as of december. perhaps most significant, over the past three years the vast majority of new bank charters - once again, about three - fourths of them - have been granted by states. we have a long history of working with the states to coordinate our supervisory programs and achieve quality results. we rely on state supervisors as equal partners to ensure consistent, effective, and high - quality supervision. together with the federal deposit insurance corporation, we believe we have a strong relationship with the states, bolstered by our common effort to develop the supervisory protocols of the last decade and, more recently, by our work with the states and the fdic to foster consistent examination processes and procedures. i believe the flexibility and dynamism of our banking system contributes to the financial soundness and performance of u. s. banks. the banking industry continues to be strong and profitable despite a tepid economy and corporate governance issues. after a record year in 2002, insured commercial banks in the united states earned $ 24. 6 billion in the first quarter of 2003 - a quarterly record. robust growth in core deposits and vibrant activity in mortgage lending have been the key forces behind recent strong earnings, which have been offset in part by weak loan demand from businesses. aggregate nonaccrual loans and foreclosed assets remain at about 1. 2 percent of loans while credit costs have declined, as first - quarter net charge - offs dropped to 0. 91 percent of average loans - the lowest level since june 2001. although all the facts are not yet in, it appears that this credit cycle hasn't tested us nearly as significantly as we have been tested in the past. community banks have also remained strongly profitable through this period, although over the past two years they experienced far less of a run - up in problem assets and charge - offs than their larger counterparts. the number of problem banks remains at about 120, but actual failures remain quite low, only ten in all of last year. corporate governance based on the current condition of the industry, you might ask what's on the supervisory agenda and where should we focus our attention? although there are a number of supervisory issues that require our attention, there are two specific areas - corporate governance and quality assurance in the audit process - where i believe we should focus some of our supervisory attention. over the past two years, corporate scandals have focused our attention on the deficiencies in corporate governance at major companies. the reforms of the sarbanes - oxley act of 2002

the business grows and new products are added, that is precisely the time when management needs to ensure that adequate controls are in place to mitigate risks. we are talking to the other banking agencies about these concerns and are considering the need for more detailed guidance for management that will strengthen banks'internal control practices. internal audit recent corporate governance events clearly demonstrate the importance of the internal audit function. while sarbanes - oxley does not focus on the role of the internal auditor, bank supervisors have long recognized the importance of an effective internal audit function to the control environment. with respect to the quality of internal audit, the audit committee must pave the way for quality assurance. as we indicated in a recently amended interagency policy statement on the internal audit function, the committee should provide for the utmost independence, objectivity, and professionalism of the internal audit process. the audit committee sets the tone, and our role as supervisors is to reinforce it. the goal for internal audit should be to have no internal control surprises. to support this goal, internal audit should have an effective quality assurance process. risk - focused audit programs should be reviewed regularly to ensure audit resources are focused on the higher - risk areas as the company grows and produces and processes change. as lower - risk areas come up for review, auditors should do enough transaction testing to be confident in their risk rating. audit committees should receive reports on all breaks in internal controls to determine where the auditing process can be strengthened. before a company moves into new or higher - risk areas, the board of directors and management should receive assurances from internal audit that the tools are in place to ensure that the basics of sound governance will be adhered to. the audit committee should actively engage the internal auditor to ensure that the bank's risk assessment and control process over financial reporting are vigorous. many of the organizations that have seen their reputations tarnished in the past two years have simply neglected to consider emerging conflicts of interest when adding new products and lines of business. it is important to make sure that appropriate firewalls are in place before the product or activity begins. as supervisors, we can focus attention on this area and watch for signs of any internal audit deficiencies at our institutions. the audit committee should also require the highest possible level of independence for the internal audit process and eliminate any threats to this independence, such as the tendency for some internal auditors to act as management consultants within the organization. many of the proposed revisions to the institute