Chapter 12

Bank Examination Bank Examination

and Enforcement and Enforcement

Introduction

The 1980s and early 1990s were undoubtedly a period of greater stress and turmoil for

U.S. financial institutions than any other since the Great Depression. Over this period more

than 1,600 commercial and savings banks insured by the FDIC were closed or received

FDIC financial assistance. As a consequence, the bank regulatory system came under intense scrutiny, and fundamental questions were raised about its effectiveness in anticipating

and limiting the number of bank failures and losses to the deposit insurance fund. 

Effective supervision can be achieved in two ways: (1) problems can be recognized

early, so that corrective measures can be taken and the bank returned to a healthy condition;

(2) supervision can limit losses by closely monitoring troubled institutions, limiting their

incentives to take excessive risks, and ensuring their prompt closure when they become insolvent or when their capital falls below some critical level. 

This chapter reviews and analyzes the bank supervisory system during the 1980s and

early 1990s by focusing principally upon bank examination and enforcement polices. The

first part surveys the federal agencies bank examination policies during the 1980s and early

1990s and discusses how changes in bank supervisory philosophy affected examination

staffing and frequency, and what the implications of these policies were for losses to the deposit insurance fund. The second part presents a retrospective on the effectiveness of bank

supervisory tools used during this period, focusing on the ability to identify troubled banks

and the ability to limit risk taking in these institutions by applying enforcement actions. The

final part of the chapter discusses the implications for the bank supervisory process of the

Prompt Corrective Action (PCA) provisions of the Federal Deposit Insurance Corporation

Improvement Act of 1991 (FDICIA). An appendix describes the bank examination process,

including the bank rating system and the nature and types of regulatory enforcement actions. 
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

422 History of the EightiesLessons for the Future

1 As of January 1, 1997, the bank and thrift regulatory agencies added a sixth component to the safety-and-soundness examination, known as the sensitivity-to-market-risk component. After that date, therefore, the CAMEL rating system would

be referred to as CAMELS. The new component evaluates how well institutions are prepared to protect bank earnings and

capital from shifts in interest rates, in foreign exchange rates, and in commodity prices, and from fluctuations in portfolio

values. In this chapter, the sixth component is not discussed. 2 The discussion of examination staffing and frequency is partly based on Lee Davison, Bank Examination and Supervision

(unpublished paper), FDIC, February 1996.

Bank Supervisory Policies, 19801994

Given the constraints imposed on banking activities by the chartering authorities and

by legislation and regulation, the primary tools the banking agencies use to ensure the

health and stability of the financial system and the solvency of the bank and thrift insurance

funds are bank examinations and enforcement actions. Currently there are four basic types

of bank examinations. The first focuses on the banks trust department, to determine

whether it is being operated in accordance with established regulations and standards. The

second investigates whether the bank is in compliance with various measures designed to

protect consumers, such as truth-in-lending requirements, civil rights laws, and community

reinvestment regulations. A third type of bank examination focuses on the integrity of the

banks electronic data processing (EDP) systems. Finally and most important, safety-andsoundness examinations focus on five key areas affecting the health of the institution: capital adequacy, asset quality, management, earnings, and liquidity (CAMEL).1 A bank is

rated from 1 to 5 in each area, or component (1 representing the highest rating, 5 the lowest

rating). After the overall condition of the bank is evaluated, a composite safety-and-soundness rating, known as a CAMEL rating, is also assigned. A composite CAMEL rating of 1

is given to banks performing well above average. A rating of 2 is given to banks operating

adequately within safety-and-soundness standards. A CAMEL rating of 3 indicates belowaverage performance and some supervisory concerns. Performance well below average

yields a CAMEL rating of 4, indicating that serious problems exist at the bank and need to

be corrected. Finally, a CAMEL rating of 5 indicates severely deficient performance and the

high probability of failure within 12 months. (The appendix includes a detailed description

of the CAMEL rating system.) A serious deficiency in any of the areas covered by trust,

EDP, and safety-and-soundness exams could lead to failure, but only safety-and-soundness

examinations, because of their broad coverage, are discussed here.

Through the early 1970s, all banksregardless of size and conditionreceived an

examination approximately every 12 months.2 But in the middle to late 1970s, bank supervision policy changed significantly, and the change remained in place through the first half

of the 1980s. The banking agencies began placing relatively more weight on off-site sur-
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 423

3 This shift in policy took place primarily at the Office of the Comptroller of the Currency and the FDIC. Although the Federal

Reserve System enhanced its off-site surveillance capabilities as well, it did not significantly reduce its commitment to annual examinations for state member banks regardless of size. 

4 FDIC, Annual Report (1990), 20. 5 The targeting of problem banks for more frequent examinations and enhanced supervision is documented in John OKeefe

and Drew Dahl, The Scheduling and Reliability of Bank Examinations: The Effect of FDICIA (unpublished paper),

October 1996.

6 The cooperative examination programs primarily meant that the two federal banking agencies that had regulatory oversight

of state banks (the FDIC and the Federal Reserve System) accepted state examinations in place of federal examinations if

certain conditions were satisfied. In addition, all three federal banking agencies occasionally scheduled joint examinations,

and they shared examination information with each other as needed. 

7 The review was ordered primarily in response to the failure of the United States National Bank. 

veillance and relatively less on on-site examinations.3 This shift occurred partly because the

Call Report data furnished by banks were increasingly comprehensive and partly because

sophisticated computer models had been developed for analyzing these data; the increases

in comprehensiveness and analytical ability allowed the agencies to make extensive use of

off-site surveillance. They viewed off-site analysis as potentially reducing the need for onsite examination visits in nonproblem institutions; it would also reduce examination costs

and the burden upon banks. These decisions had widespread implications for subsequent

examiner staffing levels and examination frequency, both of which were being reduced during the first half of the 1980s. By the latter half of the decade, however, off-site analysis had

become relatively less important in the bank evaluation process vis-à-vis on-site examinations;4 and with passage of FDICIA, frequent on-site examinations again became required,

this time as a matter of law. 

Other important changes in supervisory activity also occurred during the 1980s. Both

the Office of the Comptroller of the Currency (OCC) and the FDIC sought to concentrate

more examination resources on banks that posed greater systemic risk and relatively less on

nonproblem institutions.5 All three agencies began cooperative examination programs during the early 1980s.6 Both the FDIC and the Federal Reserve System increasingly made use

of state bank examinations for nonproblem institutions, often alternating examinations with

state regulators in a move to increase efficiency. (See the appendix to this chapter for additional details.)

OCC Policies

The National Bank Act of 1864 mandated that the OCC examine all national banks

twice a year but allowed an extension to three examinations every two years. This policy

stood until 1974, when the Comptroller of the Currency commissioned a review of the

agencys operations from Haskins & Sells, a national accounting firm.7 The Haskins &

Sells report had a major impact on the theory and practice of federal bank supervision. It

criticized the OCCs existing examination policy as inefficient and recommended that the
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

424 History of the EightiesLessons for the Future

8 See OCC, Haskins & Sells Study: 197475 (1975), A26. See also Jesse Stiller, OCC Bank Examination: A Historical

Overview, OCC, 1995, and Eugene N. White, The Comptroller and the Transformation of American Banking, 19601990

(1992), 3234.

9 White, Comptroller, 38. 10 Stiller, OCC Bank Examination, 2728. 11 In 1982, Comptroller C. T. Conover noted that in 1980 the OCC put 70 percent of its effort into examining banks constituting only 20 percent of national bank assets and said the agency had to examine smarter by reducing the frequency of

on-site examinations of small banks (changing the normal frequency for such banks from 18 months to 3 years) and by supplementing examinations with bank visitations (Linda W. McCormick, Comptroller Begins Major Revamp, American

Banker [April 29, 1982], 15). The movement toward electronic off-site analysis was symbolized by the cake at the OCCs

120th anniversary celebration in 1983: it was made in the shape of a computer (Andrew Albert, Comptrollers Office

Throws a Bash, American Banker [November 4, 1983], 16). 12 FDIC, Annual Report (1979), 4. For banks rated 1 or 2 in states where state examinations were accepted, the FDIC allowed

alternating federal and state exams (FDIC, Annual Report [1980], 89).

agency make greater use of statistical, computerized off-site analysis, focus examination resources on weak banks, and, in examinations, put more emphasis on evaluating bank management and systems of internal control and less on doing detailed audits of bank assets.8

These recommendations were gradually adopted beginning in 1976, when the OCC extended examination schedules to 18 months for banks with total assets of less than $300

million.9 At the same time, the OCC also established a risk-based examination structure by

categorizing banks according to size: multinational, regional, and community.

10

This risk-based structure was further refined under the hierarchy of risk policy in

1984. This new approach defined risk categories according to a banks size and perceived

condition. Resident examiners were placed in the 11 largest multinational banks in 1986,

and beginning early in the 1990s some larger regional banks also received resident examiners. In general, on-site resources moved toward the larger institutions and away from

smaller banks that were perceived to have no problem. This development was accompanied

by the increased use of continuous off-site analysis as well as by the use of targeted examinations (examinations that focused on a particular segment of a banks business) rather

than full-scope examinations.11

FDIC Policies

Until 1976, the FDIC required that all institutions under its supervision receive a fullscope examination annually. Starting in 1976 and continuing through the early 1980s, the

examination schedule was stretched out: only problem banks (those with CAMEL ratings

of 4 or 5) were required to receive an annual full-scope examination; banks with lesser

problems (CAMEL 3) were to be examined (full scope) at least every 18 months; and banks

in satisfactory condition (CAMEL 1 or 2) were to receive either a full-scope or a modified

(that is, somewhat less comprehensive) examination at least every 18 months.12 During the

early 1980s, the FDIC also started to emphasize the expanded use of off-site monitoring as
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 425

13 FDIC, Annual Report (1983), xi; and Annual Report (1985), 1415. The expanded intervals for on-site examinations were

paired with the requirement that either bank visitations or off-site reviews be undertaken at least annually for 1- and 2-rated

banks, every six months for 3-rated banks, and every three months for 4- and 5-rated banks. Visitations by bank regulators

generally involve meetings with bank officials to discuss a variety of issues concerning the banks operations. Some examples of these issues are compliance with formal and informal corrective orders, progress in correcting deficiencies noted

at the previous examination, and any other issues deemed relevant to the sound operations of the bank. 14 FDIC, Annual Report (1988), 2; and Annual Report (1989), 8. 15 FRB, Annual Report (1981), 180. 16 There were gradations to the Federal Reserve policy. Multinational state member banks and all banks with more than $10

billion in assets were to receive annual full-scope examinations as well as (in most cases) an additional targeted examination. Such examinations had to be conducted either independently by the Federal Reserve or jointly with state authorities.

Gradations of smaller banks allowed progressively less Federal Reserve involvement with examinations, but in all cases

annual examinations were still mandated. See Fed Policy for Frequency and Scope of Examinations of State Member

Banks and Inspections of Bank Holding Companies, American Banker (October 10, 1985), 45; on follow-up meetings,

see American Banker (October 11, 1985), 4.

well as the prioritization of examinations, which were to focus primarily upon problem institutions or those that posed the most risk to the deposit insurance fund. In 1983, the examination interval for nonproblem banks was extended to 36 months. By 1985, problem

banks (CAMEL 4- and 5-rated) were to receive examinations every 1218 months,

CAMEL 3-rated banks every 1224 months, and higher-rated institutions every 36 months,

though for banks with less than $300 million in total assets this could be extended to five

years.13

By 1986, facing a record number of problem banks, some of which had been highly

rated, the FDIC revised its examination policies. The new policy called for all 1- and 2-

rated banks to receive on-site examinations at least every 24 months, and all other banks to

be examined by either the FDIC or state examiners at least every year. At year-end 1986,

1,814 commercial banks subject to FDIC supervision had not been examined in three years;

by 1988 the number was reduced to 197, and by the following year, to 92.14 With the passage of FDICIA, the return to the examination policies of the 1970s was complete: the law

mandated annual on-site examinations of all banks except highly rated small institutions,

for which the interval could be extended to 18 months.

Federal Reserve Policies

The Federal Reserve System (FRS) also changed its examination policies in the early

1980s, placing more emphasis on remote surveillance and slightly stretching out examination schedules, but it varied the examination frequency much less than the other agencies

did. In 1981, the FRS shifted from a policy of annual examinations for all state member

banks to one that allowed the interval to extend to 18 months.15 This policy remained in

place until 1985, when the previous annual requirement for state member banks was reinstated.16
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

426 History of the EightiesLessons for the Future

17 The reduction in examination staff and examination frequency over the period 198185 was not a function of a reduced

number of banks or assets under supervision by the regulatory agencies. For the OCC, for example, the number of national

banks increased from 4,468 to 4,959; total assets under supervision increased from $1.2 trillion to $1.6 trillion; and the assets per examiner for all national banks increased from $668 million to $910 million. (In Texas, the number of national

banks increased from 694 to 1,058.) For the FDIC, the number of state nonmember banks did decline about 5 percent, going from 9,257 to 8,767, but the total assets under supervision increased from $589 billion to $805 billion, and the assets

per examiner increased from $355 million to $520 million. (In Texas, the number of state nonmember banks actually increased slightly, going from 786 to 808.) For the Federal Reserve, the total number of state member banks increased from

1,020 to 1,070; the total assets under supervision increased from approximately $387 billion to $495 billion; and assets per

examiner grew from $484 million to $593 million. (There were only a small number of state member banks in Texas.) 18 Under the directives of the Reagan administration in 1981, the OCC instituted a hiring freeze for all examiners. The FDIC,

as an independent agency, was under no legal obligation to follow suit but chose to freeze its examination staff in 1981. In

the late 1970s, the Carter administration had also attempted to limit the size of the federal work force. 

Examination Staffing and Frequency

The agencies shift in supervisory philosophy in the early 1980s, placing more emphasis on off-site analysis and relatively less on on-site examination, had major implications for examination staffing and therefore for the ability to detect problem institutions at

early stages. From 1979 through 1984 both the FDIC and the OCC reduced their examiner

resources: the FDICs field examination staff declined 19 percent, from 1,713 to 1,389, and

the OCCs declined 20 percent, from 2,151 to 1,722. The Federal Reserves examination capacity remained almost unchanged. State examiner levels, however, declined, from approximately 2,496 to 2,201. From 1979 through 1984, overall examiner resources at federal and

state levels declined by 14 percent, from 7,165 to 6,132 (see figure 12.1).17

This substantial reduction in staff, especially at the federal level, came about primarily by means of a series of freezes on the hiring of new examiners at the FDIC and the OCC

in the late 1970s and the early 1980s; these freezes were consistent with the policies of increased off-site surveillance and with the desire of first the Carter administration and then

the Reagan administration to lessen the size of government.18 As a consequence of the

freezes, staff shortages developed in subsequent years and continued until and even beyond

the mid-1980s. By year-end 1985, for example, staffing levels at the FDIC were 25 percent

below authorized levels. In addition to freezes in hiring, high turnover rates among examiners also helped produce shortages in examiner staffs. The high turnover rates were due in

part to the pay differential between the banking agencies and the private sector. Unfilled examiner vacancies persisted until the mid-1980s, when the agencies started to hire new examiners as the number of problem banks increased (rising from 217 to 1,140 between 1980

and 1985more than a fivefold increase). Thus, during a period of rapidly growing instability in banking with an unprecedented number of problem banks, the agencies examination staffs consisted of large numbers of inexperienced personnel. As a consequence,

experienced staff were forced to devote considerable effort to training new examiners and

were correspondingly less available to conduct work on safety-and-soundness examina-
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 427

Figure 12.1

Field Examination Staffs of the Federal and State

Banking Agencies, and Total Number of Problem Banks,

1979–1994

Sources: FDIC, FRB, OCC, and Conference of State Bank Supervisors.

1980 1982 1984 1986 1988 1990 1992 1994

6,000

7,000

8,000

9,000

10,000

0

400

800

1,200

1,600

Number of Examiners Number of Problem Banks

7,165

6,132

9,614

Number of

Examiners

Number of

Problem Banks*

(CAMEL Rating

of 4 and 5)

Because problem banks were not classified as those having 4 and 5 CAMEL

ratings until 1980, the number of problem banks for 1979 is not included.

Total number of examiners includes all federal and state bank regulators.

*

19 The training cycle for newly hired examiners is lengthy and complicated; approximately three to five years are required before a new hire is a fully trained, commissioned examiner. 

tions.19 From 1986 to 1992, for example, approximately half of the supervisory staff at the

FDIC consisted of assistant examiners with less than three years experience.

Furthermore, as problem banks multiplied in the Midwest and Southwest, resources

were shifted from areas with seemingly healthy banks, such as the Northeast. Experienced

FDIC examiners in the Northeast routinely spent a quarter of their time out of the region assisting with problems elsewhere. Moreover, as bank failures increased, bank examination

personnel were detailed to support bank resolution activities. In 1984, the FDIC deployed

11 percent of its total examination staff time to such matters. This shift of resources among

regions and across functions placed additional pressure on the examination forces ability

to detect problem banks, especially in a seemingly healthy area like New England, where a

crisis was about to erupt. 
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

428 History of the EightiesLessons for the Future

Figure 12.2

Total Number of Examinations per Year

and Total Number of Problem Banks, 1980–1994

Sources: FDIC, FRB, and OCC.

1980 1982 1984 1986 1988 1990 1992 1994

9,000

12,000

15,000

18,000

0

400

800

1,200

1,600

Number of Examinations Number of Problem Banks

Number of

Examinations*

Number of

Problem Banks

(CAMEL Rating

of 4 and 5)

8,312

12,267

16,549

Total number of examinations includes all examinations conducted by federal agencies

and all state examinations accepted by federal authorities.

*

The reduction in examination staff, as mentioned above, was partly a side effect of the

agencies decision to reduce the number of bank examinations and increase the median interval between examinations. The total number of examinations declined from a high of approximately 12,267 in 1981 to a low of approximately 8,312 in 1985, a drop of more than

30 percent (see figure 12.2). By far the largest decline occurred at state nonmember banks,

where on-site examinations decreased more than 40 percent, from approximately 8,000 in

1981 to approximately 4,600 during 1985. Declines were more moderate for national banks

and state member banks: both declined less than 15 percent during the same period. In addition to frequency, the scope of examinations was also curtailed, as limited resources gave

the agencies no option but to continue to modify their examination procedures.

Reductions in examination frequency are tantamount to extensions of examination intervals. Between 1979 and 1986, the mean examination interval in days for all commercial

and savings banks increased dramatically from 379 to 609 (see table 12.1). The intervals

were increasing for all CAMEL rating categories, but especially for highly rated institutions. For 1-rated banks, the interval increased from 392 to 845 days; for 2-rated banks,

from 396 to 656 days. The interval also grew for poorly rated institutions, but not as much.
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 429

Table 12.1

Mean Examination Interval for Commercial Banks,

by CAMEL Rating, 19791994 

(Days)

Composite CAMEL Rating

Year 1 2 3 4 5 All Banks

1979 392 396 338 285 257 379

1980 456 460 402 312 286 450

1981 493 482 342 279 236 472

1982 459 446 321 262 249 434

1983 500 450 309 261 243 436

1984 620 499 327 303 270 480

1985 761 596 369 324 284 564

1986 845 656 407 363 313 609

1987 754 597 386 354 284 556

1988 615 497 376 339 315 477

1989 562 487 373 324 296 466

1990 463 436 331 303 270 411

1991 420 412 323 286 273 385

1992 409 396 319 291 278 373

1993 400 379 296 286 232 363

1994 380 357 296 279 245 354

Sources: FDIC, FRB, and OCC.

20 A study specifically of Texas banks reaches the same conclusion (John OKeefe, The Texas Banking Crisis: Causes and

Consequences 19801989, FDIC Banking Review 3, no. 2 [1990]: 12).

For 4-rated banks, the interval increased from 285 to 363 days; for 5-rated banks, from 257

to 313 days. These data indicate that the regulatory policy in the early 1980s of focusing

more resources on the examination of troubled banks and thus reducing examination intervals for these organizations was generally not being carried out successfully.

20

Data on examination intervals by bank regulatory agency show that for the period

198086, overall examination intervals increased for all three agencies (see table 12.2). For

the OCC, the interval increased about 45 percent, or from 417 to 604 days. For the FDIC,

37 percent, or from 460 to 628 days. The increase for banks supervised by the Federal

Reserve was a more modest 27 percent, from 411 to 520 days.

The reductions in examination frequency were most pronounced in the Southwest,

particularly Texas, which had the largest concentration of problem and failed banks and
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

430 History of the EightiesLessons for the Future

Table 12.2

Mean Examination Interval for Commercial Banks,

by Regulatory Agency, 1980-1994

(Days)

Year OCC FDIC FRS

1980 417 460 411

1981 521 451 502

1982 468 415 503

1983 469 415 514

1984 529 446 503

1985 567 568 532

1986 604 628 520

1987 511 580 516

1988 552 452 461

1989 589 415 461

1990 482 379 439

1991 445 356 414

1992 422 351 404

1993 433 333 386

1994 395 333 401

21 For a more complete discussion of the issue of examination frequency in Texas and the Southwest during the 1980s, see

OKeefe, The Texas Banking Crisis, 114.

produced the greatest losses to the insurance fund.21 In Texas, for example, the average

number of examinations for all banks declined from a high of more than 1,200 in 1983 to

approximately 600 at year-end 1985 (see figure 12.3). This decline is reflected in the median number of days between examinations for all failed banks in the region (see figure

12.4). In the Southwest as a whole, the median interval for failed banks reached a high of

579 days in 1986; for failed Texas banks, it reached 667 days. The average for all U.S.

banks that failed in the same year was substantially lower: 455 days. 

Bank examination staffs and examination frequency continued to increase during the

second half of the 1980s and into the 1990s, as all of the agencies attempted to deal with the

backlog of problem banks. In 1993 the number of field examiners reached a high for all federal and state agencies (9,614), up more than 30 percent over the number in 1979 (figure

12.1). In addition, the total number of examinations began trending upward beginning in

1985, until by the early 1990s the number of annual examinations reached the levels of the
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 431

Figure 12.3

Average Number of Examinations per Year for

Texas Commercial Banks, 1980–1994

1980 1982 1984 1986 1988 1990 1992 1994

0

300

600

900

1,200

1,500

Number of Examinations

United States

Texas

Southwest*

Figure 12.4

Median Examination Period (Days) for

Failed Banks, 1980–1994

The Southwest region includes

Texas.

Arkansas, Louisiana, New Mexico, Oklahoma,

and

1980 1982 1984 1986 1988 1990 1992 1994

200

300

400

500

600

700

Number of Days since Prior Exam

*
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

432 History of the EightiesLessons for the Future

22 Several empirical studies have demonstrated that with more frequent examinations, problem banks would have been detected earlier. See especially OKeefe and Dahl, Scheduling and Reliability. 23 See Drew Dahl, Gerald A. Hanweck, and John OKeefe, Audits, Exams and Accounting Integrity in Banking (unpublished paper), February 1995; and R. Alton Gilbert, Implications of Annual Examinations for the Bank Insurance Fund,

Federal Reserve Bank of St. Louis Economic Review 75, no. 1 (1993): 3552. 24 A recent examination is one generally given within the preceding 12 months.

early 1980s (figure 12.2). The passage of FDICIA in 1991, therefore, reinforced a trend that

had already begun. The data show that bank regulators had recognized the need for more

frequent examinations and had begun moving in that direction.

In summary, the decisions that caused examiner levels to be reduced during the first

half of the 1980s were a public policy failure. Such policies reduced the ability of supervisors to detect problems early enough to take corrective action. This was especially true in

Texas and the Southwest, where the economy was changing rapidly and the number of

problem banks was increasing. It is reasonable to assume, although impossible to demonstrate empirically, that if examination frequency had not been reduced, problems would

have been detected earlier and losses to the insurer reduced.22 But the reduced frequency of

examinations did more than limit the usefulness of information derived from examinations.

It also limited the usefulness of the financial reports used in off-site monitoring: on-site examiners are able to evaluate the quality of the loan portfolios and verify the data reported by

banks on nonperforming loans and loan charge-offs. Thus, if examinations are less frequent, Call Report data are less reliableand the off-site monitoring systems that are based

on Call Report data are less able to predict future problems.23

Examination Ratings and Reports: Effectiveness in

Identifying Troubled Banks

To identify and control risk in troubled institutions, bank supervisors have essentially

two types of tools: on-site bank examinations and follow-up enforcement actions. (See the

appendix for a description of the examination and enforcement process.) The aim of the onsite examinations is, by means of the rating system, to identify the risk of failure in troubled

institutions in sufficient time for supervisors to take corrective action. The aim of the

follow-up enforcement actions is to control the risk-taking behavior of problem banks after

they have been identified. 

Regular on-site safety-and-soundness examinations that identify potential problem

banks early and appraise their financial condition accurately are bank supervisorsprimary vehicle in identifying troubled banks, and the analysis in this chapter shows that for most failed

banks that had had recent examinations, ratings generally did a satisfactory job of identification well in advance of failure.24 Nevertheless, some omissions in the supervisory system

were apparent, for examination ratings sometimes gave an inaccurate picture of a banks con-
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 433

1 and 2

3

4

5

0 10 20 30 40

36%

25%

8%

26%

28%

10%

CAMEL Rating

As a Percentage of Failing Banks

31%

36%

Composite CAMEL Ratings Two Years before

Failure for Banks Failing between 1980 and 1994

Figure 12.5

All Available Ratings Ratings Less Than One Year Old*

Ratings that were less than one year old as of the two-years-before-failure

date; that is, ratings based on examinations dated between two and three years

before failure.

*

25 All examinations cited were regular full-scope or modified-scope on-site safety-and-soundness examinations. Consumer

compliance, EDP, and other types of non-safety-and-soundness examinations were not included in the analysis. 26 The analysis accounts for examination ratings that existed two years before failure. However, many of the examinations

that were on the books two years before failure were several years old at that time.

dition until relatively shortly before failure. The record shows that 260 failed banks were not

identified as requiring increased supervisory attention within 24 months of failure. Of these,

141 were not detected as troubled banks within 18 months of failure; 57 were not detected

within 12 months of failure; and 9 were not detected within 6 months of failure. 

Bank examination ratings two years before failure for all failed banks are shown in

figure 12.5.25 These data refer to examinations available two years before failure, including

those that were already several years old.26 The two-year interval was selected because

FDIC bank supervisors believe that the examination system should uncover signs of potentially serious deficiencies in the financial condition of a bank within at least 24 months of
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

434 History of the EightiesLessons for the Future

Table 12.3

Failing Banks with CAMEL Ratings of 1 or 2 Two Years before Failure,

19801994

Number Percent of Total Failures

Total 1- and 2-rated future failures 565 35%

Specific types:

Cross-guarantee cases 25

Failures associated with fraud 24

First City Bancorporation affiliates 36

First RepublicBank Corporation affiliates 26

CAMEL ratings more than one year old* 194

Total of above 305 19

Remaining 1- and 2-rated future failures 260 16

* Failures of banks with ratings more than one year old (two years before failure) do not include cross-guarantee cases, failures associated with fraud, First City Bancorporation affiliates, or First RepublicBank Corporation affiliates.

27 The majority of the 565 banks were relatively small and were concentrated in a few geographic areas: approximately 80

percent of them held total assets of less than $100 million, and almost 70 percent of them were located in the Midwest or

the Southwest. In addition, almost all were either national or state nonmember banks. 

failure. The data show that within two years of failure, 36 percent of the banks that failed

had the highest ratings (a 1 or 2 rating), 25 percent had a 3 rating, 31 percent a 4 rating, and

only 8 percent a 5 rating. Examination ratings did, therefore, identify nearly two-thirds of

the total 1,617 failures as in need of increased supervisory attention (CAMEL 3, 4, or 5 ratings) at least two years before failure. 

Nevertheless, a significant number of cases went undetected in the early stages: overall, 565 banks, or approximately 36 percent of those banks that eventually failed, held a satisfactory 1 or 2 rating two years before failure. Several factors may have contributed to the

inability of the supervisory process to identify these banks. For example, some of these

banks might have deteriorated quickly or might not have been examined recently. An alternative explanation is that the examinations failed to detect the problems.27 An analysis of the

lack of supervisory identification of these 565 banks demonstrates that the most significant

factor was outdated examinations (see table 12.3). In approximately 34 percent of these

cases (194 banks), the existing examination ratings available two years before failure were

more than one year old at that time. If only examination ratings that were less than one year

old at that time are counted, the proportion of banks with 1 and 2 ratings two years before

failure declined from 36 percent to 26 percent, and the proportion of banks with CAMEL3,
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 435

28 These findings are supported by the research of Dahl, Hanweck, and OKeefe (Audits, 1820), who show that during the

period 198794, bank regulatory authorities directed their examination resources primarily at banks that had the lowest examination ratings. They concluded that examinations appear to have been consistently targeted at banks with the worst

performance as indicated by prior CAMEL ratings or nonperforming loan experience and that losses are higher with

longer gaps between examinations. 29 The FDICs cross-guarantee program generally assesses all banks in the holding company for the FDIC losses of individual members. In some cases, this assessment results in the closing of all banks in the holding company, but the end result is to reduce the insurers losses. 30 The precise role that fraud and financial misconduct played as a cause of bank failures during the 198094 period is difficult to assess. The consensus of a number of studies is that fraud and financial misconduct (1) were present in a large number of bank and thrift failures in the 1980-94 period; (2) contributed significantly to some of these failures; and (3) were

able to occur because of the same managerial deficiencies and inadequate internal controls that contributed to the financial

problems of many failed and problem institutions in the first place. With respect to the last issue, the conclusion appears to

be that internal weaknesses left the institutions vulnerable to both abuse and fraud as well as to adverse economic developments. The studies also found that for many reasons it is very difficult to estimate the dollar impact of such activity. For

a more detailed discussion of the relationship between bank failures and fraud, see Chapter 1. 

4, and 5 ratings (those identified as exhibiting various degrees of weakness) rose from 64

percent to 74 percent of the institutions that would fail two years later. (See table 12.5).

These findings are consistent with the supervisory policies adopted by the banking

agencies during the 1980s. This was a period when most banking agencies had cut examination staffs, were placing more reliance on off-site monitoring based on Call Report data,

were concentrating their examiner resources on the most troubled banks, and, in the case of

the FDIC, were using existing supervisory personnel increasingly to assist in closing and

liquidating failed banks. In many cases these changes had reduced the ability of bank supervisory examiners to detect financial problems early enough to prevent failure.28

But in addition, the failure to give sufficient warning for some of the 1- and 2-rated

banks was caused by safety-and-soundness conditions for which the CAMEL system was

not designed. Of the 565 banks, 25 were cross-guarantee failures pursuant to the provisions

of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA),

and bank examiners could not have been expected to know two years in advance that the

FDIC would decide to invoke this provision.29 Another 24 failures were associated with

bank fraud, a problem that is difficult to detect and one that bank examiners are not trained

to uncover. In some cases, bank fraud canand in these cases didresult in the quick closing of otherwise healthy banks.30 Finally, 62 banks failed when the lead banks of two large

Texas bank holding companies, First City Bancorporation and First Republicbank

Corporation, collapsed. In economic terms, these affiliates were more like branches than independent banks, and CAMEL ratings for the affiliates did not reflect the condition of the

parent companies. More important, the banking agencies were not dependent on CAMEL

ratings for information on these two holding companies; their situation had been under consideration for a protracted period. Thus, when these failures are excluded, 260 banks, or ap-
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

436 History of the EightiesLessons for the Future

31 Exclusion of banks with ratings that were more than one year old two years before failure means, in effect, that the data refer to examinations conducted between two and three years before failure. 32 The 1,617 failures during the period 198094 included 156 banks with total assets over $250 million. Of these 156 banks,

47 had a 1 or 2 rating two years before failure, while 103 had a 3, 4, or 5 rating. Six of the other banks were not counted,

because examination information on them was unavailable in electronic form. Of the 47 1- or 2-rated banks, 24 were discarded for the reasons discussed in connection with table 12.3. Thus, 23 of a total of 150 large banks were not identified by

the examiners two years before failure. 

proximately 16 percent of the 1,617 failures that occurred during the period, were not detected by the supervisory system two years before failure.31

An analysis also was undertaken to determine whether examiners were more effective

in identifying, within two years of closing, relatively larger-sized banks that failed. After

outdated examinations were eliminated and additional adjustments were made for the reasons previously discussed, the results show that approximately 15 percent of banks that received 1 or 2 ratings within two years of failure and had total assets of over $250 million

were not identified. This compares to 16 percent for the total group that is presented in table

12.3.32 These findings by themselves do not provide evidence that examiners were substantially better at identifying risk in larger-sized banking organizations two years before failure than they were with all banks that failed.

Afurther investigation was conducted to determine if the CAMEL rating system of risk

identification improved incrementally over the period 198094. As mentioned above, additional examination resources were being made available to the bank regulatory agencies during the middle to late 1980s, and examination frequency increased substantially during this

period. Thus, the detection of problem banks should have been improving over this period.

To test for this effect, the 260 banks that were rated 1 or 2 within two years of failure were

broken out by year and weighted by the total number of failures within each of the years from

1980 to 1994. The data show that from 1980 to 1986 approximately 28 percent of total failures, on average, had a CAMEL rating of 1 or 2 two years before failure. From 1987 to 1994,

however, the comparable figure was only about 12 percent of total failures. The difference in

means for the two time periods for the 1- and 2-rated group was statistically significant at the

99 percent confidence level. The analysis was also conducted for failed banks that had a 4 or

5 rating two years before failure. The data show that from 1980 to 1986, 25 percent of banks

that failed had a 4 or 5 rating within two years of failure. From 1987 to 1994, however, the

comparable figure was 46 percent. The difference in means for this group for the different

time period was also statistically significant at the 99 percent level. 

These data are presented in figure 12.6, which charts the improving accuracy of the

CAMEL rating system in identifying problem banks after 1985. The improvement in the

rating systems effectiveness was partly a function of the increasing frequency of bank examinations starting in the second half of the 1980s. In summary, given the turmoil and the
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 437

Figure 12.6

CAMEL Ratings of Failed Banks Two Years

before Failure, 1980–1994

1980 1982 1984 1986 1988 1990 1992 1994

0

20

40

60

80

100

Percent

4 and 5 CAMEL ratings

two years before failure

1 and 2 CAMEL ratings

two years before failure

33 In light of the various regional economic recessions and banking crises of the 1980s and early 1990s, most bank regulatory

agencies were more careful about monitoring regional economic conditions starting in the mid-1990s and attempted to incorporate the analysis of these conditions into the bank examination process. For example, in late 1995 the FDIC established the Division of Insurance, which monitors regional economic conditions and other potential risks to commercial

banks and works closely with the Division of Supervision. 

regional banking crises of the 1980s and early 1990s, overall CAMEL ratings (when they

were current) appear to have done a reasonably satisfactory job of focusing attention on

most of the institutions that subsequently failed.

Limitations of the CAMEL Rating System

Although the CAMEL ratings identified most failed banks that had had examinations

within two years of failure, the rating system suffers from some limitations. First, the ratings

did not necessarily capture the seriousness of the situation of banks that subsequently failed.

For example, if only officially designated problem institutions (those with 4 or 5 ratings) are

discussed, then the system identified only 46 percent of the banks in that group that failed

within two years (figure 12.5). Second, because CAMEL ratings are based only on internal

operations, they measure only the current financial condition of a bank and do not take into

account regional or local economic developments that may pose future problems but that are

not yet reflected in the banks condition.33 Third, CAMEL ratings by design are not forwardlooking and do not systematically track long-term risk factors that may cause losses several
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

438 History of the EightiesLessons for the Future

34 There may be some exceptions, however. While the overall or composite rating is not forward-looking, some examination

component ratings, like that of management (M), may be forward-looking and may yield information about the future risk

of failure. For example, a poor management component rating may indicate that the bank suffers from weak internal controls, unsatisfactory underwriting policies, or other deficiencies that could threaten the solvency of the bank. Deterioration

in this component may yield information about future risk. To test this proposition, researchers at the FDIC evaluated the

management component ratings for the 1,564 banks (excluding assistance cases) that failed between 1980 and 1994. The

results show that two years before failure, in only 6 percent of the cases was the management rating one full number worse

than the average of the other four components. 35 Bank examination ratings can change rapidly as banks conditions change during deep recessions, like those experienced

in the Southwest in the late 1980s and in New England in the early 1990s. In the Southwest during the years 198589, for

example, 34 percent of the banks that were examined recorded ratings downgrades. In the New England states between

1989 and 1992, 29 percent of the banks that were examined recorded ratings downgrades. For further discussion of this issue, see Rebel Cole and Jeffery W. Gunther, A CAMEL Ratings Shelf Life, Federal Reserve Bank of Dallas Financial

Industry Studies (December 1995): 1320. 36 Most of these banks do not fail in the sense of causing losses to the insurer. However, a large percentage survived only

through the acquisition by or merger with another organization. 

years later. Thus, the picture they provide of a banks condition is current rather than

prospective. 34 For example, many banks during the period under review engaged in risky

behaviors that in the past had been associated with failures, like excessive asset growth, high

ratios of commercial real estate loans and total loans to total assets, or a heavy dependence

upon volatile deposit liabilities, yet if the bank was performing satisfactorily, these risk factors were generally not captured or weighted in the current examination ratings.

Fourth, while not a limitation of the rating system per se, the frequent use of on-site

bank examinations that are designed to limit future bank failures imposes a burden on depository institutions, which must absorb their costs and contend with the disruption they

impose on the work environment. This can be particularly burdensome during good economic times, when the condition of most banks is reasonably healthy and examination ratings change relatively little. For example, an average of less than 15 percent of examination

ratings resulted in downgrades each year during the period 198094, although the number

varied significantly depending on region, especially during deep recessions.35

The burden of on-site examinations may also be illustrated by the fact that even most

banks that are designated as problem banks (CAMEL4 or 5 rating) do not fail.36 It can be argued either that this is a defect of the rating system as a means of forecasting failures or, conversely, that examination ratings trigger the supervisory responses that prevent troubled

banks from failing or reduce failure costs when the banks have to be closed. It must be recognized, however, that both the large number of banks whose ratings do not change through

repeated examinations and the large number of troubled banks that do not fail are unavoidable consequences of having frequent on-site examinations. Given that on-site examinations

provide information to the regulators that is otherwise unavailable, these consequences must

be borne if the condition of insured banks is to be monitored effectively.
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 439

37 The following studies analyze the effectiveness of supervisory oversight of problem banks: French, Early Corrective

Action, 112; David K. Horne, Bank Dividend Patterns, FDIC Banking Review 4, no 2 (1991): 1324; R. Alton Gilbert,

Supervision of Undercapitalized Banks: Is There a Case for Change? Federal Reserve Bank of St. Louis Review 73, no.

3 (1991): 16-30; and R. Alton Gilbert, The Effects of Legislating Prompt Corrective Action on the Bank Insurance Fund,

Federal Reserve Bank of St. Louis Review 74, no. 4 (1992): 3-22. Studies that have found formal enforcement actions to

be effective in altering the behavior of problem banks are Joe Peek and Eric S. Rosengren, Bank Regulatory Agreements

and Real Estate Lending, Real Estate Economics 24 (1996): 5673; and U.S. General Accounting Office, Bank

Supervision: Prompt and Forceful Regulatory Actions Needed, report to the Chairman, House Committee on Banking,

Finance and Urban Affairs, Subcommittee on Financial Institutions Supervision, Regulation and Insurance, April 1995. 38 In some instances, thrift regulators encouraged certain types of risky behaviors, like high growth rates, which they thought

would permit thrifts to grow out of their problems. For research documenting the existence of the so-called moral-hazard

problem associated with the behavior of thrift institutions during the 1980s, see James R. Barth, Philip F. Bartholomew, and

Carol Labich, Moral Hazard and the Thrift Crisis: An Analysis of 1988 Resolutions, in Proceedings of the Conference on

Bank Structure and Competition, Federal Reserve Bank of Chicago, May 35, 1989, 34484; and Gillian Garcia, The

FSLIC Is Broke in More Ways Than One, Cato Journal 7, no. 3 (1988): 72741. 39 For example, Gilbert (Supervision of Undercapitalized Banks) found that undercapitalized banks during the period

198589 generally did not grow rapidly, pay dividends, or make loans to insiders, all of which are behavioral patterns normally associated with high-risk strategies. Moreover, Gilbert (Legislating Prompt Corrective Action) also found no relationship between resolution cost and either the level of capital one year before failure or the length of time a bank was

undercapitalized.

Monitoring: Measures of Effectiveness in Limiting the RiskTaking Behavior of Troubled Institutions

Identifying problem banks early is one responsibility of bank supervisors. Another is

to monitor the behavior of troubled institutions in an attempt either to prevent failure or to

limit losses to the insurance fund in the event of a closing.37

As an insured depositorys capital is depleted, it has less to lose from pursuing highrisk investment strategies in an attempt to return to profitability. The institutions owners or

managers may be tempted to engage in speculative lending or to assume greater-thannormal interest-rate risk. They may also make inappropriate dividend payments or engage

in other fund transfers. Such behavior contributed significantly to the cost of resolving

failed thrift institutions during the 1980s. Marginally capitalized (or insolvent) thrifts undertook high-risk ventures that ultimately increased losses to the thrift insurance fund, and

it is widely believed that ineffective monitoring and supervisionas well as the regulators

inability to close insolvent thrifts due to inadequate fundspermitted them to do so.38

However, neither existing empirical studies of banking nor the findings presented in this

chapter have found widespread evidence of such behavior at marginally capitalized banks.39

One measure of the effectiveness of the supervisory monitoring program is the number of problem banks that recovered without cash assistance by the insurer. From 1980 to

1994, there were 4,808 institutions that were classified as either a 4- or a 5-rated bank sometime during the period. Of this total, 1,311 (27 percent) failed, while 3,497 (73 percent) ei-
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

440 History of the EightiesLessons for the Future

Table 12.4

Asset Growth Rates, Dividend Payments, and Capital Injections, 

All Banks with CAMEL Ratings of 4 or 5, 19801994

Total

Years before

Failed Banks Surviving Banks (Failed and Surviving)

Failure,

Year of Failure Year of Recovery or Merger* Year of Failure, Recovery,

Recovery, or Merger*

or Merger 198085 198691 199294 198085 198691 199294 198085 198691 199294

A. Asset Growth Rate (Percent)

3 14.60 15.65 18.77 10.39 13.38 4.42 11.91 14.09 5.93

2 10.72 1.71 −3.53 3.67 1.25 −0.61 6.21 1.40 −0.92

1 0.91 −10.17 −13.39 1.96 0.96 −0.64 1.58 −2.51 −1.98

B. Dividends to Average Assets (Percent)

3 0.34 0.21 0.09 0.20 0.21 0.13 0.25 0.21 0.13

2 0.32 0.16 0.06 0.16 0.14 0.09 0.22 0.15 0.09

1 0.16 0.05 0.02 0.13 0.13 0.08 0.14 0.11 0.07

C. Capital Injections to Average Assets (Percent)

3 0.18 0.42 0.45 0.19 0.46 0.42 0.19 0.45 0.42

2 0.22 0.52 0.54 0.39 0.56 0.42 0.33 0.55 0.43

1 0.65 0.39 0.40 0.44 0.45 0.49 0.51 0.43 0.48

Note: Data are unweighted averages of individual bank percentages.

* Recovery is either the date of a banks unassisted merger or, if the bank survived as an independent institution, the date it

received a CAMEL rating of 1, 2, or 3.

40 Capital injections include new stock issues, capital contributed through merger, and capital contributed from parent holding companies. 

ther survived as independent banks, were purchased by bank holding companies, or merged

into other banks without FDIC assistance. Therefore, approximately three out of four problem banks recovered without assistance.

The behavioral changes of all problem banks for three years before either failure (for

failed banks) or the date of recovery (for the problem banks that survived) are presented in

table 12.4. The data show that 4- or 5-rated banks slowed down their asset growth, cut dividend payments, and generally increased capital from external sources.40 These trends are

consistent over the three-year observation period for both problem banks that failed and

problem banks that survived. Furthermore, these trends became more pronounced with the

evolution of the various banking crises, as supervisors received additional examination resources during the second half of the 1980s, gained more experience dealing with the heavy

volume of problem banks, and became more aggressive in constraining the risky behavior.
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 441

41 The early period was a time when most of the banking agencies were cutting examination staffs, while the number of

problem banks was increasing significantly. The middle period was when the majority of the bank failures were occurring. The late period corresponded to a change in regulatory regime after the passage of FDICIA in 1991. 42 J. Kimball Dietrich and Christopher James argue that higher capital injections of weaker banks were not the result of supervisory pressure but the result of actions taken by the banks and the equity markets. Such a position appears unrealistic

because, from whatever source, the urgency to raise capital nonetheless reflects a desire to avoid closure or other sanctions.

The capital injection can therefore probably be considered a result of the supervisory system. See Dietrich and James,

Regulation and the Determination of Bank Capital Changes: A Note, Journal of Finance 38, no. 5 (1983): 165158. It

should be noted that new legal and institutional constraints were being put into place starting in the late 1980s to control

the incidence of moral hazard in banking. Minimum and risk-based capital standards were in place at least since the late

1980s; the least-cost test for resolving bank failures, Prompt Corrective Action, and risk-based insurance premiums originated with the passage of FDICIA in 1991. All of these actions were intended to minimize moral hazard and to place more

of the risk of loss on the shareholders of institutions and less on the U.S. taxpayer and the deposit insurance fund.

(The data are broken out for three different time intervals during the period 198094, each

reflecting a different stage of the banking crisis: the early [198085], the middle [198691],

and the late [199294] periods.)41

The findings show, therefore, that the moral-hazard problem was being contained, for

banks were shrinking their assets over this period. In the case of surviving banks, reduced

dividend payouts and increased capital injections helped restore equity positions and were

instrumental in facilitating recovery. In the case of failed banks, dividend cuts and new capital had the effect of reducing the costs of failure. Thus, the end result of changes in the operation of problem banks appears to have been a reduced number of bank failures, a

reduction in risk taking at troubled banks, and a reduction in losses to the fundwhether

the changes were due to management, stockholders, market forces, or bank supervisors.42

Number and Kinds of Formal Enforcement Actions 

To achieve effective oversight, banking authorities need adequate supervisory powers to

limit potential risk-taking behavior by undercapitalized banks. The ability to identify problem

banks is of limited usefulness without adequate authority to compel corrective actions. Most

regulatory agencies have sufficient power to improve capital, levy fines, remove management, restrict dividends and other inappropriate funds transfers, and restrict riskier lending

and excess asset growth. Bank chartering authorities also have the power to appoint a conservator or receiver, and the FDIC has the power to terminate or suspend deposit insurance.

The risk-control activity that begins with the examination process may be completed

by enforcement actions both informal and formal. Informal actions are usually assigned

when a bank receives a CAMEL 3 rating. At this time the agency generally receives a written commitment from bank management to take corrective action; the commitment is in the

form of a memorandum of understanding (MOU) or a bank board resolution. Formal actions, which are legal decrees and legally enforceable in the courts, are usually taken when
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

442 History of the EightiesLessons for the Future

43 Formal enforcement actions are issued by all federal banking agencies, but OCC data on enforcement actions brought

against troubled banks were not available for this analysis. Thus, only formal actions against FDIC-supervised and Federal

Reservesupervised banks are analyzed. 44 FDIC enforcement actions brought against state banks in all categories from 1980 to 1995 (including not only safety and

soundness but also violations of consumer laws and regulations, trust, and EDP, and other miscellaneous categories)

amounted to 3,041. 45 The data on FDIC-issued informal actions are available only from 1992. The number totaled 750 for 1992, 616 for 1993,

and 472 for 1994 for all other categories. 46 The reasons for the actions taken against the other 1- and 2-rated banks are unknown at this time.

a banks deterioration is more serious and it receives a 4 or 5 rating. Formal actions include

cease-and-desist orders and/or suspension or removal of bank officers or directors. Civil

money penaltiesfinesmay be imposed on depository institutions for failing to meet the

terms of cease-and-desist orders or for violating federal or state laws or regulations, and

these fines are often heavy.

43

FDIC formal enforcement actions. During the 1970s, the FDIC did not widely use

formal supervisory enforcement actions. The agency was first given authority to issue

cease-and-desist orders and removal authority under the FDI Act as amended in 1966, and

during the first half of the 1970s the agency issued only 37 orders. Over the next four years,

however, the agency became more aggressive, issuing 176 orders primarily under Sections

8(a) and 8(b) of the FDI Act as amended. These sections deal with termination of insurance

and cease-and-desist orders. During the 1980s, as the number of problem banks increased

dramatically, so also did the number of formal actions brought against FDIC-supervised

banks. The number of formal actions issued by the FDIC for safety-and-soundness purposes grew quickly in the early 1980s, and peaked in 1985 at 272 (see table 12.5).44 From

1986 through 1990, as the number of problem banks declined, the issuance of formal actions also declined, with an annual average of approximately 168. But the growing number

of problem banks in New England again brought an increase in the number of FDIC formal

actions, with an annual average of 200 issued in 199192. During the following years, the

numbers of actions declined as the economy improved and commercial bank earnings rebounded.45

The greatest proportion of actions were brought against 4-rated banks, which accounted for over half of all formal actions. Generally such institutions suffer from serious

problems but are usually salvageable. An additional 35 percent of the total were issued

against 5-rated banks. CAMEL 5-rated banks are thought to have substantial risk of failing

within one year. Actions against these banks are intended to correct the problems if possible, but if the institution is too ill to recover, the objective is to limit losses before failure. A

smaller number of actions (159) were brought against highly rated (1- and 2-rated) banks.

Over half of these actions dealt with the removal and suspension of officers and directors.46
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 443

Table 12.5

FDIC Formal Enforcement Actions by Examination Rating, 19801995

CAMEL Rating at Examination before Enforcement Action

Year Number 1 2 3 4 5

1980 47 1 3 1 32 10

1981 38 2 6 1 22 7

1982 93 1 4 4 56 28

1983 238 0 4 4 166 64

1984 184 2 5 9 103 65

1985 272 1 9 6 164 92

1986 174 0 4 1 89 80

1987 197 1 2 6 92 96

1988 175 0 3 5 78 89

1989 156 0 4 6 76 70

1990 137 0 4 4 73 56

1991 203 0 10 11 110 72

1992 197 0 15 14 126 42

1993 140 2 13 27 59 39

1994 85 8 29 9 18 21

1995 62 3 23 7 17 12

Total 2,398 21 138 115 1,281 843

Note: Formal enforcement actions for safety-and-soundness purposes only.

47 The number of formal enforcement actions for safety-and-soundness purposes excluded civil money penalties because it

could not be determined if the actions were related to safety-and-soundness violations or to some other areas. 

The largest number of formal enforcement actions brought by the FDIC, accounting

for over 60 percent (1,485) of the total number of actions, consisted of Section 8(b) actions,

or the issuance of cease-and-desist orders (see table 12.6). These actions are generally issued to curb unsafe banking practices like insider abuses, unsound underwriting practices,

inaccurate loan-loss reserve accounting, unwise dividend policies, and other types of unauthorized fund transfers. Other major enforcement categories include Section 8(a) proceedings for termination of insurance, and Section 8(e) removals of officers, directors, and other

principals; actions in those two categories accounted for an additional 32 percent (763) of

the total. Miscellaneous actions make up the remainder.

47

Table 12.7 shows the number of FDIC-supervised problem banks from 1980 to 1994

and their resultant status as either failed or surviving. These data show that of the 2,826
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

444 History of the EightiesLessons for the Future

Table 12.6

FDIC Formal Enforcement Actions by Type, 19801995

Type Number Description

8(a) 394 Termination of insurance

8(b) 1,485 Cease-and-desist order

8(c&b) 88 Temporary cease-and-desist order

8(e) 369 Removal and/or prohibition and/or suspension of individuals 

8(a&t) 2 Temporary suspension of deposit insurance

8(g) 19 Suspension and/or prohibition of individuals based on criminal indictment

8(i) 2 Petition for enforcement of administrative order

ILSA* 13 Capital directive 

PCA 25 PCA directive

OA 1 Other formal action

Total 2,398

Note: Formal actions for safety-and-soundness purposes only.

*International Lending Supervision Act.

Prompt Corrective Action (see section below on FDICIA).

48 Because data on FDIC-issued informal enforcement actions were not available before 1992, it was not possible to trace this

record during the early stages of the problem-bank cycle. To verify the presence of informal actions for troubled banks, a

set of randomly selected files, available for the years 1986 to 1994, on FDIC problem banks was reviewed. Of the 307 bank

files that were examined, 292, or more than 95 percent of the banks, had received some type of formal or informal action.

Only 15 of the 307 banks had no action on record. Thus, the data show that almost all problem banks received some type

of enforcement action.

banks that were classified as 4- or 5-rated at some point during this period, 662 (23 percent)

failed, while 2,164 (77 percent) either survived as independent banks, were purchased by

bank holding companies, or merged into banks without FDIC assistance. Therefore, approximately three out of four FDIC problem banks recovered without cash assistance from

the insurer. 

Tables 12.8 and 12.9 show the number and percentages of FDIC problem banks that

received some type of formal enforcement action during the period. The data indicate that

47 percent of the total FDIC problem bank population received some type of formal enforcement action over this period. When displayed by CAMEL rating, 71 percent of 5-rated

banks and 45 percent of 4-rated institutions received formal actions. Of the failed problem

banks, approximately 71 percent received a formal FDIC enforcement action; of the surviving problem banks, approximately 40 percent did also (table 12.9). These data show that

the enforcement policy of the FDIC was most aggressive with respect to the most unhealthy

institutionsthose that failed.48
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 445

Table 12.7

FDIC-Supervised Problem Banks, 19801994

(Number)

Surviving Problem Banks

Year of First 4 or 5 All Problem Failed Problem Acquired or

Camel Rating Banks Banks Independent Status Merged* Total

1980 75 24 11 40 51

1981 96 30 14 52 66

1982 213 71 35 107 142

1983 242 54 51 137 188

1984 300 88 72 140 212

1985 423 117 132 174 306

1986 399 98 146 155 301

1987 263 64 83 116 199

1988 179 31 76 72 148

1989 151 32 66 53 119

1990 158 34 62 62 124

1991 178 14 96 68 164

1992 92 4 56 32 88

1993 33 1 23 9 32

1994 24 0 17 7 24

Total 2,826 662 940 1,224 2,164

*Acquired by a bank holding company or merged with another banking organization.

49 Formal enforcement actions brought by the Federal Reserve against state member banks for violations of consumer laws

and regulations, trust, EDP and other non-safety and soundness categories are excluded from the analysis. Also excluded

are formal actions brought against bank holding companies, uninsured foreign banks, and those banks with missing examination records or other information. 

Federal Reserve Formal Enforcement Actions. The number of formal enforcement

actions issued by the Federal Reserve System for safety-and-soundness purposes only

against state member banks for the years 198095 is shown in table 12.10.49 The number is

broken out by CAMEL rating for the years 198095. The data show that the number of actions issued rose in the early 1980s as the number of problem banks increased, and reached

a peak (47) in 1985. The number of actions fluctuated at lower levels until the early 1990s,

when the total again increased, this time in response to the Northeast banking crisis. (The

FDIC enforcement action program showed a similar temporal pattern.) Most Federal

Reserve actions were brought against 4-rated banks, which accounted for over half of the
Table 12.8

FDIC Problem Banks That Received Formal Enforcement Actions, 1980-1994

(Number)

Year of All Problems Banks Failed Problem Banks

First 4 or 5 CAMEL CAMEL CAMEL CAMEL Surviving Problem Banks

Camel Rating Rating Rating Rating Independent Acquired or

Rating 4 5 Total 4 5 Total Status Merged* Total

1980 42 3 45 16 2 18 19 8 27

1981 52 5 57 19 2 21 21 15 36

1982 139 16 155 48 11 59 64 32 96

1983 116 19 135 36 11 47 50 38 88

1984 133 19 152 49 13 62 67 23 90

1985 157 21 178 63 16 79 76 23 99

1986 111 23 134 44 18 62 51 21 72

1987 70 14 84 20 10 30 38 16 54

1988 66 9 75 17 6 23 31 21 52

1989 59 4 63 21 2 23 29 11 40

1990 55 15 70 16 12 28 27 15 42

1991 81 10 91 3 7 10 65 16 81

1992 54 3 57 3 1 4 40 13 53

1993 13 4 17 0 1 1 12 4 16

1994 11 0 11 0 0 0 8 3 11

Total 1,159 165 1,324 355 112 467 598 259 857

*Acquired by a bank holding company or merged with another banking organization.

An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

446 History of the EightiesLessons for the Future

Table 12.9

Percentage of FDIC Problem Banks That Received Formal Enforcement Actions,

by CAMEL Rating, 19801994

Camel Failed Problem Surviving Problem Total Problem

Rating Banks Banks Banks

4 70% 39% 45%

5 73 66 71

4 + 5 71% 40% 47%

actions. However, 3-rated banks accounted for a higher percentage of actions (18 percent)

than did 5-rated institutions (14 percent).

A breakdown of the types of formal actions issued by the Federal Reserve is shown in

table 12.11. Written agreements is the category that accounted for the majority of the actions, with 203 (56 percent of the total). Cease-and-desist orders made up an additional 25
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 447

Table 12.10

Federal Reserve Formal Enforcement Actions by Examination Rating, 19801995

(Number)

CAMEL Rating at Examination before Enforcement Action

Year Number 1 2 3 4 5

1980 7 0 0 2 5 0

1981 17 0 1 3 13 0

1982 18 1 3 3 8 3

1983 20 0 1 1 12 6

1984 23 0 1 3 13 6

1985 47 1 6 9 25 6

1986 43 0 1 7 27 8

1987 13 1 0 1 9 2

1988 25 0 3 4 12 6

1989 17 2 1 2 7 5

1990 26 0 2 8 14 2

1991 18 0 1 4 12 1

1992 40 2 8 6 22 2

1993 18 1 2 2 11 2

1994 19 1 1 8 8 1

1995 11 4 2 1 4 0

Total 362 13 33 64 202 50

Source: FRB.

Note: Formal enforcement actions for safety-and-soundness purposes only.

Table 12.11

Federal Reserve Formal Enforcement Actions by Type, 19801995

Type Number Description

8(b) 90 Cease-and-desist order

8(c) 10 Temporary cease-and-desist order

8(e) 56 Removal and/or prohibition and/or suspension of individuals

PCA 3 PCA directive

WA 203 Written agreement

Total 362

Source: FRB.

Note: For safety-and-soundness purposes only.

percent, and removal actions against problem bank officials accounted for another 15 percent. When the Federal Reserve assigns formal enforcement actions to correct management
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

448 History of the EightiesLessons for the Future

Table 12.12

Federal ReserveSupervised Problem Banks, 19801994

(Number)

Surviving Problem Banks

Year of First 4 or 5 All Problem Failed Problem Independent Acquired or

Camel Rating Banks Banks Status Merged* Total

1980 11 1 8 2 10

1981 12 5 3 4 7

1982 20 6 7 7 14

1983 23 7 9 7 16

1984 27 13 11 3 14

1985 50 18 25 7 32

1986 49 16 28 5 33

1987 40 16 22 2 24

1988 26 7 10 9 19

1989 19 4 12 3 15

1990 22 6 11 5 16

1991 42 4 31 7 38

1992 19 1 10 8 18

1993 2 0 1 1 1

1994 3 0 2 1 3

Total 365 104 190 71 261

*Acquired by a bank holding company or merged with another banking organization.

practices, it starts by issuing written agreements. If these actions are ineffective in altering management practices, the process is ratcheted upward by the issuance of cease-anddesist orders. 

The number of Federal Reservesupervised problem banks from 1980 to 1994 that received a 4 or 5 CAMEL rating, and their resulting status as either failed or surviving, are presented in table 12.12. The total number is significantly smaller than (only approximately 13

percent of ) the number of FDIC-supervised problem banks. These data show that of the 365

banks that received a 4 or 5 rating during this period, 104 (29 percent) failed, while 261 (72

percent) either survived as independent banks, were purchased by bank holding companies,

or merged into banks without FDIC assistance. Therefore, almost three-fourths of the

Federal Reserve problem banks recovered without cash assistance from the insurerabout

the same percentage as for the FDIC. The number and proportions of problem banks that received formal enforcement actions during the period are presented in tables 12.13 and 12.14.

The data show that 50 percent of the 365 problem banks received some type of formal action. In contrast to FDIC actions, 4-rated Federal Reserve-supervised institutions received

formal actions at a higher rate (51 percent) than for 5-rated banks (39 percent). Therefore, the
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 449

Table 12.13

Federal ReserveSupervised Problem Banks That Received 

Formal Enforcement Actions, 19801994

(Number)

Surviving Problem Banks

Year of First 4 or 5 All Problem Failed Problem Independent Acquired or

Camel Rating Banks Banks Status Merged* Total

1980 7 1 5 1 6

1981 8 4 1 3 4

1982 11 4 4 3 7

1983 15 4 7 4 11

1984 19 10 7 2 9

1985 28 11 11 6 17

1986 17 11 5 1 6

1987 14 7 6 1 7

1988 12 2 5 5 10

1989 6 3 3 0 3

1990 8 2 4 2 6

1991 20 4 12 4 16

1992 15 1 9 5 14

1993 1 0 1 0 1

1994 2 0 1 1 2

Total 183 64 81 38 119

Source: FRB.

Table 12.14

Percentage of Federal ReserveSupervised Problem Banks That Received 

Formal Enforcement Actions, by CAMEL Rating, 19801994

Camel Failed Problem Surviving Total Problem

Rating Banks Problem Banks Banks

4 68% 46% 51%

5 35 46 39

4 + 5 62% 46% 50

highest percentage of actions were brought against 4-rated institutions, or those that had a

fair chance of surviving; the remainder were applied against 5-rated banks, or those in more

imminent danger of failing. Of the failed problem banks, approximately 62 percent were issued a formal action; of the surviving problem banks, 46 percent received one. 
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

450 History of the EightiesLessons for the Future

50 Some studies have found that formal enforcement actions were effective in altering bank behavior. See Peek and

Rosengren, Bank Regulatory Agreements; and U.S. General Accounting Office, Bank Supervision, 610. 51 The event date was not the date when the bank actually received the enforcement action; rather, it was the date of the examination that led to the decision to issue a formal action. The reason for choosing the earlier date as the event date is

that remedial changes in bank behavior are expected to start at least at the earlier time, if not before (in anticipation of the

action). The legal document itself is not presented to the problem institution until the paperwork is completed, generally at

least six to nine months after the examination. 52 As previously indicated, although some problem banks may not have been presented with a formal enforcement action, at

the time of their rating as a problem bank most of them had an informal action already in place. 

Formal Enforcement Actions: Relation to Risk-Taking Behavior

Above, the behavior of all problem banks (for the period 198094) is analyzed in relation to the dates of the banks failure, recovery, or merger. In this analysis, problem-bank

behavior is analyzed in relation to the dates of regulatory intervention, specifically, the

dates of the on-site examinations that produced CAMEL ratings either with or without formal actions. To perform this analysis, an event study was undertaken to analyze the ex ante

and ex post behavioral patterns of these institutions. The hypothesis to be tested was that

formal corrective actions are more effective in bringing about behavioral changes than are

informal actions because informal agreements outstanding are not administratively or judicially enforceable in court, whereas formal actions have legal standing, and noncompliance

often carries serious penalties. The variables examined were the same as in the earlier

analysis: asset growth, dividend restrictions, and capital injections.50

The event date chosen for the analysis was the date of the on-site examination that led

to the formal enforcement action.51 To analyze the effect of enforcement actions, two sets

of banks were observed: (1) those banks subsequently issued formal actions; and (2) those

banks that did not receive a formal action.52 The population of banks was the combined

sample of 2,826 FDIC and 365 Federal Reserve problem banks. Over the period 198095,

the FDIC issued 2,398 formal actions, and the Federal Reserve issued 362. For the asset

growth variable, the data were collected for four quarterly periods before and four after the

event date. But because many firms do not report dividend payouts and capital contributions on a quarterly basis, these two variables were analyzed on an annual basis (for which

all banks report data) for one year before and four years after the event date. To determine

the stability of the relationship between regulatory intervention and changes in bank behavior over time, three different subperiods were analyzed: 197985, 198590, and

199095. The boundaries of the subperiods correspond with the various regional banking

crises that occurred over the period under review. 

For the asset growth variable, the results for the two groups are presented in figure

12.7. The median quarterly asset growth rates of banks supervised by the FDIC and the

Federal Reserve with CAMEL ratings of 4 declined before the date of regulatory interven-
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 451

1990–1995

1979–1985 1985–1990

Figure 12.7

Median Asset Growth Rates of CAMEL 4-Rated Banks before and

after Regulatory Intervention

(Annualized)

Note: Data are median asset growth rates of FDIC- and Federal Reserve supervised banks before and after regulatory

intervention. Forthis analysis, the intervention dates were dates of

–

(1) examinations that resulted in the downgrading of the bank's CAMEL rating to 4 but did not result in a formal

enforcement action, or

(2) the last examination before the issuance of a formal enforcement action against a bank with a CAMEL 4 rating.

Normally, a bank is informed at the time of the examination of the prospect of a CAMEL rating downgrade or a formal

enforcement action. Data were run on a constant population sample for each period. The number of observationsranged from

200 to almost 500 for the different periods for banks downgraded to CAMEL 4 rating that did not receive formal enforcement

actions, and from200 to 300 for 4-rated banksthat did receive formal enforcement actions.

Banks Downgraded to CAMEL 4 Rating That Received No Formal Action

4-Rated Banks That Did Receive Formal Action

-4 -3 -2 -1 0 1 2 3 4

-8

-4

0

4

8

12

Quarter Relative to Intervention

Percent

-4 -3 -2 -1 0 1 2 3 4

-8

-4

0

4

8

Quarter Relative to Intervention

Percent

-4 -3 -2 -1 0 1 2 3 4

-12

-8

-4

0

4

8

Quarter Relative to Intervention

Percent
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

452 History of the EightiesLessons for the Future

53 The analysis was also run for 3- and 5-rated banks but, because of the limited sample size of the observations, the data are

not presented here. The results for the 3-rated banks showed no significant and consistent results between the assignment

of formal actions and changes in behavior. The results for the 5-rated banks were consistent with the overall findings for

the 4-rated institutions. 54 However, during the 1980s Congress itself had mandated several statutory forbearance programs for financial institutions,

including the Net Worth Certificate Program for thrift institutions and the loan-loss amortization for agricultural banks. 

tion and generally remained negative in the quarters immediately following the intervention.53

This was true both for banks that did and for banks that did not receive formal actions. Banks

with formal actions showed more pronounced changes in growth rates, on average, from before to after intervention than banks without such actions. Other measures revealed similar results (see figure 12.8). Dividend rate reductions and increases in external capital infusions

began before regulatory intervention and generally accelerated in the first year after intervention; banks subject to formal enforcement action showed the largest dividend cuts and capital

infusions. The data for loan-loss provisions (not presented here) revealed comparable results.

The analysis indicates that bank management was taking remedial actions before the

examinations that triggered reductions in CAMEL ratings and (possibly) formal enforcement actions. It is not known whether these remedial actions were a response to market

forces, managements own analysis, or anticipated regulatory action, but in any event, regulatory intervention apparently had the effect of reinforcing and accelerating these remedial

actions. Changes in the behavior of problem banks were greatest for banks subject to formal enforcement actions, but it is not clear whether the differences associated with formal

enforcement actions were primarily due to the more stringent nature of such actions or to

the relatively poorer condition of those banks that received them.

In general, the reduction in asset growth indicates that moral hazard was being containedthat troubled banks were not attempting, or were not allowed, to grow out of their

problems; indeed, in most cases the assets were shrinking. In the case of the surviving

banks, reduced dividend payouts and increased capital injections helped restore equity positions and were instrumental in facilitating recovery. In the case of the failing banks, dividend cuts and new capital had the direct effect of reducing the costs of failure. Again,

whether these favorable results were due to the actions of management, stockholders, market forces, or supervisors, they were consistent with the objectives of preventing the failure

of troubled banks and reducing costs to the insurer for banks that did fail.

FDICIA and Prompt Corrective Action

Congress passed FDICIA in 1991 to correct what it perceived as the banking agencies regulatory forbearance toward undercapitalized banks during the 1980s.54 FDICIA

was designed to limit regulatory forbearance by requiring (1) a more timely closure of failing institutions and (2) earlier intervention in problem banks. These provisions are referred
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 453

1990–1995 1990–1995

1985–1990 1985–1990

1979–1985 1979–1985

0

0.1

0.2

0.3

0

0.05

0.10

0.15

0.20

0.25

Percent of Assets

0

0.4

0.8

1.2

1.6

2.0

Percent of Assets

0.2

0.4

0.6

0.8

-1 0 1 2 3

0

0.2

0.4

0.6

0.8

1.0

Note: Data are averages of individual bank ratios. See note to figure 12.7.

Figure 12.8

Dividend Rates and Capital Infusions of CAMEL 4-Rated Banks

before and after Regulatory Intervention

Capital Infusions

-1 0 1 2 3

0

0.5

1.0

1.5

2.0

Dividends

Year Relative to Intervention Year Relative to Intervention

Banks Downgraded to CAMEL 4 Rating That Received No Formal Action

4-Rated Banks That Did Receive Formal Action
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

454 History of the EightiesLessons for the Future

55 The Prompt Corrective Action provisions of FDICIA did not become effective until one year after passage of the act, or

about year-end 1992. 56 FDICIA mandated five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly

undercapitalized, and critically undercapitalized. For banks in the last three categories, supervisors are required to impose a ladder of constraints on their operations. 57 Under FDICIA, when an institution is critically undercapitalized for 90 days a receiver or conservator must be appointed

or some other action must be taken to achieve the purpose of the provision. The 90-day delay may be extended, provided

that the regulator and the FDIC concur and document why extension would better serve the purposes of the provision. After

the institution has been critically undercapitalized for 270 days, a receiver or conservator must be appointed unless the regulator and the FDIC certify that the institution is viable and not expected to fail. Under the conditions existing in the 1980s

when failures were bunched and the market for failed institutions was often saturated, it seems reasonable to suppose that

taking more than 90 days to spread out marketing efforts for failed banks would have been an acceptable reason for delay

up to the 270-day limit.

to as prompt corrective action (PCA).55 PCA specifically mandated certain rules the

banking agencies had to follow with respect to the supervision of undercapitalized banks.56

As an institutions capital position declines, the appropriate federal regulator is required to

take increasingly stringent actions; for undercapitalized institutions, these include establishing a capital restoration plan and restricting deposit taking, asset growth, dividends, and

management fees; for banks that are critically undercapitalized for a prescribed period,

this includes closing the bank.

The question arises how FDICIA and PCA might have affected problem banks during

the 1980s if the law had been in effect then. Would PCA provisions have reduced losses to

the bank insurance fund between 1980 and 1992 by requiring earlier closure of some

banks? Conversely, would other banks that did not fail have been closed unnecessarily, with

increased losses to the fund? 

It is difficult to reach any conclusion about what would have happened if PCA had

been in effect during the 1980s, because both banks and bank regulators would have been

responding to a different statutory and regulatory regime. Thus, the analysis presented here

to quantify the effects of PCA is only an approximation.

Timely Closure

Concerning timely closure, it is unclear what impact FDICIA would have had on undercapitalized banks during the period 198092. PCA requires that banks be closed when

their tangible capital ratio reaches 2 percent for a specified period.57 Had this provision

been in effect during the 1980s, some banks that failed might have been closed earlier, but

it is also possible that some banks that did not fail might have been closed unnecessarily.

During the period 198092, most banks that failed were closed within the time frame specified by FDICIA for critically undercapitalized banks. However, 343 banks (approximately

21 percent of all failures) with $88 billion in total assets might have been closed earlier, presumably resulting in reduced losses to the insurance fund (see table 12.15). The table also
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 455

Table 12.15

Estimated Number of Failed Banks That Would Have Been Closed Earlier

under FDICIA Rules, 19801992

Average

Average Number of Total

Number of Number of Days Assets

Year Banks Days* (Weighted) ($Millions)

1984 1 16 16 $ 9.6

1985 2 180 169 182.9

1986 16 99 96 1,111.4

1987 49 127 168 1,857.1

1988 69 144 173 9,095.8

1989 78 164 271 13,497.3

1990 63 252 334 5,561.2

1991 39 172 257 36,565.1

1992 26 238 507 19,946.4

Total 343 174 308 87,826.7

Note: Before 1984 no banks would have been closed earlier under FDICIA. The PCA provisions of FDICIA became effective

in December 1992 so the following years are not included.

* Number of days beyond the 270 allowed before bank would have had to be closed under FDICIA.

Days are weighted by total assets. Total assets are as of PCA failure date.

This figure is not a total; rather, it is the average number of days for the 343 banks.

shows the average number of days that the banks remained open beyond the PCA mandate.

For the group as a whole, the number averaged 174 days on an unweighted basis and 308

days when the number of days is weighted for bank size, a differential suggesting that size

was a factor in the closing decisions. When this group is broken out by bank charter class,

the data show that 201 of the 343 banks (59 percent) were national banks, 131 (38 percent)

were state nonmember banks, and 11 (3 percent) were state member institutions (see table

12.16). 

The closing of depository institutions is the shared responsibility of both federal and

state banking authorities. The OCC has the responsibility for closing national banks, and the

state banking departments for closing state-chartered institutions. Because the chartering

authority and not the insurer has authority to declare insolvency, the various agencies may

have different incentives leading them to pursue different closure strategies. The insurer

will usually want earlier action, but the chartering agency may have practical reasons to delay closing. These reasons may include the effect on the local economy or some feeling of

allegiance to a bank the agency itself chartered. Charterers also are seen as having some in-
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

456 History of the EightiesLessons for the Future

terest in promoting their own segment of the banking industry. Meanwhile, the insurer assumes any additional costs associated with a delayed closing. 

Data for the banks whose closings were delayed beyond the PCA limit are broken

down for the six states that had the most closings overall and the most late closings (see

table 12.17). Of the 343 banks nationwide whose closings were delayed, 256 were located

within these six states. The data show that state banking authorities in the six states generally closed problem banks in a more timely fashion than did the OCC. Of the total 473 national banks closed in the six states during the years 198092, the OCC closed 178 (38

percent) later than would have been required under the PCA mandate. Conversely, regulators in the six most active states closed 459 banks, only 78 of which (17 percent) would

have violated the PCA requirement. These differences were especially apparent in the

southwestern states of Texas and Oklahoma, which accounted for more than 75 percent of

all failures over the period. In these two states, national banks were closed late 38 percent

of the time, whereas the comparable figure for state banks was less than 16 percent. The

timely closing pattern was observed in all six states except Louisiana, where 38 percent of

the 58 banks were closed later than would have been called for by the PCA ruleyet even

there the state had a better record than the OCC, which was late in the case of more than half

of the national banks closed. 

Table 12.16

Estimated Number of Failed Banks That Would Have Been Closed Earlier under

FDICIA Rules, by Bank Charter Class, 19801992

National State Nonmember State Member

Average Average Average

Number Number Number Number Number Number

Year of Banks of Days of Banks of Days of Banks of Days

1984 1 16 0 0 0 0

1985 1 204 1 156 0 0

1986 9 83 6 123 1 94

1987 25 155 24 98 0 0

1988 40 154 23 148 6 64

1989 56 164 19 181 3 75

1990 49 252 13 252 1 267

1991 13 241 26 138 0 0

1992 7 181 19 259 0 0

Total 201 184* 131 167* 11 88*

Note: Refer to footnotes for table 12.15.

*This figure is not a total; rather it is the average number of days for the 201 banks.
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 457

Table 12.17

Estimated Number of Failed Banks That Would Have Been Closed Earlier under

FDICIA Rules in the Six States with the Greatest Number of Closings, 19801992 

(by Closing Authority)

OCC State

PCA Total PCA Total

Required OCC Late Average Total Required State Late Average Total

Earlier Failures Closing Closing Assets Earlier Failures Closing Closing Assets

State Closure (Number) (Percent) (Days) ($Millions) Closure (Number) (Percent) (Days) ($Millions)

Texas 136 359 37.9 185 $24,418 41 230 17.8 134 $ 2,811

Oklahoma 20 51 39.2 203 626 7 71 9.9. 137 333

Louisiana 7 12 53.3 139 136 22 58 37.9 216 1,614

Colorado 7 25 28.0 107 95 0 33 0.0 0 0

NewYork 4 9 44.4 392 826 4 24 16.7 771 20,525

California 4 17 23.5 104 100 4 43 9.3 63 262

Total 178 473 37.6 185* $26,201 78 459 17.0 186* $25,545

Note: Refer to footnotes for table 12.15.

*This is not a total; rather it represents the average number of days for the 178 banks.

58 Information on the statutory authority of the six state banking departments is based on conversations with representatives

of each of the six departments.

Part of the reason for the OCCs comparatively greater delay may be the bank closure

rules adopted by the respective closing authorities. Up through mid-December 1989, OCC

rules prohibited the closing of a national bank until all primary capital was exhausted (the

regulatory-insolvency rule). This was based on a statutory requirement that a national bank

be closed if the Comptroller was satisfied that the bank was insolvent and the OCCs own

definition of insolvency. Primary capital was defined to include both total equity capital

and loan-loss reserves. Most individual states were not constrained by the same set of rules.

The six states where most of the bank failures occurred during this period had the authority

to close banks when capital was impaired or when the bank either faced imminent insolvency or was in an unsafe or unsound condition. These more flexible standards

made it possible for the states to close banks earlier.

58 However, although the OCCs closing

policy was constrained by a statutory insolvency requirement, the agency had wide latitude

to define insolvency and could have adopted a more flexible standard than it did during most

of the 1980s. In December 1989, after about a year of study, the OCC changed the historical

closure rules by adopting an equity capitalonly rule, excluding reserves, which allowed for
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

458 History of the EightiesLessons for the Future

Table 12.18

Changes in Total Equity Capital for Failed Banks That Would Have 

Been Closed Earlier under FDICIA Rules, 19801992

Equity Capital Equity Capital

at PCA at Actual

Number Failure Date Failure Date

Year of Banks ($Thousands) ($Thousands)

1984 1 $ −140 $ −161

1985 2 −543 −6,032

1986 16 12,299 46,501

1987 49 −56,944 −136,232

1988 69 −189,748 −256,323

1989 78 −73,577 −693,064

1990 63 −64,654 −359,590

1991 39 21,184 −539,336

1992 26 571,826 358,068

Total 343 $219,703 $ −1,586,169

Note: Refer to footnotes for table 12.15 where applicable.

59 OCC, Bulletin BB-89-39, December 13, 1989. 60 Edward J. Kane argues that bank supervisors have incentives to forbear from prompt closure of insured banks because bank

failures and insurance losses make it appear that supervisors are not effectively discharging their responsibilities of oversight. He claims that this was one of the prime motives for the forbearance granted to insolvent thrift institutions during the

1980s (The S&L Insurance Mess: How Did It Happen? [1988], chap. 4). 

more timely closures.59 But by the time this change was made, most of the failures of the

1980s had already been resolved. 60

To estimate the cost of delaying the closure of the 343 undercapitalized institutions

that might have been closed earlier, FDIC researchers analyzed changes in total equity capital between the date of the PCA-required closing and the date of actual failure (see table

12.18). The results show that the 343 banks had total equity capital of approximately $220

million at the PCA-required closing date and approximately a negative $1.6 billion at the

actual closing date. However, a large part of these losses were not accrued over the sixmonth average holding period, because a substantial percentage were already embedded

within bank portfolios at the PCA failure date, although not yet recognized. Operating

losses might still have been incurred, however, because of the higher private sector funding
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 459

61 The avoidable cost is estimated as the sum of (1) the actual funding costs of these banks minus the one-year Treasury rate and

(2) the operating expenses of transactions and nontransactions deposit accounts as estimated by the 1990 Functional Cost

Analysis of the Federal Reserve Board. The avoidable cost was computed for the period of time beyond 270 days that the

banks tangible capital ratio was below 2 percent. In cases where the tangible capital ratio fluctuated below and above 2 percent, the bank was considered to be critically undercapitalized for the entire period after the ratio first fell below 2 percent,

except when the ratio subsequently rose above 3 percent. In the latter case, that bank was counted as critically undercapitalized only for the period it was below 2 percent subsequent to having reached the 3 percent level. Two large savings banks that

had entered into Income Maintenance Agreements with the FDIC in connection with the acquisition of other failed institutions were counted as critically undercapitalized from the time the banks agreement was terminated (in one case) and (in the

other case) from the date the FDIC formally permitted the bank to miss capital targets prescribed in its agreement. 62 Gilbert makes this point in volume 2 of this study. 

costs and the cost of operating retail branch systems.61 These costs that would have been

saved (estimated to be approximately $825 million) are approximately 8 percent of the total resolution costs of the 343 banks and approximately 2 percent of the cost of all bank failures during the period 198092. Approximately 60 percent of the estimated cost savings are

attributable to six large banks that operated with less than 2 percent tangible capital for relatively long periods of time.

An alternative estimate of the avoidable cost, based on net operating losses, produced

essentially the same aggregate result. Net operating losses before loan-loss provisions,

gains/losses on transactions, taxes, and extraordinary items totaled $815 million for the 343

banks for the intervals between closure dates required by PCA and actual closure dates. As

in the previous estimate, these losses were concentrated in a few large banks.

Some caveats should be mentioned with respect to these estimates. Regulators bank

closure policies would have been different if PCA had been in effect in the 1980s, and such

policy changes might have reduced projected cost savings. For example, for the many

banks that were allowed to operate with tangible capital below 2 percent for only a few

months beyond the interval allowed by PCA, earlier closure might have meant insufficient

time to market the institution among potential acquirers and therefore the resolving of more

banks through insured-deposit payoffs.62 This outcome would have been likely in periods

when failures were proliferating and the market for failed bank and thrift deposit franchises

and assets was temporarily saturated. Spreading closures over a longer period of time might

have attracted improved bids and offset some of the additional costs resulting from delayed

closings. Therefore, the savings resulting from the earlier implementation of PCA might

have been smaller for many of the 343 banks than these estimates suggest. For the 6 large

banks that operated for extended periods of time with low capital levels, earlier closure

would probably have achieved cost savings, although for some of these banks lengthy marketing periods might have been needed, which might have reduced the amount of the savings. Presumably, because of PCA, regulators might have had to start the marketing process

earlier, while the banks had capital well above the 2 percent level. 
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

460 History of the EightiesLessons for the Future

Table 12.19

Estimated Number of Problem Banks That Survived but 

Might Have Been Closed under FDICIA Rules, 19801992

Number Total Assets Total Equity

Year of Banks ($Millions) ($Thousands)

1982 1 $ 8.4 $ −24

1983 1 33.8 256

1984 7 366.8 18,255

1985 9 363.6 13,784

1986 14 844.2 11,455

1987 19 378.1 6,311

1988 26 2,974.4 88,358

1989 16 2,892.8 46,912

1990 15 1,305.0 −18,573

1991 25 1,160.0 −107,041

1992 10 602.0 3,933

Total 143 $10,929.1 $ 63,626

Note: Refer to footnotes on table 12.15 where applicable.

63 A large percentage of these banks were able to raise capital within 12 months of the PCA failure date; thus, many of these

banks would probably have been recapitalized rather than closed.

Conversely, the 2 percent tangible equity capital rule might have forced the possibility of unnecessary closure on 143 problem banks (those rated CAMEL 4 or 5), with $11 billion in total assets, that did not fail. The result might have been increased cost to the deposit

insurance fund (see table 12.19).63 The data show that at the time when FDICIA might have

mandated their closure, the 143 banks had total assets of $10.9 billion and $64 million in

equity capital. What it might have cost the insurer to resolve these cases is unknown. And

in addition to payoff costs by the insurer, there would have been social or deadweight costs

that the public and the local communities would have had to absorb upon the unnecessary

closing of local institutions.

The assumptions underlying the forbearance programs that Congress mandated during the 1980s differed from those underlying the later PCA provisions of FDICIA. Thus,

banks in those forbearance programs were excluded from the computations that produced

the estimates that 343 failing banks would have been closed earlier and that 143 banks

might have been unnecessarily closed if PCA had been applied in the 1980s. Nevertheless,

to complete the record, a similar methodology was used for banks that participated in these

forbearance programs. The results show that 48 banks that actually failed, with $11 billion
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 461

64 See Gilbert, Legislating Prompt Corrective Action. 65 Recent studies show that bank supervisors generally intervened with problem banks at much earlier stages, initiating more

formal enforcement actions during the 1980s and early 1990s than would have been required by PCA legislation, and these

actions were more stringent than those PCAwould have imposed. This was especially true with respect to the New England

banking crisis of the early 1990s. See two articles by Peek and Rosengren: Will Legislated Early Intervention Prevent the

Next Banking Crisis? Federal Reserve Bank of Boston, Working Paper 96-5 (1996), and The Use of Capital Ratios to

Trigger Intervention in Problem Banks: Too Little, Too Late, Federal Reserve Bank of Boston New England Economic

Review (September/October 1996). 66 Enforcement data were unavailable on four of the FDIC-supervised banks that would have been closed earlier under the

FDICIA rules. 

in assets, would have been closed earlier as a result of PCA, and 66 banks that actually survived, with $16 billion in assets, would have been closed. 

Early Intervention

Recent empirical studies of banking show that in most cases, PCAs early-intervention

provisions would not have required bank supervisors either to impose more severe restrictions on banks or to intervene earlier. In fact, supervisors had identified most problem banks

and had some enforcement actions in place at significantly earlier stages than might have

been required under the PCA provisions.64 Moreover, the restrictions the regulators imposed were more comprehensive than those prescribed in the PCA legislation.65 The reason

behind this finding is that capital ratios prescribed in PCA are lagging indicators of the

health of the institution and would trigger enforcement actions well after problems had been

identified in examinations. Examiners evaluate considerably more information than capital

ratios to determine the banks likelihood of failure.

These findings are supported by an analysis of FDIC-supervised problem banks, some

of which failed and some of which survived. Of the 127 banks that might have been closed

earlier, 101 (approximately 80 percent) had received enforcement actions to control or limit

risk-taking behaviors before PCA closure would have been required.66 On average, these

enforcement actions were brought 419 days before the mandated PCA failure date and 570

days before actual failure (see table 12.20).

For problem banks that survived but might have been closed by PCA provisions, 33 of

the 58 banks (57 percent) received a formal enforcement action (see table 12.21). The average number of days that enforcement actions were brought before PCA failure was 550.

The data also show that 16 banks (28 percent) received no formal action, and another 9

banks received a formal action after the required PCA closure; these data suggest that something may have been lacking in the enforcement process.
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

462 History of the EightiesLessons for the Future

Table 12.20

Timing of FDIC Enforcement Actions against FDIC Problem Banks That Failed

and Would Have Been Closed Earlier under FDICIA Rules, 19801992

Enforcement Action Enforcement Action Between FDICIA

FDIC before FDICIA before Actual Failure Date and

Enforcement Number Failure Date Failure Date Actual Failure Date

Action of Banks (Average Days) (Average Days) (Average Days)

Formal 101 419 570 151

No Formal 16 84

Formal 10 −48 187 235

(after FDICIA Failure Date)

Total 127

Note: Formal enforcement actions for safety-and-soundness purposes only.

Conclusion

Several lessons can be drawn from this analysis about the bank supervisory system.

First, hindsight shows that the public policy decisions to reduce examination resources in

the early 1980s were a failure. Few could have anticipated the severity of the regional recessions or their attendant problems, but reducing examination staffs was a high-risk policy.

Second, to identify risk early and ensure the integrity of bank financial reporting, frequent onsite examinations are necessary. Third, early detection of problem institutions increases the

likelihood that supervisory monitoring and enforcement actions will be effective in stemming

losses to the insurance fund. Fourth, the examination system needs to capture more risks systematically, including those posed by changes in local and regional economic conditions.

Table 12.21

Timing of FDIC Enforcement Actions against FDIC Problem Banks That

Survived but Might Have Been Closed under FDICIA Rules, 19801992

FDIC Enforcement Action

Enforcement Number FDICIA Failure Date

Action of Banks (Average Days)

Formal 33 550

No Formal 16

Formal 9 −244

(after FDICIA Failure Date)

Total 58

Note: Formal enforcement actions for safety-and-soundness purposes only.
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 463

67 In the past, examinations were conducted on a surprise basisespecially for smaller-sized and problem banks. Institutions

are now notified of pending examinations and allowed time to assemble requested information. 

Appendix

The Examination Process 

Supervisory responsibilities for the nations insured commercial banks are divided

among the 3 federal banking agencies and the 50 state supervisory authorities. Of the federal banking agencies, the Office of the Comptroller of the Currency is responsible for supervising national banks; the Federal Reserve System is responsible for supervising both

state member banks and holding companies; and the FDIC is responsible for supervising

state nonmember banks and FDIC-insured savings banks. The FDIC also has back-up supervisory responsibility for monitoring the condition of national banks and state member

banks, and in fulfilling these responsibilities it works with the other two federal regulatory

agencies. Under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989

(FIRREA), it also has back-up authority to examine thrift institutions as well. State banking

departments supervise state-chartered banks.

Within the context of maintaining public confidence in the integrity of the banking

system and protecting the insurance fund, bank examiners evaluate all aspects of a banks

operations. In particular, examiners analyze the overall financial condition of an institution; appraise the quality of its management, including its board of directors; determine its

overall compliance with applicable laws and regulations; review the adequacy of its internal controls and procedures; identify areas where corrective action may be necessary; and

establish a factual record to support recommendations for corrective actions. The examination consists of three major stages: off-site analysis and review, on-site examination, and

preparation of a report that documents the results of the examination. When the examiners

identify significant problems, there is a fourth stage: the use of informal or formal administrative corrective actions.

Chapter 13 discusses off-site analysis and review. The other three stages of the examination process are surveyed here. Also discussed here are cooperation between state and

federal agencies in the examination process, and coordination among the federal agencies.

On-Site Examinations

An examination starts when the field office supervisor schedules an examination for a

specific date and assigns an examiner-in-charge to supervise the job.67 This examiner has

full responsibility for supervision of the entire examination process. The examiner-incharge is assisted by a junior commissioned examiner or assistant examiner, who oversees
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

464 History of the EightiesLessons for the Future

68 Chain banking relationships refers to banks that are controlled by the same ownership group but are not associated with

a bank holding company.

the financial analysis and operational portions of the review. The size and composition of

the examination team depend on the scope of the examination and the size and complexity

of the bank. The team is normally composed of assistant and commissioned examiners from

a wide range of grade levels and with varied examination experience.

In anticipation, the examiner-in-charge reviews past examination reports, information

on bank holding companies and chain banking relationships,68 various off-site reviews,

bank correspondence, and any other available information. Although pre-exam review and

planning always existed during the 1980s, the process was not formalized. Recently, however, the federal agencies developed more formalized procedures, and current procedures

require written pre-examination plans. To gather pre-exam information, regulators submit

requests for various bank records and often use informal questionnaires before physically

entering the bank. The FDIC also requires management to complete a formal questionnaire. 

Generally the examination focuses on two broad areas: (1) the review of asset quality,

and especially the loan portfolio, which generally constitutes the largest share of the banks

total assets; and (2) the financial analysis of the banks condition, as well as a review of all

other aspects of the banks operation. The more experienced examiners generally focus on

the loan portfolio, while the assistant and less-experienced examiners work on the financial

analyses and the remaining operations work not associated with the loan portfolio. 

The examiners conducting the loan-portfolio review first determine a loan cutoff, 

or the percentage of the loan portfolio that will be reviewed. The percentage of loans

reviewed depends on a number of factors, including the banks last composite CAMEL

rating, trends in loan quality, and local economic conditions. Examiners normally analyze

not only the loans identified by the cutoff but also the previously classified credits, nonperforming loans, loans included on the banks internal watch list, and insider loans. (When

the OCC determines which loans will be reviewed by its examiners, it generally relies on

statistical and judgmental sampling techniques. The FDIC uses sampling procedures in

larger banks and in institutions with strong internal monitoring and quality review programs.) The examiner-in-charge has the option of expanding the volume of loans reviewed

at any time, particularly in banks with deteriorating asset quality. In institutions with severe

or deteriorating asset problems, examiners often review 70 percent or more of a banks loan

portfolio. 

During the loan review, examiners make a judgment as to which credits are of poor

quality or have deteriorated in quality and/or have more than the normal risk of repayment.

These credits are flagged for further discussion with the loan officers and management. In
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 465

69 FDIC, DOS Manual of Examination Policies, pp. 1.1-1 to 1.1-4; and Policy Statement on Uniform Financial Institutions

Rating System (UFIRS), Federal Register 62 (January 6, 1997), 752. Use of UFIRS began in 1979.

addition to the loan quality analyses, examiners review the loan portfolio for concentrations

of credit, violations of legal lending limits, technical exceptions to the credit files, and loans

made in contravention of the banks internal loan and underwriting policies. Loans are then

discussed with the loan officers and management and are classified on the basis of their

overall quality and the examiners perception of the risk of loss to the bank. The examiner

will either pass a credit or assign it to one of the following categories: (1) special mention, (2) substandard, (3) doubtful, or (4) loss. Management is provided with a list of the adversely classified loans, of loans that are held in apparent violation of banking laws and

regulations, and of concentrations of credit. In addition, management is provided with a list

of those credits that have documentation exceptions (if the volume is significant).

The more-junior examiners, charged with completing the financial analysis and operational aspects of the examination, conduct nearly all the remaining aspects of the on-site

review: they examine the other asset and liability accounts, capital and reserve adequacy,

liquidity and interest-rate sensitivity, insider activities, subsidiary and affiliate information,

litigation, contingent liabilities, and any off-balance-sheet activities.

The overall examination procedures are directed primarily toward the five performance categories used in the Uniform Financial Institutions Rating System (UFIRS),

namely, Capital Adequacy, Asset Quality, Management, Earnings, and Liquidity

(CAMEL).69 The examiners must address each of these areas and must include an assessment of each in the final report of examination (see box 1, below).

Once the on-site review is complete, the examiner-in-charge conducts an exit meeting

at which the examination findings are fully discussed with the active officers of the bank.

Managements and the banks strengths are recognized, but the primary focus of the comments and recommendations is on those areas needing managements special attention.

Emphasis is placed on providing management with a complete summary of the examination

findings and obtaining a commitment from management to correct any deficiencies.

Management is given an opportunity to discuss these findings and to agree or disagree with

the results of the review.

The final step of the on-site examination is a meeting to which all members of the

board are invited. The board meeting could be scheduled either during the on-site review or

within a reasonable period of time after the examiners leave the bank. (The FDIC does not

always require a board meeting but schedules one whenever a bank is, or probably will be,

given a composite rating of 3, 4, or 5. In contrast, the OCC is required to conduct a final

meeting with the board during or following the on-site review.) The results of the review are
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

466 History of the EightiesLessons for the Future

discussed with individual board members, who are given the opportunity to express their

views and opinions. In these meetings the emphasis is on getting a commitment from the

board members, individually and as a group, to take strengthening or corrective actions

where necessary. Management weaknesses and strengths are also discussed. If the results of

the review are such that the condition of the bank has deteriorated enough to become a

problem, the likelihood of informal and/or formal corrective action is also discussed. In

cases in which the bank is, or is likely to be, rated a composite 4 or 5, the regional or district office would send a representative to the meeting with the board. 

The examiner is required to disclose the banks composite rating to the banks board

of directors. (For the definition of each of the five CAMEL composite ratings, see box 2,

below.) Historically the five component CAMEL ratings were used internally by the regulators and were not disclosed to management or the banks board. Since January 1997, however, under revised examination procedures worked out by all federal bank regulatory

agencies, component CAMEL ratings have been released to officials of the bank. The ratings are confidential and are available only to bank officials and the regulators.

Preparation of the Examination Report

A written report is prepared in conjunction with every on-site examination and is subsequently sent to the banks board of directors for review. The report makes a factual presentation of the institutions overall condition and is organized in accordance with the components

of the CAMEL rating system: capital adequacy, asset quality, management, earnings, and liquidity. It also summarizes the scope of the examination; references the meetings held with

management and the board, including the topics discussed and any of managements actions,

commitments, and responses; and makes recommendations for improving the areas containing deficiencies and other weaknesses. The report should enable bank directors to identify areas in which they are not fulfilling their duties and should encourage them to discharge

properly their responsibilities for operating the bank in a safe and sound manner.

Before the final report is forwarded to the bank, the report plus recommendations for

any informal or formal enforcement action are transmitted to the FDIC regional office for

review. (The OCC has delegated much of its review process to the field level, with the district office involved in reviewing only 3-, 4-, or 5-rated banks or banks subject to various

enforcement actions.) The examiner-in-charge works closely with various staff members of

the regional or district office, especially when examining a deteriorating or problem bank,

keeping the staff members informed of any unusual activities or findings. A transmittal letter and the report of examination are then forwarded to the banks board for final action.

Any additional supervision and follow-up are generally handled by the various regulatory

regional or district office staffs. 
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 467

70 FDIC, Annual Report (1974), 10. 71 Ibid. (1977), 3. 72 Ibid. (1980), 5; and an address by FDIC Chairman L. William Seidman to the Conference of State Bank Supervisors,

Washington, D.C., December 9, 1985. 73 FDIC, Annual Report (1980), 5.

Use of Formal and Informal Enforcement Actions

A number of formal and informal administrative corrective actions are available to the

federal bank regulatory agencies. The primary corrective tools of all the regulatory agencies

are the use of reason and moral persuasion during the on-site examination, management

meetings, and final board review; the commentary and recommendations in the report of

examination; and communications from the regional and Washington offices. Informal corrective procedures consist of the use of memorandums of understanding (MOU) and the

banks adoption of a board resolution. Under Section 8 of the FDI Act as amended in 1966,

the FDIC Board of Directors was given broad formal enforcement powers (cease-and-desist and removal authority), and FDICIA mandated the use of Prompt Corrective Action.

Finally, the federal regulatory agencies have the authority to impose civil money penalties

in certain cases. Although the three regulatory agencies may vary in this respect, formal or

informal administrative actions are generally taken on banks whose composite uniform ratings are 3, 4, or 5, unless specific circumstances warrant otherwise. (For a description of the

types of enforcement actions, see box 3, below.)

Federal-State Cooperation

In the early 1970s, all state-chartered banks were examined annually by both state and

federal agencies. In 1974, the FDIC started an experimental program in three states to determine the feasibility of using state examinations in alternate years for nonproblem

banks.70 Three years later, it made its first agreement with a statewith Georgia.71 By 1980

it had examination agreements with 14 states, and during the decade the number grew.

72

To qualify for the program, a state is required to have sufficient examination resources

and capabilities to complete the task satisfactorily. Problem banks (4- and 5- rated) and

banks of supervisory concern (3-rated) are not included in the program. The FDIC and state

authorities coordinate their examination schedules to take advantage of their combined resources and to minimize duplication and burden on the institutions. In addition to alternating examinations, the FDIC allows state authorities access to computerized databases that

provide Call Report information.73 The FDIC also works closely with state authorities in issuing enforcement actions and in developing common application forms, to minimize duplicative filings.
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

468 History of the EightiesLessons for the Future

74 Ibid. (1981), 183. 75 Ibid. (1977), 78. 76 Ibid. (1978), 910. 77 Ibid., 9. 78 Before passage of FIRREA, the Federal Home Loan Bank Board was represented on the FFIEC.

In 1981, the Federal Reserve also adopted a policy of alternating federal and state examinations for certain of the banks it supervised.74

In addition to alternating examination cycles, state and federal agencies conduct concurrent and joint examinations, to reduce the supervisory burden on state banks. Joint examinations result in one examination report used by both agencies, while a concurrent

examination usually yields two separate reports.

Federal Agency Coordination

The federal banking agencies began to coordinate their operations and policies in the

mid-1970s. In 1976, they began their shared national credit program for all loans $20 million or more that are owned by two or more banks.75 The review and classification of these

credits are conducted independently of the regular bank examination by an interagency

team of examiners, who review the loans for credit quality. The classification of these credits is then used in the examination of each institution that participated in the loans. 

In 1977 the Interagency Supervisory Committee, which included representatives from

the five federal banking, thrift, and credit union agencies, was established to coordinate supervisory policies and procedures.76 A significant accomplishment of the committee was

adoption of the uniform interagency system for rating the condition of banksthe immediate predecessor of the CAMEL rating system. The uniform rating system provided a basis

on which the examination findings of all federally insured banks could be compared, so that

for the first time meaningful reports on the condition of the nations banking system could

be given to the public and to Congress. 

In 1979, after passage of the Financial Institutions Regulatory and Interest Rate

Control Act of 1978 (FIRIRCA), the Interagency Supervisory Committee was replaced by

the Federal Financial Institutions Examination Council (FFIEC).77 The councils membership consists of the OCC, the Federal Reserve Board, the FDIC, the Office of Thrift

Supervision, and the National Credit Union Administration.78 The council has established

task forces to work on coordination of supervisory activities, uniformity of consumer protection laws and regulations, use of common data-gathering systems, and use of common

educational programs. Some of its early accomplishments were standardizing instructions

and forms for banks quarterly reports of condition and income, bringing uniformity to bank

performance reports, instituting interagency examiner training, and preparing a number of

uniform supervisory policy statements.
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 469

Box 1

The CAMEL Evaluation Components

An institutions Capital Adequacy is evaluated in relation to the volume of risk

assets; the volume of marginal and inferior quality assets; the banks growth experience, plan and prospects; and the strength of management. Consideration is also given

to an institutions capital ratios relative to its peer group, its earnings retention, its dividend policies and its access to capital markets or other appropriate sources of financial assistance. Capital adequacy for the FDIC, the OCC and the Federal Reserve is

guided by regulation.

Asset Quality is evaluated by the level, distribution and severity of adversely

classified assets; the level and distribution of non-accrual and reduced-rate assets; the

adequacy of the allowance for loan losses; and managements demonstrated ability to

administer and collect problem credits. In addition, examiners evaluate the volume of

concentrations of credit, trends in asset quality, volume of out-of-territory loans, level

and severity of other real estate held and the banks underwriting standards.

Management is evaluated against virtually all factors considered necessary to

operate the bank within accepted banking practices and in a safe and sound manner.

Thus, management is evaluated in relation to technical competence; leadership and

administrative ability; compliance with banking regulations and statutes; adequacy

of, and compliance with, internal policies and controls; and whether the board has a

plan covering management succession. The assessment of management also takes

into account the quality of internal controls, operating procedures and all lending, investment, and other operating policies. Finally, examiners review and assess the composition, experience level, abilities and involvement of the officers, directors and

shareholders. 

Earnings are evaluated with respect to their ability to cover losses and provide

adequate capital protection; trends; peer group comparisons; the quality and composition of net income; and the degree of reliance on interest-sensitive funds.

Consideration is also given to the banks dividend payout ratio, the rate of growth of

retained earnings and the adequacy of bank capital. The adequacy of provisions to the

allowance for loan losses, and the extent to which extraordinary items, securities

transactions and tax effects contribute to net income, are also assessed.

Note: Information in Box 1 and Box 2 is quoted from the FDICs DOS Manual of Examination Policies.
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

470 History of the EightiesLessons for the Future

Box 1continued

Liquidity is evaluated in relation to the volatility of deposits; the frequency and

level of borrowings, use of brokered deposits, technical competence relative to the

structure of liabilities, availability of assets readily convertible into cash; and access

to money markets or other ready sources of funds. The overall effectiveness of assetliability management is considered, as well as the adequacy of, and compliance with,

established liquidity policies. The nature, volume and anticipated use of credit commitments are also factors that are weighed.
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 471

Box 2

Definitions of Composite CAMEL Ratings

Composite 1  Institutions in this group are basically sound in every respect;

any adverse findings or comments are of a minor nature and can be handled in a routine manner. Such institutions are resistant to external economic and financial disturbances and more capable of withstanding the vagaries of business conditions than

institutions with lower ratings. As a result, such institutions give no cause for supervisory concern.

Composite 2  Institutions in this group are fundamentally sound, but may

reflect modest weaknesses correctable in the normal course of business. The nature

and severity of deficiencies, however, are not considered material and, therefore, such

institutions are stable and able to withstand business fluctuations quite well. While areas of weakness could develop into conditions of greater concern, the supervisory response is limited to the extent that minor adjustments are resolved in the normal

course of business and operations continue to be satisfactory.

Composite 3  Institutions in this category exhibit financial, operational or

compliance weaknesses ranging from moderately severe to unsatisfactory. When

weaknesses relate to financial condition, such institutions may be vulnerable to the

onset of adverse business conditions and could easily deteriorate if concerted action

is not effective in correcting the areas of weakness. Institutions that are in significant

non-compliance with laws and regulations may also be accorded this rating.

Generally, these institutions give cause for supervisory concern and require more than

normal supervision to address deficiencies. Overall strength and financial capacity,

however, are still such as to make failure only a remote possibility.

Composite 4  Institutions in this group have an immoderate volume of serious financial weaknesses or a combination of other conditions that are unsatisfactory.

Major and serious problems or unsafe and unsound conditions may exist that are not

being satisfactorily addressed or resolved. Unless effective action is taken to correct

these conditions, they could reasonably develop into a situation that could impair future viability, constitute a threat to the interest of depositors and/or pose a potential for

disbursement of funds by the insuring agency. A higher potential for failure is present,

but is not yet imminent or pronounced. Institutions in this category require close supervisory attention and financial surveillance and a definite plan for corrective action.

Composite 5  This category is reserved for institutions with an extremely

high immediate or near term probability of failure. The volume and severity of weak-
An Examination of the Banking Crises of the 1980s and Early 1990s Volume I

472 History of the EightiesLessons for the Future

Box 2continued

nesses or unsafe and unsound conditions are so critical as to require urgent aid from

stockholders or other public or private sources of financial assistance. In the absence

of urgent and decisive corrective measures, these situations will likely result in failure

and involve the disbursement of insurance funds to insured depositors, or some form

of emergency assistance, merger or acquisition.
Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 473

Box 3

FDIC Informal and Formal Actions to Correct

Unsafe and Unsound Practices

Informal Corrective Actions

Memorandum of UnderstandingA memorandum of understanding is the

means of seeking informal corrective action from institutions that are considered to be

of supervisory concern but have not deteriorated to the point where they warrant formal administrative action. As a general rule this informal action is to be considered for

all institutions rated a composite 3. A memorandum of understanding is generally

drafted at the regional level and is based on the recommendations of the examiner and

the report of examination. This document is signed by the institutions board of directors and a representative of the FDIC, with the state authority invited to join the action. Use of a memorandum of understanding is generally appropriate when the

regional office believes that the problems discussed with management and the board

of directors of the institution have been adequately detailed and that the institution

will move in good faith to eliminate the problems.

Board ResolutionA board resolution is generally used in lieu of, and contains

basically the same items as those covered in, a memorandum of understanding. An institutions board of directors, after reviewing and concurring with the problems discussed by the examiner and outlined in the report of examination, adopts a resolution

indicating the directors intent to take corrective action and eliminate the problems.

The board resolution is a formal commitment adopted by the banks board members

but is not signed by the FDIC. A board resolution is generally used when the bank is

rated a composite 3 and management and the board have demonstrated an ability and

willingness to initiate corrective action to eliminate the problems.

Formal Enforcement Actions

Section 8 of the Federal Deposit Insurance ActSection 8 provides the FDICs

Board of Directors with a broad range of formal administrative enforcement powers.

The FDIC Board of Directors has delegated certain Section 8 actions to the various

levels within the Division of Supervision and has retained certain authority at the

Board level. Banks with composite ratings of 4 or 5 will, by definition, have problems

of sufficient severity to warrant formal action. Division of Supervision policy requires

the FDIC to take formal action pursuant to Section 8 of the FDI Act against all insured

state nonmember banks rated 4 or 5 when evidence of unsafe or unsound practices is 
Box 3continued

present. This enforcement action normally consists of either a cease-and-desist order

under either Section 8(b) or Section 8(c) or initiation of termination of insurance proceedings under Section 8(a). Section 8(e) gives the FDIC the power to order the removal of an institution-affiliated party (director, officer, employee, controlling

stockholder, independent contractor, etc.) from office. This section also allows the

FDIC to prohibit the party from participating in the conduct of the affairs of any insured depository institution.

Other Actions

Written Agreements/Capital DirectivesThe use of a written agreement should

normally be used for a bank whose problems are limited to a capital deficiency that has

not been caused by the unsafe and unsound practices of its management. A written

agreement is intended to be used only when a Section 8(a) or Section 8(b) action or a

capital directive against a bank is not justified or practical. This document must be between a bank and its primary federal regulator, with the FDIC a party to the agreement.

A capital directive is an order to a state nonmember bank that fails to maintain capital

at or above its minimum capital requirements, and is to be used solely to correct a capital deficiency.

Prompt Corrective ActionThe Federal Deposit Insurance Corporation

Improvement Act of 1991 (FDICIA) requires each appropriate federal banking

agency to take prompt corrective action to resolve the problems of insured depository

institutions at the least possible long-term loss to the deposit insurance fund. Prompt

Corrective Action is a framework of supervisory actions for insured depository institutions that are not adequately capitalized. Other supervisory actions associated with

prompt corrective action are discretionary and may be imposed on an institution by

the FDIC.

Civil Money PenaltiesAlthough this specific proceeding is not a formal enforcement action, the FDIC and the other federal regulatory agencies have the authority and power to assess civil money penalties in certain situations. The Financial

Institutions Regulatory and Interest Rate Control Act of 1978 (FIRIRCA) gave the

FDIC authority to prospectively assess civil money penalties against both banks and

individuals. The Financial Institutions Reform, Recovery, and Enforcement Act of

1989 (FIRREA) significantly increased their applicability and the dollar amount of

the penalties that could be assessed. Civil money penalties may be assessed for the violation of any law or regulation, any final order or temporary order issued, any conAn Examination of the Banking Crises of the 1980s and Early 1990s Volume I

474 History of the EightiesLessons for the Future
dition imposed in writing by the appropriate federal banking agency in connection

with the approval of any application, and any written agreement between a depository

institution and federal banking agency. An interagency statement of policy regarding

the assessment of civil money penalties was adopted by the FDIC in 1980. This policy statement describes 13 factors an agency should consider in determining whether

to pursue civil money penalties.

Chapter 12 Bank Examination and Enforcement

History of the EightiesLessons for the Future 475