15861. 

Community Development Investments 

The OTS will not take enforcement action against thrift institutions for making investments in projects 

outside areas receiving "concentrated development assistance" under Title 1 of the Housing and 

Community Development Act (HCDA), provided certain standards are met. Federal associations no 

longer need to apply to the OTS for case-by-case no-action letters for investments that meet the 

investment standards. Associations may participate directly in real-estate investments that meet the 

standards and in a limited partnership or corporation that invests exclusively in real-estate investments 

that meet the standards. Among the standards set forth are: the investment must be located in a Title 1 

Community Development Block Grant entitlement community, in a nonentitlement community that has not 

been specifically excluded by the state in statewide submissions for CDBG funds, or in an area that 

participates in the Small Cities Program; and the investment must be made in a residential housing 

project that benefits low- and moderate-income persons. In regard to investments that do not meet the 

standards, but that are consistent with program objectives embodied in the Home Owners' Loan Act, 

associations may continue to seek case-by-case OTS no-action review by the chief counsel. NEWS, 

OTS, 6/7/95. 

Court Rules on Capital Agreements 

The U.S. Court of Appeals for the District of Columbia, in a case involving the failed Great Life Savings 

Association of Sunrise, Florida, ruled that the OTS cannot compel compliance with capital infusion 

agreements made with buyers of troubled thrifts unless it shows that the buyer has been "unjustly 

enriched." Before 1990, purchasers of thrifts were required by regulators to guarantee that the institutions 

would always be fully capitalized. AB, 7/19/95, p. 4. 

Release of Unpublished Information 

The OTS issued a final rule describing the procedures that requesters must follow to obtain unpublished 

information by document or testimony and the criteria on which the agency will evaluate requests for such 

information. The rule includes requests for release of records that are exempt from disclosure under the 

Freedom of Information Act (FOIA), such as examination and related reports, and information relating to 

the business operations and finances of individual savings associations. Requesters who obtain 

unpublished OTS information may not disclose such information without the agency's authorization. The 

final rule, for the first time, authorizes savings associations to release their examination reports and 

related supervisory correspondence to their holding companies, and similarly authorizes holding 

companies to release their examination reports and related supervisory correspondence to their 
 

 

 

 

 

 

 

 

 

subsidiary savings associations. Reports and other information released under this rule remain the 

property of the OTS, regardless of where such reports or information are physically located. FR, 5/30/95, 

p. 28027. 

Filing Fee Changes 

The OTS has reduced fee levels for certain applications to more accurately reflect the agency's actual 

processing costs. Fees are lowered for Permission to Organize applications and Holding Company 

applications, and the fee is eliminated for processing service corporation applications for participation in 

Community Development Corporations. OTS' policy on the waiver of filing fees is clarified. Thrift Bulletin 

48-13, OTS, 3/31/95. 

Thrift to Offer Services on the Internet 

The OTS gave approval for Cardinal Bancshares, Lexington, KY, to change a subsidiary, Security First 

Network Bank, Pineville, into an on-line bank serving customers on the Internet. The bank will offer 

services similar to those available from some banks by telephone. While a number of banks now offer 

information about their services on the Internet, Security First is unique in that it plans to do most of its 

business on-line, and will use the Internet for actual checking account transactions, not just information. 

Requirements to be imposed by the OTS include company-paid independent tests of certain security 

systems, and a report from the bank in six months on its lending to low- and moderate-income applicants, 

and precise definition of the community it is serving. Security First plans to make checking accounts the 

focus of its Internet operations and restrict its lending chiefly to the rural southeastern Kentucky county 

where it will maintain its only brick-and-mortar branch. AB, 5/12/95, p. 3. 

Federal Financial Institutions Examination Council 

Guidelines For Relying on State Examinations 

The FFIEC adopted guidelines, effective on June 27, 1995, that establish standards for determining the 

acceptability of state reports of examination. A federal banking agency may conduct an annual, on-site 

examination of an insured depository institution in alternate 12-month periods (except those insured 

institutions with total assets of less than $250 million for which an 18-month examination cycle is 

permitted) if the federal banking agency determines that a state examination of that institution conducted 

during the intervening period is adequate. 

The federal and state banking agencies have worked together, to varying degrees, in several areas, 

among which are conducting alternate, joint and concurrent safety-and-soundness examinations; 

processing examination reports and applications; using common examination report and application 

forms; and developing and issuing informal and formal enforcement actions. Currently, the federal 

banking agencies, individually, have entered into formal or informal arrangements or working agreements 

with most state banking departments in a number of supervisory areas, among which are the number of 

institutions to be examined on an alternating basis; the frequency of safety-and-soundness examinations; 

the type of examinations to be conducted (independent, joint, or concurrent) by each agency; and the 

responsibilities of each agency for processing reports of examination, and for conducting specialty 

examinations (compliance, information systems, trust, etc.). 

Under the guidelines, the federal banking agencies will accept and rely on state reports of examination in 

all cases in which it is determined that state examinations enable the federal banking agencies to carry 

out effectively their supervisory responsibilities. Among the criteria that may be considered in determining 

the acceptability of a state report of examination are the completeness of the examination report; 

adequacy of documentation; and the adequacy of any formal or informal arrangement or working 

agreement between a state banking department and a federal banking agency. FR, 6/27/95, p. 33206. 
 

 

 

 

 

 

 

 

 

 

Home Loans to Minorities Up Sharply in 1994 

Disclosure statements from more than 9,800 lenders (including commercial banks, savings associations, 

credit unions, and mortgage companies) covered by the Home Mortgage Disclosure Act (HMDA) show 

that the number of their conventional home purchase loans rose in 1994 from 1993 by 27.0 percent for 

lower-income households, and 12.5 percent for the highest income households, the FFIEC reported. The 

numbers increased by 54.7 percent for blacks, 42.0 percent for hispanics, 23.8 percent for native 

Americans, 18.6 percent for Asians, and 15.7 percent for whites. Denial rates for those loans in 1994 

were 33.4 percent for blacks (34.0 percent in 1993), 31.6 percent (27.8) for native Americans, 24.6 

percent (25.1) for hispanics, 16.4 percent (15.3) for whites, and 12.0 percent (14.6) for Asians. The data 

suggest that the affordable home loan programs that mortgage originators have initiated in recent years -­

- to benefit low-income, moderate-income, and minority households and neighborhoods --- may be having 

an impact, the FFIEC said. 

The FFIEC prepared and distributed the individual disclosure statements for lenders on behalf of its five 

member agencies and HUD. Upon request, lenders are required to make the statements available at their 

home office within three business days of receipt, and at certain branch offices in other metropolitan 

areas within ten business days of receipt. Press Release, FFIEC, 7/18/95. 

Guide to HMDA Reporting 

The FFIEC prepared an interim edition of the Guide to take account of amendments that the FRB 

adopted to its Regulation C in December 1994. The amendments require reporting in machine-readable 

format (except for institutions reporting 25 or fewer line entries), require institutions to update their loan 

application registers quarterly during the year as data are being collected, and make a number of other 

changes. The FFIEC will publish and distribute a more comprehensive edition of the Guide to HMDA 

respondents by year-end for use with 1996 data. The Guide was developed by the Department of 

Housing and Urban Development and member agencies of the FFIEC. A Guide to HMDA Reporting --­

Getting it Right!, FFIEC, March 1995. 

National Credit Union Administration 

Corporate Credit Unions 

The NCUA proposed a rule to strengthen the capital of corporate credit unions, reduce the risk of their 

investments, and improve asset-liability management. The rule would return corporate credit unions to 

their primary functions of serving as liquidity centers and service providers. 

Specifically, the proposed rule would, among other things, limit corporate credit union membership to 

credit unions and other specified groups; restrict lending to member credit unions and limit lending to 100 

percent of primary capital; set borrowing limits to meet liquidity needs at ten times capital or 50 percent of 

shares, whichever is less; and establish minimum primary capital at four percent, phased in over the next 

three and one-half years. Also, the proposal would require that 75 percent of overnight investments be 

matched with assets of similar terms; allow up to 25 percent of investments to be matched with variablerate securities, with up to three-years maturity, that reprice monthly; require that term accounts be fully 

matched; and provide specific divestiture requirements. "Letter to Credit Unions No. 168," NCUA, 4/24/95; 

FR, 4/26, p. 20438; 5/23, p. 27240; BBR, 4/17. p. 785. 

The assets, liabilities, and field of membership of Capital Corporate Federal Credit Union were acquired 

by Mid-Atlantic Corporate Federal Credit Union, of Harrisburg, PA. CapCorp had been operating under 

NCUA conservatorship since January 31, 1995 (see this Review, Spring 1995, p. 44). Losses from 

CapCorp's investment portfolio are estimated at about $61 million, all of which will be absorbed by its 

primary and secondary capital, with no loss to the National Credit Union Share Insurance Fund. BBR, 

4/17/95, p. 787. 
 

 

 

 

 

 

 

 

 

 

 

 

Divestitures of Risky Investments 

The NCUA issued a clarification of its position on divestiture of Collateralized Mortgage Obligations 

(CMOs) and Real Estate Mortgage Investment Conduits (REMICs) that fail one or more parts of the highrisk securities test (HRST). A review by the agency of credit unions that have reported large investments 

in CMOs and REMICs indicated that 57 percent of these credit unions were holding at least one security 

that failed one or more parts of the HRST; 29 percent of these credit unions ran the HRST semiannually 

or less often; and 39 percent of the managers did not have an adequate understanding of the risks 

involved in these investments. 

Federal credit unions are prohibited from purchasing fixed-rate CMOs or REMICS that fail any one of the 

three parts of the HRST, which are the average life test, average life sensitivity test, and price sensitivity 

test. When a credit union is holding securities that fail one or more parts of the HRST, it should 

immediately dispose of them or, within five business days of discovery, submit to the NCUA a written 

action plan. A credit union will be required to sell HRST-failed assets, in accordance with a written 

directive, if the examiner does not feel that a suitable action plan has been developed. Letter to Credit 

Unions No. 169, NCUA, April 1995. 

Mergers or Conversions of Federally Insured Credit Unions to Non-Credit Union Status 

The NCUA adopted with minor change the interim rule it issued in September 1994 (see this Review, 

Spring 1995, p. 44) with additional requirements to ensure an informed membership vote, to safeguard 

against potential safety-and-soundness problems and to prevent breaches of fiduciary duty. Key 

provisions are: NCUA Board approval is required in advance of any transaction whereby a federally 

insured credit union transfers all or any part of its members' shares or similar accounts to any non-credit 

union institution; a majority of all members of record must vote to approve the transaction; directors must 

agree to receive no benefits in excess of those available to the members; notice to members must be 

preapproved by the NCUA Board and must include all pertinent information required by the rule as well as 

any additional information deemed necessary on a case-by-case basis; FISCUs may only engage in the 

transaction if they obtain approval from the state authority to proceed with the merger or conversion; and 

FISCUs must follow the rule's provisions (part 708a) unless they obtain a waiver from the NCUA. FR, 

3/8/95, p. 12659. 

Credit Union Conversion to Savings Bank Approved 

The NCUA approved the application of the $52.9 million-asset Lusitania Federal Credit Union, Newark, 

NJ, to convert to a federal mutual savings bank. It was the first such approval granted by the NCUA for a 

charter change, which would be transacted under the agency's rules in effect before the amendments that 

were adopted late last year. Only 20 percent of the credit union's total membership will be required to 

approve the conversion, while under the new rules a majority vote would have been necessary. If 

Lusitania's membership approves the conversion, the institution will be supervised by the OTS, and its 

deposits insured under the SAIF. BBR, 5/29/95, p. 1054. 

Court Restricts CU Expansion 

A U.S. District Court judge in Washington, DC ruled that the NCUA exceeded its authority when it 

permitted Communicators Federal Credit Union to expand its membership to anyone over 50 years old 

living or working within 25 miles of Houston, TX. In this case brought in 1994 by the Texas Bankers 

Association, the judge said NCUA's broad interpretation would render the common bond limitation 

meaningless. The NCUA has won previous court decisions involving credit unions taking into membership 

existing unrelated groups, each comprised of persons having a common bond within the group. The judge 

upheld the NCUA in allowing Communicators to add seven unrelated occupational groups, stating that 

where the law is "ambiguous" the courts must defer to the regulatory agencies. Communicators, originally 
 

 

 

 

 

 

 

 

 

 

 

sponsored by Southwestern Bell Telephone Co., now serves 93 different groups with a membership of 

over 38,000. AB, 6/5/95, p. 1. 

Banks Can Sue Over CU Expansion 

A judge in the U.S. District Court in Montana ruled that a group of seven banks in Montana can sue to 

negate an expansion in 1992 by the Missoula Federal Credit Union over a 3,600 square mile area in the 

western part of the state. The NCUA argued in the suit brought in 1993 that bankers did not have the right 

to sue because the Federal Credit Union Act was not designed to protect banks. The banks have " a 

competitive interest in limiting the expansion of MFCU pursuant to the common bond provision," the judge 

wrote. AB, 4/17/95, p. 15. 

Appraisals 

The NCUA proposed amending its regulation regarding the appraisals of real estate, adopted pursuant to 

Title XI of FIRREA, to clarify and expand the circumstances in which a Title XI appraisal is not required. 

The Board proposes to eliminate standards that parallel standards issued by the Appraisal Foundation, 

and to amend the regulation concerning appraiser independence to permit credit unions to use appraisals 

prepared for other financial-service institutions. Other parts of the proposal would simplify compliance for 

both credit unions and appraisers and reduce costs without affecting the reliability of appraisals used in 

connection with federally related transactions. FR, 3/13/95, p. 13388. 

Incentive Compensation For CU Employees 

The NCUA proposed to clarify its regulations that prohibit officials and certain employees of federally 

insured credit unions from receiving either incentive pay or outside compensation for certain activities 

related to credit union lending, and to authorize lending-related compensation in certain situations where 

it is currently prohibited, and to prohibit it in other situations. 

The structure of the regulation would be changed to a broad prohibition, with specific exceptions, against 

an official or employee receiving compensation in connection with any loan made by the credit union. The 

proposal would allow loan officers to receive incentive pay; however, the incentives for making 

recommended or final decisions to approve or disapprove loans could not be based on the number or 

dollar amount of loans approved. The regulation also would require that the board of directors establish 

written policies and controls for any incentive plan and monitor compliance on at least a quarterly basis. 

FR, 4/20/95, p. 19690. 

Guidelines For the Supervisory Review Committee 

The NCUA issued a final Interpretive Ruling and Policy Statement, pursuant to the RCDRIA, concerning 

the establishment of an independent appellate process to review material supervisory determinations. In 

the final IRPS, which is effective March 22, 1995, a three-member supervisory review committee, and the 

time frames for committee action, are provided. FR, 3/20/95, p. 14795. 

Operating Fee Exemptions 

The NCUA proposed to exempt natural-person federal credit unions with assets of $500,000 and less 

from paying operating fees, and fees assessed on credit unions with assets between $500,000 and 

$750,000 would be cut by 40 percent. The NCUA currently does not assess operating fees on credit 

unions with assets of up to $50,000, which exempts only 59 institutions. The restructured operating fees 

would exempt a total of 839 credit unions, 780 of which currently pay an average fee between $100 and 

$117. An additional 349 institutions with assets of $500,000 to $750,000 would pay a minimum fee of 

$100, instead of the current average fee of $167. The total projected revenue shortfall from the proposed 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

cuts in operating fees would be spread among all other federal natural-person credit unions. A $100 

million-asset credit union is currently assessed $26,890 in operating fees, while a $500 million-asset 

credit union pays $265,000, which amounted to only .73 percent of their total operating expenses for 

1994. NCUA NEWS, 6/14/95. 

STATE LEGISLATION AND REGULATION 

Interstate Banking/Branching 

Interstate Regulatory Plan Developed 

A plan developed by the Conference of State Bank Supervisors and approved by 45 state banking 

supervisors, would establish mechanisms to enable state-chartered banks to take advantage of the 

interstate banking provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, 

and be subject in respect to these activities to a single regulator. Implementation of the plan would be 

dependent upon states enacting the enabling legislation. Primary responsibility for conducting safety-andsoundness and compliance examinations would belong to an institution's home-state regulator, but the 

home state would coordinate its activities with the host states and federal authorities, and would use hoststate examiners. The home state would share examination information and reports with the host state and 

federal regulators. The home state would have authority over applications for new branches, bank powers 

and mergers, subject to certain requirements involving analysis of the antitrust impact in the host state 

and compliance with its laws, and consultation with other regulators before approving any actions in other 

states. AB, 5/9/95, p. 2. 

Alabama: A new law enacted pursuant to the Riegle-Neal Act allows nationwide banking, effective 

September 29, 1995. It permits interstate branching through merger and acquisition as of May 1997. 

BBR, 6/5/95, p. 1089. 

Colorado: The Governor signed a bill that allows interstate branching in the state after June 1, 1997. The 

new law prohibits "de novo" interstate branching, and allows out-of-state banks to buy only branches that 

have existed for at least five years. BBR, 5/29/95, p. 1050. 

Connecticut: The Governor signed legislation that "opts-in" under the Riegle-Neal Act, permitting merger 

transactions between in-state and out-of-state banks, and allowing de novo interstate branching. A fiveyear age limitation is imposed on target institutions, and a 30-percent limit on concentration of deposits in 

both interstate and intrastate acquisitions, mergers, and consolidations. BBR, 7/17/95, p. 107. 

Idaho: A new law, to be effective July 1, 1995, allows out-of-state banking firms to convert banks they 

own in the state into branches. Under the Riegle-Neal Act, a bank holding company may convert a bank 

into a bank branch unless the state in which the bank is located enacts "opt-out" legislation before June 1, 

1997. Continuing existing Idaho banking provisions, the new law does not permit de novo entry, only 

entry by acquisition. Also, it does not allow the purchase of branches only, the entire bank must be 

purchased. BBR, 3/20/95, p. 589. 

Maryland: The legislature passed an "opt-in" bill which, if signed by the Governor, would become effective 

on September 29, 1995. Contingent upon reciprocity, an out-of-state bank could branch in Maryland 

either de novo or by acquiring an existing branch. AB, 4/13/95, p. 9. 

Minnesota: A new law requires banks to be at least five years old before they are eligible to be purchased 

by out-of-state banking organizations. The law also places a 30-percent deposit cap on interstate banking 

operations. Northwestern Financial Review, 6/3/95, p. 21. 
 

 

 

 

 

 

 

 

 

 

 

 

 

North Dakota: A recently enacted law "opts-in" under the Riegle-Neal Act by allowing interstate branching 

by consolidation after May 31, 1997. The law removes certain existing restrictions on interstate banking, 

including requirements for reciprocity, and lending commitments from out-of-state bank holding 

companies acquiring in-state banks. The legislation also expands intrastate banking by permitting banks 

to establish a "facility" anywhere in the state, starting August 1, 1996, and with no limit on the number of 

"facilities" a bank may have. "Facilities" will include bank paying and receiving stations, drive-in/walk-up 

facilities and banking offices. In-state commercial banks are permitted to purchase branches of savingsand-loan associations that were in existence on March 1 of this year and convert them into their own 

branch facilities. BBR, 5/1/95, p. 869. 

Oregon: Oregon became the first state to enact "opt-in" legislation under the Riegle-Neal Act. The state's 

law went into effect on February 28, 1995. BBR, 3/13/95, p. 535. 

Pennsylvania: An "opt-in" law, taking effect immediately, allows out-of-state banks to branch into the state 

either by acquisition or de novo, with a reciprocity requirement until June 1, 1997. State-chartered banks 

are given the same rights as national banks to branch into other states that allow interstate branching. 

AB, 7/25/95, p. 10. 

Tennessee: The legislature voted "opt-in" legislation to be effective June 1, 1997, under the Riegle-Neal 

Act. BBR, 4/24/95, p. 820. 

Texas: The Governor signed legislation that prohibits out-of-state banks from branching into Texas until at 

least September 1999, when the issue again will be taken up by the legislature. Texas allows out-of-state 

banking organizations to operate in the state through separately chartered banks. Texas banks will be 

able to branch outside the state in cases where federal regulators approve national bank 30-mile 

relocations. BBR, 5/1/95, p. 868; AB, 5/12, p. 6. 

Utah: The Governor is expected to sign an "opt-in" bill that would take effect June 1, 1995. The bill 

prohibits de novo branching, and requires that an institution be at least five years old before being 

acquired by an out-of-state bank. BBR, 3/13/95, p. 535. 

Virginia: New legislation creates a procedure for out-of-state banking firms to establish branches in the 

state beginning July 1, 1995, if those banks' home states have similar procedures allowing entry by 

Virginia banks. BBR, 4/10/95, p. 747. 

Lending Limits 

Iowa: Revisions in the state's banking code, now awaiting the Governor's signature, set the lending limit 

for state-chartered banks at 15 percent of their aggregate capital, defined as common and preferred 

stock, surplus, undivided profits, and loan-loss reserves. Banks could use another ten percent of 

aggregate capital to make loans on breeder livestock, in addition to the 15 percent general lending limit. 

AB, 4/17/95, p. 9. 

Interest-Rate Restrictions Eliminated 

Maine: A new law allows the state's banks to export interest rates into other states, and also deregulates 

bank credit-card fees. The revised credit code is now similar to Delaware's, putting Maine in a position to 

become a location for credit-card issuers. The new law identifies specific allowable credit-card charges, 

such as periodic charges, transaction charges, and late fees, and treats them as interest so they can be 

exported. A major reform law last year eliminated an 18-percent ceiling on interest rates, and the $12 

maximum on annual fees, and replaced a prohibition on late fees with a five percent or $10 maximum fee. 

BBR, 6/5/95, p. 1087. 
 

 

 

 

 

 

 

 

Lenders Allowed to Own Insurance Agencies 

Michigan: A new law regulates the relationship between insurance firms and financial institutions, and in 

some cases allows lenders to own agencies and sell insurance. A lender may not require a borrower to 

buy any policy through a particular agency, nor may a lender fix or vary the terms of a loan as an 

inducement to purchase insurance. A lender generally is not allowed to require a person to buy any 

insurance product from the lender or an affiliate as a condition of making a loan. Among other provisions, 

lenders are allowed to provide names, addresses and similar information to agents or affiliated agencies, 

but cannot disclose account information or documents such as credit reports and financial statements. 

BBR, 1/23/95, p. 176. 

Savings Bank Powers 

Minnesota: The Governor signed a bill that updates state-chartered savings association laws. The state 

has 16 federal savings banks and no state-chartered savings banks. Savings banks are granted powers 

similar to powers possessed by the state's commercial banks. Northwestern Financial Review, 6/3/95, p. 

21. 

Securities Losses Cause For Concern 

Minnesota: The Commerce Commissioner warned the 411 state-chartered banks that those with 

unusually high depreciation in securities portfolios or suspected of speculating "will receive special 

attention in examinations or targeted visitations." In part because of rising interest rates, the banks' 

portfolios shrank in 1994 by 3.5 percent. State officials emphasized that no individual banks are in danger 

at this time. They are concerned, however, that some banks have invested in sophisticated products such 

as financial derivatives without adequate knowledge about these instruments. AB, 3/1/95, p. 9. 

Loan Limits, Charter Conversions 

Mississippi: The Governor signed legislation, effective March 8, 1995, designed to clarify, modernize and 

improve various regulations that apply to commercial banks chartered by the state. Among the 

regulations involved are those governing loans to insiders, single-borrower loan limits, conversions of 

national banks to state-chartered banks, requirements applicable to the acquisition of branches, and 

conversion from federal savings associations to state-chartered associations. The mandatory examination 

cycle is lengthened from 12 months to 18 months. The Mississippi Banker, May 1995, p. 6. 

Subsidized Loan Program 

New York: Recently enacted legislation extends the state's linked-deposit loan program until April 1, 

1998, and allows savings banks and savings-and-loan associations to participate. Under the program the 

state accepts below-market interest rates on certain state deposits in commercial banks that agree to 

make low-interest loans to small businesses. The program thus far has provided 155 small-business 

loans amounting to $66 million. BBR, 4/24/95, p. 821. 

Constraints on Accountant Liability Suits 

New Jersey: A new law makes accountants liable only for those financial statements they approve in 

writing for a specific user. Thus, each time anyone other than the client intends to use such a financial 

statement, the written verification procedure would be required. AB, 4/20/95, p. 20. 

Environmental Liability 
 

 

 

 

 

 

 

 

 

 

Michigan: A new law, revising legislation enacted in 1989-1990, changes the focus from ownership status 

to causation in creating environmental liability. Among other changes, the law revises the degree of 

cleanup that will be required based on the intended use of the property. Legislative-Legal Bulletin, 

Michigan Bankers Association, 6/5/95, p. 2. 

Mississippi: The Governor signed legislation, effective July 1, 1995, that addresses lender liability and 

creates a limited environmental self-evaluation privilege. The limited privilege concerns the discovery or 

admissibility of information relating to voluntary self-evaluations in judicial and administrative proceedings. 

The state's existing penalty policy is amended to include a new and substantial mitigating policy for 

voluntary self-disclosure of non-compliance. The privilege does not apply in cases of fraud and in certain 

other cases. Mississippi became the eleventh state to enact environmental self-evaluation 

privilege/voluntary self-disclosure legislation, and the fourth state to allow voluntary self-disclosure to 

count as a mitigating factor. BBR, 4/17/95, p. 782. 

Pennsylvania: Under a new law, lender environmental liability is changed from strict, joint and several 

liability to a direct causation standard. Instead of a "participation in management" concept, the new law 

holds a bank liable if the lender or its agents directly cause an immediate release or directly exacerbate a 

release of a regulated substance, or the lender or its agents knowingly and willfully compelled the 

borrower to take an action that caused an immediate release or violated a state environmental law. BBR, 

6/12/95, p. 1153. 

Texas: A new law, effective on signing, will protect companies that voluntarily disclose environmental 

violations found in self-audits from criminal, civil, or administrative penalties, provided they correct the 

non-compliance within a "reasonable" period of time. A decision by an administrative hearing officer that 

an audit is, or is not, privileged may be appealed in state district court. Thirteen other states have 

environmental audit privilege laws, including eight that have taken action in 1995. BBR, 6/5/95, p. 1103. 

Banking Laws Updated 

Texas: A new law, effective September 1, 1995, generally updates and recodifies the existing banking 

code. Among substantive changes is the elimination of the three-member Banking Board and transfer of 

its bank-chartering authority to the banking Commissioner. BBR, 7/3/95, p. 18. 

New Banks 

West Virginia: Citizens Southern Bank, Beckley, opened for business on June 12, the first new bank in 

the state in the past thirteen years. At least three more banks are being organized and expect to open 

soon. Among the reasons for the renewed interest in new banks is the turnaround in the economy of the 

state. The number of banks in West Virginia has declined to 140 from 235 a decade ago. The fact that 

most communities are now being served by branches of regional institutions has created opportunities for 

more locally owned banks, the organizers believe. AB, 6/16/95, p. 7. 

BANK AND THRIFT PERFORMANCE 

Commercial Banks' Earnings Strong in First Quarter 

FDIC-insured commercial banks reported net income of $11.1 billion (preliminary) in the first quarter of 

1995, an increase of nearly $400 million from the previous three months. This followed record earnings of 

$44.7 billion for the year 1994, up by 3.7 percent from 1993. The main contributors to the improved 

earnings in the quarter were reductions in certain expense items, including noninterest expenses, 

securities losses, and provision for loan losses. Net interest income declined slightly, but still was $2.5 

billion higher than in the same quarter a year ago. 
 

 

 

 

 

 

 

 

 

 

 

 

Assets of insured commercial banks grew by 2.6 percent in the first quarter to $4.1 trillion. The increase in 

commercial and industrial loans of $32.7 billion was the largest quarterly increase in the more than 20 

years that banks have reported quarterly loan data. The C&I loan growth was evident in all regions, but 

the largest share occurred at banks in the Northeast Region, while overall loan growth was strongest in 

Southeast Region banks. Banks' securities holdings declined for the fourth consecutive quarter, falling by 

$9.7 billion, most of which was in mortgage-backed securities. Noncurrent loans were up by $1.6 billion to 

$32.2 billion, the first quarterly rise since the first quarter of 1991. Most of the increase was in noncurrent 

real- estate loans, a substantial portion of which resulted from a new accounting rule (FASB 114) that 

caused some banks to report as nonaccrual loans assets that were previously reported as other real 

estate owned (OREO). 

Total deposits at insured commercial banks fell slightly in the quarter, due to declines in demand and 

savings deposits in domestic offices, while deposits in foreign offices and time deposits in domestic 

offices both increased. A $105-billion rise in nondeposit liabilities was attributable mostly to higher trading 

account liabilities concentrated in a few large banks. Equity capital climbed by $12.1 billion in the first 

quarter to $324.2 billion, one-third of the increase resulting from new GAAP accounting rules. Banks' 

unrealized losses on available-for-sale securities, which under the new rules are deducted from equity 

capital, fell by $6.3 billion during the quarter, producing a $4.1 billion rise (net of tax effects) in equity 

capital. The ratio of equity capital to assets was 7.88 percent at the end of the quarter. 

The number of insured commercial banks reporting financial results declined by 209 during the first 

quarter to 10,241. The number of banks absorbed through unassisted mergers and consolidations rose to 

228, a quarterly high, over four-fifths of which resulted from consolidations within bank holding 

companies. 

There were 215 commercial banks on the FDIC's "Problem List" on March 31, down from 247 at year-end 

1994, and 383 a year ago. The assets of the problem banks totaled $27 billion, compared to $33 billion at 

year-end 1994 and $53 billion on March 31, 1994. Six insured banks, with assets totaling $867 million, 

have failed in 1995 (through July 31). FDIC Quarterly Banking Profile, First Quarter 1995; PR-40-95, 

FDIC, 6/14/95. 

FDIC-insured, private-sector savings institutions earned $1.7 billion (preliminary) in the first quarter of 

1995, up by $122 million from the fourth quarter and $448 million higher than in the first quarter of 1994. 

Earnings for the year 1994 totaled $6.4 billion. Over 94 percent of all savings institutions were profitable 

in the first quarter. 

Industry assets rose by $5.2 billion in the quarter to $1.0 trillion, marking the third consecutive quarterly 

increase. The largest growth category was loans secured by 1-4 family residential properties. Deposits 

rose by $7.4 billion, the first quarterly increase since 1988. Other borrowed funds declined for the first 

time since 1992. Equity capital rose by $1.8 billion during the quarter, as thrifts retained over $900 million 

of their earnings, and also they reported an increase of $1.1 billion in the fair value of available-for-sale 

securities. The industry's first-quarter capital ratio of 8.07 percent was the highest since 1952. Noncurrent 

real-estate loans as a percent of total real-estate loans declined to 2.10 from 2.19 at the end of 1994, and 

3.18 in the first quarter of 1994. 

The number of savings institutions declined during the first quarter by 34 to 2,118, as takeovers by 

commercial banks and consolidation within the industry continued. Following 27 conversions from mutual 

to stock ownership, the number of stock-owned thrifts exceeded mutuals, with 1,066 institutions holding 

$830 billion in assets, compared to 1,052 mutuals holding $184 billion in assets. Seventy-one savings 

institutions with $39 billion in assets were on the FDIC's "Problem List" on March 31, both numbers 

unchanged from year-end 1994, and down from 118 institutions with assets of $89 billion in the first 

quarter of 1994. 

Banks' Loans Grew Faster Than Securities in 1994 
 

 

 

 

 

 

 

 

 

 

Half of the 117 bank investment managers surveyed by the American Bankers Association reduced their 

securities portfolios as a percentage of total assets last year, while only 23 percent increased the 

securities percentage. Analysts said that excess liquidity and low loan demand in the banking system in 

1990-1993 were reversed in 1994. AB, 4/3/95. p. 1. 

Banks Raise Mutual Funds Market Share 

The assets of bank-managed mutual funds grew 7.3 percent in the first quarter of this year, exceeding the 

6.2 percent growth rate of the mutual funds industry. The first-quarter increase brought the banks' share 

of the $2.3 trillion mutual fund business to 14.3 percent, up from 10.5 percent in March 1994. Most banks 

reportedly have been building mutual fund assets by reorganizing trust assets and acquiring mutual fund 

management companies. According to a survey prepared for the American Banker, Mellon Bank Corp., 

PNC Bank Corp., and NationsBank are the top three bank mutual fund management companies. 

While the recent growth in mutual funds managed by banks, and the industry, has been strongest in 

equity funds, money-market mutual funds represent 57.8 percent of bank-managed mutual fund assets, 

compared to 29.5 percent for the mutual funds industry. Banks generally are said to be attempting to 

move closer to the industry average because of the higher potential profits in stock and bond funds. Of 

the 115 banks with proprietary mutual funds, 55 had less than $1 billion in fund assets under 

management at the end of March. Some of the smaller organizations may depart from the industry 

because of insufficient diversification and other reasons. AB, 5/10/95, pp. 1, 23. 

Small Banks to Reduce Derivatives Investments 

While 84 percent of more than 800 community banks recently surveyed currently invest in financial 

derivatives, less than 60 percent plan to invest in these instruments in the future. The complexity of 

financial derivatives and sharp declines in portfolio values with rising interest rates are seen as principal 

reasons for the decline. The largest decline expected is for structured notes, which is one of the more 

complex kinds of derivatives, and which also has had the most growth in the past year. AB, 5/16/95, p. 1. 

Bank Fee Increases Exceed Inflation, Study Says 

The annual maintenance costs to consumers for interest-bearing checking accounts rose by 11 percent, 

to $219, between 1993 and April 1995, and the costs for regular checking accounts rose ten percent, to 

$202, according to a study by the U.S. Public Interest Research Group. Among other findings, 

maintenance fees for savings accounts increased nine percent, to $31 a year, and the average checkingaccount balance required to avoid fees increased by 30 percent, to $1,242. Surveying 271 banks in 25 

states and the District of Columbia, the highest fee states were reported to be Maryland, Florida, North 

Carolina, and Illinois, and also the District of Columbia, while the lower fees were found in Hawaii, Idaho, 

New Mexico, Maine and Washington. The American Bankers Association disputed the study's results, 

noting the survey's limited coverage, and the fact that the data do not reflect service quality 

improvements, and also the rising costs of administering consumer deposits which are making some 

accounts unprofitable. WSJ, 8/9/95, p. A2. 

Credit Unions' Asset Growth Slows 

Total assets of federally insured credit unions increased 4.5 percent in 1994, the smallest rate of growth 

since 1948. In the last six months, assets fell slightly, from $289.7 billion at midyear to $289.5 billion at 

year-end. The profitability of federally insured credit unions declined during 1994, as measured by a fall in 

the ratio of net income to average assets to 1.2 percent from 1.4 percent in 1993. There were 588 credit 

unions reporting a net loss in 1994, an increase of 58 from 1993. First-quarter 1995 data for the 1,160 

federally insured credit unions with assets over $50 million show a two percent increase in assets to 

$206.4 billion. These institutions experienced a slight decline in return on assets in the quarter, from 1.2 
 

 

 

 

 

 

 

percent to 1.1 percent, while their capital-to-assets ratio rose to 10.1 percent from ten percent. Letter to 

Credit Unions No. 166, NCUA, March 1995; NCUA NEWS, 6/2/95. 

Bankers Surveyed on Regulatory Burden 

According to the results of a recent survey by KPMG Peat Marwick, the Community Reinvestment Act 

and Fair-Lending are at the top of regulations that bankers consider to be the most burdensome. The 

three regulatory areas next in order of perceived burden are asset quality, truth-in-lending and truth-insavings. Ninety-one percent of bank CEOs said the CRA was their first choice for regulatory reform, and 

96 percent believed the Act should be extended to nonbank financial-service companies. Eighty percent 

of the CEOs said they had reviewed fair-lending policies and procedures for discrimination, however only 

23 percent have tested their bank by using mystery shoppers, while 43 percent have done a quantitative 

analysis of application and loan files. A total of 1,311 banker questionnaires were sent out and 660 were 

completed and returned. AB, 3/23/95, p. 16. 

Minority Discrimination Case Settled 

Northern Trust Co., Chicago, and three suburban affiliates agreed to pay $566,500 to minorities to settle 

a Justice Department complaint that, in 1992 and 1993, Northern's employees made special efforts to 

qualify white applicants for mortgage loans but did not give similar assistance to minority applicants. The 

firm does not believe it violated the law, an official said. It was the sixth major fair-housing case filed and 

settled by the Justice Department, and is said to be unique in that Justice documented it with a review of 

individual loan files, rather than with statistical analyses. A Justice official said the message from the case 

is that "institutions should look at the procedures they use to process applications for financing and make 

sure they are affording minority applicants an opportunity to present qualifications that is comparable to 

the opportunity being afforded to white applicants." AB, 6/2/95, p. 1. 

ATM Use Continues Growth 

A telephone survey in six states --- Arkansas, Louisiana, Texas, Oklahoma, New Mexico and Colorado --­

found that 60 percent of persons having a checking or savings account with a financial institution have an 

ATM card, up from 49 percent in 1993. The increase occurred in all states surveyed, among all age 

categories, both genders, and in all types of financial institutions. Cardholders used their card 3.47 times 

during a two-week period to make purchases this year, up from 1.62 times during the same period in 

1993. Texas Banking, June 1995, p. 9. 

RECENT ARTICLES AND STUDIES 

Efficiency Improvement From Mergers Is Questioned 

This study by Tanya Azarchs, published by Standard & Poor's, analyzes the results of mergers involving 

the nation's 30 largest banking companies, to determine whether these transactions resulted in increases 

in efficiency in the surviving institutions. Comparing institutions that merged with those that did not, using 

data for 1990 through 1994, the study found no advantages in efficiency, as defined here, that could be 

attributed specifically to the mergers. While cost savings occured in many cases, the author generally 

believes these benefits could have been realized by management implementation without mergers. 

Expense/income ratios for the general population of banking organizations show that the ratios each year 

of firms having assets of $100 million or less were much higher than the industry average of about 70 

percent. Beyond $1 billion in assets, increasing size does not appear generally to result in further cost 

efficiencies. The firms in the study group that had undergone significant mergers were not more efficient 

than those not involved in mergers, and the most efficient institutions were not more likely to be among 

those that merged. The non-merging firms generally experienced the greatest improvement in efficiency 

during the period. One of the benefits from mergers is that they can provide a politically acceptable 
 

 

 

 

 

justification and opportune situation for implementing what are otherwise very difficult cost cuts. However, 

the "real" benefits are more likely to be those that can result from a company's diversification --- an 

important factor in S&P ratings --- or the enhancement of market position where being a leader in a 

product line has tangible benefits such as enabling the firm to charge premium prices or attract clients. 

Standard & Poor's Creditweek, January 2, 1995. 

Interstate Banking: Experience in Three States 

This GAO report to Congress discusses interstate banking in three states --- California, Washington and 

Arizona --- that have allowed both interstate and intrastate banking for a number of years. The report 

evaluates the experience in these states, for the period 1985 through mid-1993, to determine whether 

their interstate banking laws have had any effect on the market share and number of large banks, the 

viability of the smaller banks, and the availability of credit to small businesses. Interstate Banking: 

Experiences in Three States, U.S. General Accounting Office, December 1994. 

Outlook For Debit Cards 

Debit cards have been the greatest disappointment thus far in the payments revolution but may be turning 

the corner, say Gordon H. Sellon, Jr. and John P. Caskey in this article. The authors analyze the factors 

that have limited the success of debit cards and examine prospects for their future growth. The failure of 

debit cards to reach their usage potential has resulted largely from, first, coordination issues among 

payments system participants that affect incentives to adopt new payments technology, and second, the 

inefficient pricing of existing methods of payment. 

For the debit card to replace existing payment methods, not only must the merchant accept it, consumers 

must be willing to use it for retail purposes. Based on convenience and other non-cost factors, debit cards 

could replace cash transactions for some consumers, for example, because they find carrying a debit 

card to be more secure compared with checks. A debit card can be faster in checkout time, while checks 

have an advantage in delayed clearance, and they also permit more detailed recordkeeping. Some 

convenience users of credit cards could find advantages in debit cards in avoiding having to write monthly 

settlement checks, and making it easier to enforce personal budgets. Also, some retail stores permit 

personal debit card holders to receive cash, which is rarely permitted with credit cards. In summary, the 

outlook for acceptance of debit cards by consumers is believed to be the most favorable where they value 

its convenience, and with consumers who have limited access to existing payments media. 

The acceptance of debit cards by merchants is more likely to be based on cost factors. But if debit cards 

are seen as a way to increase sales volume or as necessary to maintain market share, they may be 

adopted even with a cost disadvantage. Promotional programs of an informational or educational nature 

could be a key factor in determining the speed of debit card growth in the future. Also critical are 

technological developments, for example, the falling cost of debit card readers has influenced merchants' 

decisions to offer debit cards. Developments affecting alternative payments methods --- for example, 

check imaging and truncation may make checking more automated and less costly --- could also 

importantly affect debit card usage. Economic Review, Federal Reserve Bank of Kansas City, 4th Quarter 

1994, pp. 79-94. 

The Electronic Purse 

This article by John Wenninger and David Laster discusses how an electronic purse system might work, 

the advantages of the system for consumers, merchants, and issuers, and the difficulties that could arise. 

The electronic purse, which is a multipurpose prepaid card the size of a credit card, could if successful 

bring fundamental change in the U.S. payments system. 

In contrast to "closed system" cards which have one or a few possible uses, such as transportation cards, 

the electronic purse is in an "open system" card that can be used in a variety of locations for a broad 
 

 

 

 

 

range of purchases. In this system, a bank issues the cards to customers who then transfer value from 

their accounts to the cards at an ATM, a personal computer, or a specially equipped telephone. Funds 

are deducted directly from the cards and transferred to the terminals of the vendors, who in turn move the 

funds into their bank accounts whenever they wish to do so. As funds are spent from the cards, 

consumers can replace these funds from their accounts. Systems of the above type, while not in 

existence currently in the U.S., are operating in other countries, for example, Denmark and Finland. 

For the electronic purse to have sufficient flexibility and protection against fraud they would probably 

require smart-card technology employing a plastic card in which one or more computer chips are 

embedded and having a capability of storing, retrieving and manipulating data. Regarding usage of such 

systems in the U.S., various issues are unsettled, for example, whether the transactions should be 

traceable, requiring a consideration of the benefits for law enforcement against the recordkeeping 

requirements which could be quite burdensome and expensive. 

The advantages to consumers would appear to derive mainly from the convenience factor in the use of 

the card for small transactions, reducing the need for carrying cash and speeding transactions because 

the customer would always have the "exact change." Among the possible obstacles could be the creation 

of numbers of incompatible systems requiring consumers to carry several different cards. Similar 

advantages in respect to time-saving and enhanced security from reducing the handling of cash would 

also apply for merchants. Other benefits to them would be that prepaid cards will likely have lower 

transactions fees than on-line debit cards and unlike checks, offer assured payment, and perhaps open 

new markets such as pay-per-view television. If merchants, however, were required to pay transaction 

fees and purchase new card readers or retrofit existing ones, they could be reluctant to accept electronic 

purses unless their use generates enough new business to justify the costs. 

Regarding the issuers of the cards, a significant advantage, with increased uses for electronic purses and 

the number of cards issued, could be the "float" from their earnings on investment of customer balances 

held in electronic purses. Among other issues involved in establishing the electronic purse is whether 

organizations other than banks would issue the cards. Some potential is seen for facilitating some kinds 

of money laudering. For example, if card systems allow person-to-person transfers of value and transfers 

over specially equipped phone lines, it would enable holders of prepaid card value to move funds rapidly 

to remote locations where they could make several smaller, undetected deposits. Current Issues in 

Economics and Finance, April 1995, Federal Reserve Bank of New York.